financial pacific - what if a grey or black skies lie ahead (third party)

UBS Investment Research

US Equity Strategy

“What if” Grey or Black Skies Lie Ahead?

We answer the question of “What if” we have a recession In this report, we detail the stock-by-stock projections for earnings and valuations under both Grey Skies and Black Skies recession scenarios. In summary, the GreySkies scenario reduces earnings by roughly 13% versus our base case and theBlack Skies scenario reduces earnings by roughly 27% versus our base case.

We estimate that a 40% chance of a recession is currently discounted Equity markets have sold off sharply, volatility has spiked, and Treasury yieldshave collapsed to levels not seen since the depths of the financial crisis. Whetherattributable to the S&P downgrade, European sovereign debt issues or deceleratingmacroeconomic indicators, we believe markets are now pricing in an increasedprobability of recession. Using the target prices from our base case and valuationsfrom our two scenarios defined below, we believe the market is pricing in a roughly 40% chance of a recession, allocated between a 30% chance of a GreySkies recession and a 10% chance of a Black Skies recession.

Nevertheless, we continue to believe a recession is unlikely Our “base case” scenario assumes US real GDP grows 1.8% in 2011 and 2.3% in2012. In addition to recent constructive signs in the employment market, additionalrationale for our “no recession” base case include (1) satisfactory credit flows; (2)lower oil price circuit breakers ‘kicking in’; (3) home prices tentatively stabilizingas rents rise; (4) recent improvements in job quality, (5) the investing public’sownership of rallying bonds (as well as retreating stocks); and (6) the back-end loaded nature of the Budget Control Act of 2011.

Global Equity Research

Americas

Equity Strategy

Investment Strategy

16 August 2011

www.ubs.com/investmentresearch

Jonathan Golub, CFA

[email protected]

+1-212-713 8673

Chip Miller, CFAStrategist

[email protected]+1-203-719 3720

Manish Bangard, CFAStrategist


Daniel MurphyStrategist


Vishal PatelAssociate Strategist


Thomas M. Doerflinger, Ph.D.Strategist


Natalie Garner, CFAStrategist


Maury N. HarrisEconomist


David A. BleusteinDirector of US Equities Research


Ana RecinosAnalyst


This report has been prepared by UBS Securities LLC ANALYST CERTIFICATION AND REQUIRED DISCLOSURES BEGIN ON PAGE 166. UBS does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that the firm 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.

US Equity Strategy 16 August 2011

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16 August 2011

To our valued clients,

Based on our discussions with you, one of the critical issues in your investment process relates to the near-term economic outlook. The debate on the topic is complicated by a confluence of divergent factors, including regulatory and fiscal policy uncertainty, decelerating macroeconomic data points and the market decline itself on one side, but offset by numerous non-recessionary data points, the already depressed state of activity in key markets (auto/housing), solid corporate balance sheets and a few key leading indicators of economic recovery.

Although in this document we outline the rationale for our “base case” of no recession, the purpose of the document is to answer the question “What if” we have either a normal (Grey Skies) or severe (Black Skies) recession.

In this report, we have included our strategists’ analysis of S&P earnings and valuations in the scenarios defined by our economists. We have also included the backbone of that analysis, which is the company-by-company projection of earnings and valuations using the macroeconomic scenarios defined by our economists.

The project led to projections for companies with over $9 trillion of market capitalization in the US alone. Over the last 8 days, we believe over 1,000 hours have been invested in this analysis. We hope you find it helpful.

With our thanks and regards,

David Bleustein Head of U.S. Equities Research UBS Investment Research 1285 Avenue of the Americas New York, NY 10019 Phone: (212) 713-2615 E-mail: [email protected]


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Contents page

Executive Summary 5 — We continue to expect growth in 2012 ................................................................... 6 — Is a moderate recession already priced in?............................................................ 7 — Consensus Estimates Would Fall Significantly in Either Recession Scenario ....... 9

The Current Recession Debate 12 — Early Warnings ..................................................................................................... 12 — Signs Point to Weak Growth, Not Recession ....................................................... 13 — Tug-of-War ........................................................................................................... 16

Scenario Analysis — Base Case, Grey & Black Skies 17 Earnings Drivers 20

— Revenues Driven by Nominal GDP ...................................................................... 20 — Margins Driven by Capacity Utilization................................................................. 21

Valuations — The Long View 22 — Disco Regime: Inflation the Key Driver of Multiples ............................................. 22 — The Great Moderation: Interest Rates the Key Driver of Multiples....................... 22 — The Millennium Regime: Baa Yields the Key Driver of Multiples ......................... 23

Market Targets 24 — Analysts Underestimate Earnings Downside ....................................................... 24 — Prices and Multiples Move Before EPS Estimates............................................... 25 — Market Targets in Base Case, Grey & Black Skies .............................................. 26

Market Leadership 27 — Leadership Since February Slowdown................................................................. 28

Stock Selection: By Scenario 30 UBS Cyclical and Defensive Baskets 33

— Historical Results.................................................................................................. 33 — Background .......................................................................................................... 34 — Construction Methodology.................................................................................... 35

Appendix A: Additional Assumptions 36 — Global Economic Assumptions............................................................................. 36 — Commodity Price Assumptions............................................................................. 36 — Key End Market Demand Assumptions................................................................ 36

Appendix B: UBS Return Drivers 37 — Computation ......................................................................................................... 37

Appendix C: U.S. Style Indices 39 Communications 41

— Cable & Satellite / Telecom Services ................................................................... 42 — Internet & Interactive Entertainment..................................................................... 44 — Media & Entertainment ......................................................................................... 46

Consumer 49 — Apparel, Footwear & Luxury................................................................................. 50 — Beverages ............................................................................................................ 52 — Lodging, Cruise Lines and Leisure....................................................................... 54 — Hardline Retail ...................................................................................................... 58 — Household & Personal Care and Tobacco ........................................................... 62 — Packaged Food .................................................................................................... 64

Jonathan Golub, CFA

[email protected]

+1-212-713 8673

Chip Miller, CFAStrategist


Manish Bangard, CFAStrategist


Daniel MurphyStrategist


Vishal PatelAssociate Strategist


Thomas M. Doerflinger, Ph.D.Strategist


Natalie Garner, CFAStrategist


David A. BleusteinDirector of US Equities Research


Ana RecinosAnalyst



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— Restaurants .......................................................................................................... 66 — Toys...................................................................................................................... 68

Energy 71 — Electric Utilities & IPPs ......................................................................................... 72 — Independent Refiners ........................................................................................... 76 — Integrated & Regulated Natural Gas .................................................................... 78 — Integrated Oil / Oil & Gas E&P ............................................................................. 82 — Oil Services & Drilling........................................................................................... 86

Financials 89 — Brokers and Universal Banks ............................................................................... 90 — Consumer & Specialty Finance ............................................................................ 92 — Exchanges and E-Brokers.................................................................................... 94 — Homebuilders & Building Products....................................................................... 96 — Insurance (Life)..................................................................................................... 98 — Insurance (Non Life) ........................................................................................... 100 — REITs.................................................................................................................. 102

Healthcare 105 — Biotechnology..................................................................................................... 106 — Healthcare Distribution ....................................................................................... 108 — Healthcare IT ...................................................................................................... 110 — Healthcare Providers/Hospitals .......................................................................... 112 — Large Cap Pharma, Specialty Pharma & Generics ............................................ 114 — Life Sciences & Diagnostic Tools ....................................................................... 118 — Managed Care.................................................................................................... 120 — Medical Supplies & Devices ............................................................................... 122

Industrials 125 — Aerospace & Defense......................................................................................... 126 — Airfreight & Surface Transportation .................................................................... 128 — Airlines & OTAs .................................................................................................. 130 — Autos & Auto Parts ............................................................................................. 132 — Chemicals........................................................................................................... 134 — Coal and Metals & Mining................................................................................... 136 — Electrical Equipment & Multi-Industry................................................................. 138 — Engineering & Construction................................................................................ 140 — Machinery ........................................................................................................... 142 — Paper & Forest Products .................................................................................... 144 — Small/Mid Cap Industrials................................................................................... 146

Technology 149 — Business, Education and Professional Services ................................................ 150 — Computer Services & IT Consulting ................................................................... 152 — Data Networking & Wireline Equipment ............................................................. 154 — IT Hardware........................................................................................................ 156 — SemiCap Equipment / Alternative Energy .......................................................... 158 — Semiconductors.................................................................................................. 160 — Software ............................................................................................................. 162 — Technology Supply Chain & Wireless Equipment .............................................. 164


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Executive Summary Over the past few weeks, equity markets have sold off sharply, volatility has spiked, and Treasury yields have collapsed to levels not seen since the depths of the financial crisis. Regardless of the root causes of the current pullback (e.g., S&P downgrade, European sovereign debt issues, decelerating macroeconomic indicators, etc), we believe markets are now pricing in an increased probability of recession.

Exhibit 1: S&P 500

Jan-09 Jul-09 Jan-10 Jul-10 Feb-11 Aug-11

700

800

900

1000

1100

1200

1300

1400

Source: S&P, FactSet and UBS

Exhibit 2: 10-Year Treasury Yields

Jan-09 Jul-09 Jan-10 Jul-10 Feb-11 Aug-112.0

2.5

3.0

3.5

4.0

Source: Federal Reserve, FactSet and UBS

This report contains scenario analyses against three economic outcomes: our base case scenario, our standard recession “Grey Sky” scenario and our deep recession “Black Sky” scenario. For each scenario, our analysts have estimated earnings and valuations for the stocks under coverage. Our strategists then calculated both bottoms-up and top-down S&P earnings forecasts under each scenario.

What odds of a recession are already priced in?

As we support later in the document, we believe a recession is unlikely… and maintain the moderate growth “base case” scenario defined below. Nevertheless, given the recent market decline, we attempted to calculate what “odds” of a recession are already priced in. One complicating factor is the additional question of the severity of any potential recession.

With those caveats, using the target prices from our base case and valuations from our two scenarios defined below, we believe the market is pricing in a roughly 40% chance of a recession, split between a 30% chance of a Grey Skies recession and a 10% chance of a Black Skies recession. Obviously, the same market level could be discounting a smaller chance of the deeper recession or a larger chance of a smaller recession, but our Economics team formed a consensus around this analysis of what is being discounted by the market today.

The algebra to get there was to solve for the percentages that made 1,200 the discounted level today, or a 60% chance of an S&P 500 at 1,425 at year end (855), plus a 30% chance of an S&P 500 at 1,100 at year end (330), plus a 10% chance of an S&P 500 at 900 at year end (10), less the expected return between now and year end (75) = 1,200. Although this is not a UBS forecast or target

Markets are pricing in an increased probability of recession


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price, we use the 60/30/10 percentages throughout the document, notably in the stock selection section.

We continue to expect growth in 2012 One key historical driver of recessions — a severe credit shock — appears unlikely. That said, downside risks have clearly increased, as many of the economic indicators we watch have decelerated, albeit not to the point of indicating a contraction of economic activity.

Exhibit 3: Non-Farm Payrolls

90 92 94 96 98 00 02 04 06 08 10-800

-600

-400

-200

0

200

400

Source: Dept. of Labor, FactSet and UBS

Exhibit 4: ISM Manufacturing

90 92 94 96 98 00 02 04 06 08 10

35

40

45

50

55

60

Source: ISM, FactSet and UBS Note: Shaded areas mark recessions

In this report, we examine the likely behavior of U.S. equities, including the broad market, sectors, and individual stocks, under the following three economic scenarios:

Base Case Scenario. This scenario assumes modest, but positive growth over the remainder of 2011 and 2012. UBS's current estimates and forecasts are based on this set of assumptions. Independent of this recession debate, we believe we have entered a lower multiple environment, reflecting more modest secular growth in coming years. We use a 12.5x NTM forward P/E as our baseline, applied to consensus EPS, to construct our base case S&P 500 target. Our current S&P 500 price target is 1,425 (12.5 * $113.67), 21% upside from current levels, with S&P 500 EPS estimates of $99.35 in 2011 and $108 in 2012.

Grey Skies Scenario. This scenario assumes a GDP decline in-line with the post-war recession average of 2% beginning in 3Q11 and lasting four quarters. In such a scenario, we believe the S&P 500 would fall by roughly 7% through year-end to 1,100 and 15% to a trough of 1,000 in early 2012. We would expect S&P 500 earnings of $74 in 2012.

Black Skies Scenario. This scenario assumes a more severe recession in both depth and duration. Beginning in 3Q11 and lasting six quarters, GDP would decline 4.1%. In this case, we believe the S&P 500 would fall by 24% through year-end to 900 and 34% to a trough of 775 in late 2012. We would expect S&P 500 earnings of $60 in 2012.

The purpose of this scenario exercise is to evaluate "what if". To make this process most pertinent, we applied this to the economy in the current quarter.

In this report, we examine potential outcomes for the market, sectors, and stocks under three scenarios


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Fortunately, recent economic data appears non-recessionary. If a recession were to hit in the current quarter, it would be quite abrupt, causing a substantial disruption to corporate profits. As such, our Grey Skies and Black Skies EPS forecasts for 2011 of $87 and $85 reflect such a sharp back-half decline. By contrast, consensus estimates would be slower to adjust. Most importantly, we believe that this scenario analysis provides a constructive starting point upon which to evaluate recent market movements and the future path for risk assets.

Is a moderate recession already priced in? A wide variety of factors contribute to the onset of recessions, the most common of which are credit events, the bursting of bubbles and oil supply shocks. The following exhibit shows the pattern of GDP growth in the post-war period.

Exhibit 5: Real GDP

-5

-2

1

4

7

10

13

16

48 53 58 63 68 73 78 83 88 93 98 03 08

Real GDP growth, 4-quarter % chg

Source: BEA and UBS Note: Shaded areas mark recessions

There have been 11 recessions since the end of WWII. In our opinion, only two of these periods would be defined as Black Skies (1973-75 and 2007-09).

Moderate recessions: The nine more moderate recessions lasted 10 months on average and caused GDP to contract by 1.9% in real terms. The market tends to reach a high roughly eight months before the beginning of a moderate recession, with stocks falling 20%, on average, from peak-to-trough. The decline typically ends about halfway, or five months, into the downturn. Importantly, prices usually rebound sharply and make new highs within 12 months of the start of the recession.


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Exhibit 6: Average Market Price Change Around Moderate Recessions

0.80

0.85

0.90

0.95

1.00

1.05

1.10

1.15

-8 -6 -4 -2 0 2 4 6 8 10 12 14 16 18

MarketTrough

MarketPeak

RecessionBeginning

Source: NBER, S&P, FactSet, and UBS Notes: The horizontal axis represents the number of months from the recession beginning. Market price indexed to 1.0 at average market peak

Severe recessions: The two severe recessions lasted 17 months on average and caused GDP to contract by 4.2% in real terms. Not surprisingly, the market decline around severe recessions tends to be much greater in both depth and duration. Just as with shallower economic downturns, the market generally tops out several months before the recession begins. However, the peak-to-trough decline is about 50%. On average, stock prices do not find a bottom until about a year after the recession begins. Notably, even two years after the onset of a downturn, the market is still more than 25% below the pre-recession peak.

Exhibit 7: Average Market Price Change Around Severe Recessions

0.4

0.5

0.6

0.7

0.8

0.9

1.0

-9 -6 -3 0 3 6 9 12 15 18 21 24

MarketPeak

RecessionBeginning

MarketTrough

Source: NBER, S&P, FactSet, and UBS Notes: The horizontal axis represents the number of months from the recession beginning. Market price indexed to 1.0 at average market peak

During a moderate recession, the market typically hits new highs within 12 months of its onset

During a Black Skies recession, the market typically remains below peak levels 2 years following its onset


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On average, in the post-War period, stocks have declined by 19.8% in moderate recessions; 49.4% in severe downturns.

Exhibit 8: Stock Performance in Post WWII Recessions S&P 500

Max. GDP Peak toLength Decline Trough

Peak Trough (months) (%) (%)

Nov-48 Oct-49 11 -1.6 -15.4Jul-53 May-54 10 -2.6 -12.2

Aug-57 Apr-58 8 -3.7 -16.5Apr-60 Feb-61 10 -1.6 -11.8Dec-69 Nov-70 11 -0.6 -29.9Nov-73 Mar-75 16 -3.2 -46.2Jan-80 Jul-80 6 -2.2 -6.6Jul-81 Nov-82 16 -2.9 -23.8Jul-90 Mar-91 8 -1.4 -15.8

Mar-01 Nov-01 8 -0.3 -46.3Dec-07 Jun-09 18 -5.1 -52.6

Average All 11 -2.3 -25.2

Average Black Skies 17 -4.2 -49.4

Average All Other 10 -1.9 -19.8

BlackSkies

Source: NBER, S&P, FactSet, and UBS Note: Peak-to-trough market decline based on month-end index prices

Using the same scale, the stock market has pulled back roughly 13% from its peak at the end of April, which supports a view that some component of a moderate recession is already priced in, although we believe that some of the decline relates to discounting some chance of a more severe recession.

Consensus Estimates Would Fall Significantly in Either Recession Scenario Much like stocks, earnings generally fall dramatically in recessions, but also snap back quickly. On average, earnings fell by 20.1% in the past six recessions, which we believe is a fair estimate for a moderate recession scenario. EPS fell 48.8% in the most recent period (2008/09), 35.6% excluding asset write-downs. Importantly, analysts’ forecasts tend to remain much too rosy in recessions and lag once the economy begins to recover.

Revenues Driven by Nominal GDP. S&P 500 revenues are quite economically sensitive, moving roughly 2.9% for every 1% shift in nominal GDP. Of the traditionally cyclical sectors, Energy and Materials are the most sensitive to changes in the economy.

Margins Driven by Capacity Utilization. Operating leverage is a function of fixed costs, and is best explained by capacity utilization. On average, a 1% shift in revenues results in a 1.5% and 2.5% shift in operating and net income margins.

Revenues are roughly 3x more volatile than GDP


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Exhibit 9: Y/Y Nominal GDP Growth

50 55 60 65 70 75 80 85 90 95 00 05 10

-4

0

4

8

12

16

20

Source: BEA, FactSet and UBS Note: Shaded areas mark recessions

Exhibit 10: Capacity Utilization

70 75 80 85 90 95 00 05 10

65

70

75

80

85

90

Source: Federal Reserve, FactSet and UBS Note: Shaded areas mark recessions

Our Bottoms-Up Estimates are Significantly Above the Results of Prior Recessions

The backbone of our scenario analysis is the work of the single-stock analysts, who were asked to provide earnings estimates and valuations for 2012 under the Grey and Black Skies scenarios. The analysts were provided with a set of macroeconomic assumptions, the most significant of which was US and Global GDP. The following exhibit illustrates how real GDP in our base, Grey, and Black Skies scenarios compares to the recent trend as well as the 2008-09 Great Recession.

Exhibit 11: Real GDP with UBS Scenarios

-6

-4

-2

0

2

4

6

06 07 08 09 10 11 12

Baseline Grey skies Black skies

Real GDP growth, 4-quarter % chgEstimates

Source: BEA and UBS Note: Shaded areas mark recessions


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While not a surprise, the bottoms-up aggregation of UBS analyst forecasts under the two recessionary scenarios leads to a much rosier outlook than a top-down approach. More specifically, UBS analysts project a fall in earnings of 4% and 19% in 2012, versus the current base case estimates.

Exhibit 12: UBS Change in Net Income Under 3 Scenarios Total 2011-12 2011-12 2011-12Sector Base Case Grey Skies Black SkiesNet Income ($m) % Change % Change % ChangeEnergy -2% -23% -58%Materials 16% -38% -75%Industrials 18% -7% -27%Consumer Discretionary 15% 3% -13%Consumer Staples 8% 7% 3%Healthcare 4% 3% 1%Financials 25% 2% -19%Information Technology 9% -1% -10%Telecom Services 26% 5% 0%Utilities -2% -8% -12%Total 10% -4% -19%

Source: S&P, Haver and UBS

In Exhibit 12, we detail the sector by sector net income projections for the 485 stocks (with a combined market capitalization of over $9 trillion) for which the analysts provided scenario-based forecasts. In order to present the percentages in an easy-to-compare format, the percentage change columns contain the growth rates (or rates of decline) in 2012 vs. our current 2011 forecasts. As expected, the segments that are most vulnerable to a Black Skies scenario are Energy, Materials, Industrials and Financials. The sectors that are most resilient include Consumer Staples, Healthcare and Telecom Services.

Of note, UBS has created two baskets; one designed to capture the market’s upside should the economy strengthen, as in our base case, and the other to provide protection on the downside should conditions deteriorate: the UBS Cyclical (UBSECYC) and Defensive (UBSEDEF) Baskets.

UBS has created baskets designed for expansions and recessions


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The Current Recession Debate Given historical stock declines around recessions, it’s no wonder that markets have recently sold off sharply into rising fears of a double dip. While there are a number of cautionary indicators pointing to a recession, we believe the overall data is more consistent with modest growth.

Early Warnings In our May 6 report entitled Spring Break, we highlighted a number of potential warning signs including economic disappointments and defensive market leadership.

As illustrated below, the UBS U.S. Economic Surprise Index began to deteriorate in February. At the time, much of this weakness was attributed to a sharp rise in oil prices and industrial weakness resulting from the Japanese natural disasters. In other words, it was widely believed that the ‘soft patch’ would be transitory.

Exhibit 13: U.S. Economic Surprise Index

-4

-3

-2

-1

0

1

2

3

06 07 08 09 10 11

> 0 represents Positive Surprise

< 0 represents Negative Surprise

Source: Bloomberg and UBS Global Economics team

While the S&P 500 held up relatively well through May, the tone of the market began to change in February as defensive stocks began outperforming their more economically-sensitive peers. To that extent, the case could be made that investor sentiment began to turn well before the market peak.

Exhibit 14: S&P 500 vs. Cyclical Outperformance

660

835

1010

1185

1360

Mar-09 Aug-09 Jan-10 Jun-10 Nov-10 Apr-11

60

67

74

81

88

95

Cycl. vs. ►Non-Cycl.

◄ S&P 500

Feb 2011

Source: S&P, Haver, FactSet and UBS Note: Performance indexed to 100 as of Dec. 31, 2004

Economic data began to surprise to the downside in February

While stocks held up well through May, investors began to position defensively in conjunction with weakening economic data


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Signs Point to Weak Growth, Not Recession As discussed above, while the skies may be darkening over the capital markets, UBS Chief U.S. Economist Maury Harris places the probability of a recession at just 20%. As further outlined in the “Scenario Analysis” section, we do not believe that the preconditions of a downturn are currently in place.

A Severe Credit Disruption Appears Unlikely

While it is possible that concerns surrounding the European sovereign debt situation and/or S&P’s recent downgrade of U.S. debt could lead to a credit event, we believe this remains unlikely.

As illustrated by the TED spread (the difference between three month Treasuries and LIBOR), there are few signs to date of stress in the U.S. inter-bank markets. This is in contrast to the tremendous strain experienced during the financial crisis. Deterioration here could be swift, however, and is important to monitor.

Exhibit 15: TED Spread

00 02 04 06 08 100.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

4.0

4.5

Source: Federal Reserve, BBA, FactSet and UBS

Likewise, the corporate credit environment has not deteriorated, as it did during the prior recession. This is evidenced by Baa bond spreads, which appear well contained, although they have been rising.

Exhibit 16: Baa Bond Spreads

00 02 04 06 08 10

2

3

4

5

6

Source: Moody’s, Federal Reserve, FactSet and UBS

Funding markets show few signs of strain

Corporate spreads remain well contained


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Traditional Recession Signals Have Not Emerged

While it is conceivable that concerns over long-term global imbalances could reduce demand to a level that leads to a contraction, this scenario is inconsistent with history.

We are particularly focused on economic data in three key areas for signs of stability or further deterioration: (1) business activity; (2) employment; and (3) credit expansion. Recent readings in these areas are consistent with a subdued growth environment, but not recession.

Business Activity: Decelerating, but not Recessionary

As the exhibit below highlights, the most recent ISM manufacturing and services sector reports point to a continued modest expansion. According to UBS economists, these combined scores are consistent with an economy growing 1.8%.

Exhibit 17: ISM Manufacturing & Non-Manufacturing

98 00 02 04 06 08 10

35

40

45

50

55

60

50.9

53.7

>50 is Expansionary

<50 is Contractionary

◄ ISM Mfg

◄ ISM Non-Mfg

Source: ISM, FactSet and UBS

While economic data is extremely helpful in ascertaining the direction of the economy, we cannot overemphasize the importance of boots on the ground — analysts speaking to scores of line managers in every industry and region. At this time, the anecdotal evidence is consistent with slow growth and is best described as mixed:

Amitabh Passi, Technology Analyst — Companies across the technology supply chain saw decelerating growth exiting the June quarter, with many reporting book-to-bill ratios at or just below 1. While companies are incrementally more cautious based on the financial and economic gyrations it does not yet appear many are seeing any major impact to their businesses day to day and the business environment appears more akin to a general softening than a major drop-off.

Andy Cash, Chemicals Analyst — US-based chemical companies have experienced very, very strong gross profit improvement in the current cycle on volume and price. However, the pricing story has buoyed the gross profit more recently, and with volume slip-sliding away gross profit will very likely fall. The pricing story will collapse without the support of volume growth. Interestingly, the decline in volume has been across the globe.

Data is pointing to weak economic growth – NOT a recession

Recent ISM readings are consistent with GDP growth of 1.8%

We cannot overemphasize the importance of analyst insights at economic turning points


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Henry Kirn, Machinery Analyst — Our rental survey continues to indicate improving business conditions and rental rates, corroborated by recent conference calls held by URI and RRR on August 5th and 8th, respectively. Both companies noted rental rates, volumes and utilization levels improved sequentially in July.

Employment: No signs of Deterioration in Unemployment Claims

Economies don’t move in pretty sine waves and recessions don’t approach quietly. For this reason, it is important to focus on signposts that move rapidly around periods of economic change. Job conditions are such a signpost. Weekly jobless claims tend to rise and fall precipitously around recessions and recoveries. Importantly, it is the direction of change rather than the level of employment that is most critical in this analysis. To date, we have not seen signs of deterioration in this important area.

Exhibit 18: Weekly Unemployment Claims (4-Week Average)

70 75 80 85 90 95 00 05 10

200

300

400

500

600

700

4-week avg. 405k

Source: Department of Labor, FactSet and UBS

Loan Volumes: Pointing to Continued Growth

Similarly, commercial and industrial loan activity also tends to fall dramatically during recessions due to a combination of falling loan demand and tighter credit standards, as banks become fearful of accelerating loan losses. As Maury Harris points out with great regularity, this is a source of improvement in the economic picture.

Exhibit 19: C&I Loan Volumes

-30

-20

-10

0

10

20

30

40

73 77 81 85 89 93 97 01 05 09

Source: Federal Reserve, Haver and UBS Note: 3-month moving average

Jobless claims spike around recessions

C&I loan volumes fall dramatically during recessions


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Tug-of-War While economic data and analyst expectations are not signaling a recession, capital markets seem to have a differing opinion.

Typically, analysts’ projections are a function of incoming economic data as well as guidance from management. With few signs of actual deterioration in the economy and generally constructive, albeit cautious comments from company managements, analysts have continued to ratchet their 12-month forward earnings estimates higher.

Stock multiples, by contrast, typically act in anticipation of longer-term events/patterns. The exhibit below highlights this tug-of-war, with stock valuations rolling while analyst estimates remain rosy.

Exhibit 20: S&P 500 PE vs. NTM Bottom-Up Estimates

70

80

90

100

110

Sep-09 Jan-10 May-10 Sep-10 Jan-11 May-11

9.0

10.5

12.0

13.5

15.0

◄ Fwd EPS ▼Fwd P/E ►

$109

10.9x

Source: S&P, Thomson Financial, FactSet and UBS

Multiples have gotten crushed, while earnings estimates have remained steady


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Scenario Analysis — Base Case, Grey & Black Skies This exercise begins with a series of assumptions developed by our U.S. Economics Team, and are summarized below. Please note that additional assumptions including global GDP growth, key global indicators and end-market demand are provided in Appendix A of this note.

Exhibit 21: U.S. Economic Scenario Assumptions Percent change, except where noted Base Case Grey Black

Annual change Annual change Annual change2010A 2011E 2012E 2010A 2011E 2012E 2010A 2011E 2012E

Real GDP (Chain) 3.0 1.8 2.3 3.0 0.9 -1.0 3.0 0.8 -2.5

Personal consumption expenditures 2.0 2.3 2.1 2.0 1.5 -0.4 2.0 1.4 -1.2

Business fixed investment 4.4 7.1 7.9 4.4 4.4 -3.8 4.4 2.9 -12.5

Government purchases 0.7 -2.3 -0.4 0.7 -2.3 -1.7 0.7 -2.5 -3.5

Private final demand 1.5 2.7 2.8 1.5 2.1 0.1 1.5 2.0 -1.0

Real domestic purchases 3.4 1.7 2.5 3.4 0.6 -1.7 3.4 0.3 -3.9

Nominal GDP 4.2 3.8 4.1 4.2 2.9 0.4 4.2 2.6 -2.3

Key business indicators

FRB industrial production index 5.3 4.2 4.5 5.3 2.4 -2.3 5.3 1.9 -5.3

Capacity utilization rate (%, level) 74.5 77.5 80.9 74.5 76.2 74.3 74.5 75.8 71.7

Civilian unemployment rate (%, level) 9.6 8.9 8.6 9.6 9.3 10.5 9.6 9.5 11.7

Saving rate (%, level) 5.3 5.0 4.7 5.3 5.5 6.3 5.3 5.6 7.8

Global real output 4.3 3.4 3.8 4.3 2.9 1.9 4.3 2.4 0.0 Source: Department of Commerce, Federal Reserve Board, Bureau of Labor Statistics, Treasury Department, and UBS estimates

Base Case

Despite dramatic moves in the financial markets, we believe modest economic growth remains the most likely outcome. In our Base Case, economic growth is modest but positive. Real GDP grows 1.8% this year and 2.3% in 2012, weighed down in part by a decline in government spending.

As discussed earlier, the July payrolls report and other data points such as jobless claims and the ISM employment measure, point to continuing improvement in the labor market, albeit with slower momentum than in 1Q. Meanwhile, average hourly earnings growth accelerated from 2.3% y/y in July from 2.0% the prior month and consumers continue to spend despite weak consumer confidence gauges. Nominal retail sales rose 0.5% in July while May and June were revised up. Based on this retail sales data, we estimate real consumer spending beginning 3Q up at about a 1¾% annual rate, a decent acceleration from the flattish readings for 2Q.

Additional rationale for our “no recession” base case can be summarized as follows, (1) credit flows remain satisfactory; (2) lower oil price circuit breakers are ‘kicking in’; (3) home prices are tentatively stabilizing as rents rise; (4) job quality recently has been improving; (5) the investing public owns rallying bonds as well as retreating stocks; and (6) the Budget Control Act of 2011 is back-end loaded.


UBS 18

Grey Skies

Our Grey Skies recession assumes that the GDP decline matches the post-war recession average of 2%. The recession begins in 3Q11 and lasts for four quarters. The unemployment rate rises to a quarterly peak of 10.7% in 2Q12. There are several differences to the “normal” post-war recession. First, federal fiscal policy cannot fill in to the degree it has in past dips. On the other hand, already-depressed residential investment is also unlikely to plunge to the same degree. (Also, there are limited export impacts from the mainly homegrown disaster.) In short, the recession is a consumption-led downturn, with associated inventory correction and some weakness in capex.

We see two main reasons why this scenario may play out: (1) low momentum US recovery is more vulnerable to weakening European economy; and (2) fiscal austerity/policy uncertainties generate extreme caution.

Main Differences with Our Base Case

Relative to our baseline forecast, real GDP growth is a bit less than a point weaker in 2011 and a bit more than 3 points weaker in 2012. In 2011, weaker consumer spending accounts for almost all of the deterioration, with slower inventory accumulation also contributing. Employment effects limit income growth; and weaker confidence and negative wealth effects push the saving rate up. Business and residential investment also decline, but with smaller impacts on overall spending.

In 2012, the drag from a weaker household sector continues as does the inventory correction. Together they account for about 80% of the downgrade to total growth. The spillover into investment spending is also somewhat greater than in 2011.

Black Skies

The Black Skies recession repeats the severity of the most recent recession, with about a 4% cumulative decline in real GDP. In comparison to the Grey Skies scenario, the drop in GDP is sharper and lasts longer — with average quarterly declines of 2.75% at an annual rate, beginning in 3Q11 and continuing for six quarters. Consumption weakness spills to a greater degree into capex, residential spending, and inventory cuts, and there is also a bit more federal spending weakness. In the Black Skies simulation, the unemployment rate reaches 12.5% at the end of 2012.

Data points to watch for signs of deterioration towards either of these recession scenarios include jobless claims, bank lending, and our all-economy ISM index.

We see the following reasons why this scenario may play out: (1) Grey Skies recession reasons discussed above; (2) plus potential contagion effects from a European banking crisis on US credit conditions.


UBS 19

Main Differences with Our Base Case

Relative to our baseline forecast, real GDP is 1% lower in 2011 and almost 5% weaker in 2012. In 2011, consumption accounts for 60% of the downgrade and inventories another 30% — with investment spending making up a bit more of the cut to GDP than in the grey skies simulation. That relative weakness in investment is a function of greater credit market strains than in our baseline or Grey Skies scenarios.

The larger difference occurs in 2012. Consumption declines account for about half of the overall downgrade and inventories for another quarter. However, a plunge in business fixed investment figures more importantly (almost half of the overall downgrade to 2012). Government spending is also a more noticeable drag as budgets are strained. Residential investment, although plunging, is a small enough share of the economy that the overall GDP effects are not too great.


UBS 20

Earnings Drivers Corporate earnings tend to follow a similar pattern as the economy. The table below summarizes changes in S&P 500 EPS over the past 6 recessions. Earnings, on average, have declined by 20% during these instances, which we believe is a fair representation of what to expect under the Grey Skies scenario recession. For our Black Skies scenario, we assume a contraction of 35%, similar to that witnessed in the 2008-09 recession.

Exhibit 22: S&P 500 EPS in Past Recessions S&P 500 EPS

Year Peak Trough4-Qtr Peak

4-Qtr Trough

% change

1970 3Q69 4Q70 5.89 5.13 -12.9

1974-75 3Q74 3Q75 9.11 7.65 -16.0

1981-82 4Q81 1Q83 15.36 12.42 -19.1

1990-91 3Q90 4Q91 23.80 20.34 -14.5

2000-01 3Q00 1Q02 56.71 44.19 -22.1

2008-09 4Q07* 3Q09 93.41* 60.14* -35.6

Average 5.3 qtrs -20.1 Source: S&P, FactSet, First Call, UBS Note: 2008-09 EPS of $93.41 and $60.14 adds back $8.85 and $9.30, respectively, to account for extraordinary write-offs taken by the Financials sector

Revenues Driven by Nominal GDP As expected, U.S. GDP and S&P 500 revenue growth are highly correlated over time. However, S&P 500 revenue is significantly more volatile than the broader economy due to exposure to non-U.S. markets, a heavier weighting toward cyclical sectors, and other structural differences.

For every 1% increase in nominal U.S. GDP, S&P 500 revenues rise 2.8x, with a correlation of roughly 81%.

Exhibit 23: S&P 500 Revenues vs. Nominal GDP

-24%

-18%

-12%

-6%

0%

6%

12%

18%

00 01 02 03 04 05 06 07 08 09 10 11

-4%

-1%

2%

5%

8%◄ Revenues

GDP ►

YoY YoY

Source: BEA, Compustat, S&P, and UBS Note: Universe excludes Financials

Earnings have fallen by 20% on average during recessions

EPS declined by 35% during the 2008-09 recession

Revenues move roughly 3% for every 1% shift in nominal GDP


UBS 21

Based on this relationship, we can calculate sales growth under our three scenarios. More specifically, we can adjust our base case for a degradation in GDP growth. The following table provides projections based on these assumptions.

Exhibit 24: Revenue Growth Scenarios Base Case Grey Black

2011E 2012E 2011E 2012E 2011E 2012E

Real GDP (YoY) 1.8 2.3 0.9 -1.0 0.8 -2.5

Nominal GDP (YoY) 3.8 4.1 2.9 0.4 2.6 -2.3

S&P 500 Rev Growth 7.8 5.6 5.0 -5.4 4.2 -13.0 Source: UBS

Margins Driven by Capacity Utilization Generally speaking, changes in margins primarily result from fixed costs being spread over higher or lower volumes. Margins are particularly variable in more capital intensive industries with cyclical demand, such as Industrials, Autos, Semiconductors, Materials and Energy. These types of companies are much more prevalent in the S&P 500 than in the broader economy.

Historically, the best proxy for this has been capacity utilization. While revenues gyrate with GDP on a quarterly basis, margins and capacity utilization move in large sweeping cycles.

Exhibit 25: S&P 500 Operating Margins vs. Capacity Utilization

9%

11%

13%

15%

00 01 02 03 04 05 06 07 08 09 10 11

62

66

70

74

78

82

◄ S&P 500 (ex-Finl.) Operating Margins

Capacity Utilization ►

9.8%

14.6% 14.8%

74.5

Source: Federal Reserve Board, Compustat, S&P, and UBS Note: Note universe excludes Financials

Under our base case, we believe that margins can drift higher even though they are near peak levels. Our analysis shows that while margins are near prior highs, input costs should not be an impediment given low unit labor costs.

Exhibit 26: Operating Margin Scenarios Base Case Grey Black

2011E 2012E 2011E 2012E 2011E 2012E

Nominal GDP (YoY) 3.8 4.1 2.9 0.4 2.6 -2.3

Capacity Utilization 77.5 80.9 76.2 74.3 75.8 71.7

S&P 500 EBIT Margin 15.9 16.2 14.6 13.0 14.5 11.6 Source: UBS

2012 revenues would decline by roughly 13% in a Black Skies recession

Margins move as a function of capacity utilization


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Valuations — The Long View According to our work, stock multiples tend to become anchored on a single valuation variable for prolonged periods of time. To some, a single variable approach to stock valuation may seem a bit simplistic. However, as demonstrated below, there is an impressive fit between a single key valuation metric and stock multiples for prolonged periods of time that we call Investment Regimes.

Disco Regime: Inflation the Key Driver of Multiples In the 70’s, earnings yields moved in almost perfect lock-step with inflation expectations, largely ignoring other factors. More specifically, we found a tight correlation between CPI (lagged by 3 months) plus 2% and S&P 500 earnings yields.

Exhibit 27: CPI and S&P 500 Earnings Yield

70 72 74 76 78 804

6

8

10

12

14

16

Inflation

Earnings Yield

Source: Dept of Labor, Standard and Poor’s, First Call, FactSet and UBS Note: Inflation is represented as CPI + 2%, lagged three months.

The Great Moderation: Interest Rates the Key Driver of Multiples With inflation whipped and GDP relatively benign from 1980-1999, the ‘Fed Model’ ruled the day, with equity valuations marching in almost perfect lock-step with the nominal level of interest rates.

Exhibit 28: 10-Year Treasury Yield and S&P 500 Earnings Yield

82 84 86 88 90 92 94 96 984

6

8

10

12

14

16

◄ Earnings Yield

10-year Yield ▲

Source: Federal Reserve, S&P, FactSet and UBS

Stock multiples were anchored to inflation expectations in the 1970s

After Paul Volcker squashed inflation, nominal yields drove stock multiples


UBS 23

The Great Moderation resulted in tremendous economic prosperity in general and in asset values in particular. Ultimately, however, the combination of overly accommodative monetary policy, low inflation, and a stable economy, drove excessive risk taking by investors.

The Millennium Regime: Baa Yields the Key Driver of Multiples Following the implosion of the TMT bubble, the market began to use a full cost of capital, including credit spreads, as the primary discounting mechanism for future stock earnings.

Exhibit 29: Baa Bond Yield and S&P 500 Earnings Yield

5

6

7

8

9

10

04 05 06 07 08 09 10 11

Earnings Yield ►

▲ Baa Yield

P/E anchored to Bond Yields

Slower GrowthRecessionary

Fears

Source: Moody’s, S&P, First Call, FactSet, and UBS

The relationship between corporate bond yields and stock multiples began to break down in November 2009 — six months following the market's post-crisis lows.

Our work indicates that between November 2009 – June 2011, investors began to discount slower growth. More specifically, our model suggests that with a multiple of 12.4 at the end of June, the market was discounting one-third slower long-term growth.

The more recent fall in multiples, however, is most likely the result of investor disbelief in analyst forecasts given their recessionary concerns.

From Nov 09 to June 11, stock multiples implied weaker long term growth

More recently, multiples are signaling recession


UBS 24

Market Targets Below, we discuss our methodology for developing market price targets in our Base Case, Grey, and Black Skies scenarios. Our price targets are based upon (1) our estimate of forward consensus earnings at a certain point in time, multiplied by (2) a projected forward P/E multiple.

Importantly, our process takes into account both how sell-side analysts and buy-side investors normally behave around recessions.

Analysts Underestimate Earnings Downside The bars in the exhibit below compare each quarter’s actual S&P 500 operating earnings to bottom-up consensus earnings estimates one year prior. As illustrated, analysts tend to do a relatively good job of projecting company results in the middle innings of the economic cycle. However, they tend to significantly underestimate the magnitude of earnings declines that typically occur during recessions.

Exhibit 30: Percent Error in S&P 500 Next-Twelve-Months Consensus Expectations

-20%

0%

20%

40%

60%

80%

100%

01 02 03 04 05 06 07 08 09 10 11

> 0 is Overestimation

< 0 is Underestimation

Source: Thomson Financial, FactSet and UBS Note: Black bars indicate quarters during a recession

As such, our process for projecting consensus earnings estimates consists of two steps. First, we project actual earnings using our revenue and margin frameworks (see pages 20-21). Second, we assume that analysts will continue to underestimate the amount of earnings decline during a recession.

More specifically, we ‘gross up’ our actual earnings forecasts for the amount that we believe analysts will underestimate actual results. For both our Grey and Black Skies scenarios, we assume that analysts will miss actual earnings by an amount similar to the 2001 recession.

As illustrated below, even in the 2001 relatively moderate economic downturn, analysts’ forward estimates were considerably higher than reported actuals — at times differing by more than 30%.

Our price target is based on our P/E forecast applied to expected consensus estimates

Analysts remain too optimistic in recessions


UBS 25

Exhibit 31: S&P 500 Next-Twelve-Months Consensus EPS vs. Actuals

5861

63 6360

58 5754 53

56 5552

4845 44 45 46 48

30

40

50

60

70

4Q00 1Q01 2Q01 3Q01 4Q01 1Q02 2Q02 3Q02 4Q02

Consensus

Actual


We have chosen not to apply a level of underestimation that typically occurs in severe recessions, such as the recent 2008-09 recession caused by the financial crisis, as we do not expect a similar level of write-downs, even in our Black Skies analysis.

Prices and Multiples Move Before EPS Estimates In determining multiples to apply to projected consensus earnings, we consider the difference in reaction time between investors and analysts to turns in economic data.

While analyst estimates tend to lag behind underlying fundamentals around recessions, stock prices and multiples tend to trade with leading indicators. Put differently, investors tend to sell stocks at the first signs of a significant downturn, and load up when early signs of a bottom in economic activity emerge.

By way of example, this dynamic was easily seen coming out of the 2008-09 recession. As illustrated below, stocks began to rally in late-2008 on early signs of an economic recovery. While this trend was interrupted following Lehman’s bankruptcy, P/E’s continued to expand while consensus earnings estimates trended down until mid-2009.

Exhibit 32: S&P 500 P/E vs. NTM Bottom-Up Estimates

60

70

80

90

100

May-08 Sep-08 Jan-09 May-09 Sep-09

10.0

11.5

13.0

14.5◄ Fwd EPS ▼

Fwd P/E ►


Analyst expectations can be more than 30% too high in a recession

Stock prices and multiples move well before estimate changes


UBS 26

In developing our market targets, we assume that a similar dynamic will occur in future recessions. More specifically, we assume that, in a recession, P/E multiples will bottom roughly one quarter ahead of a trough in trailing four quarters earnings growth.

Market Targets in Base Case, Grey & Black Skies The following bullets detail our price targets under each of the three scenarios. Our market targets are based upon (1) our estimate of forward consensus earnings at a certain point in time, multiplied by (2) a projected forward PE multiple.

Base Case. Our base case S&P 500 year-end 2011 price target of 1,425 remains unchanged. This is based upon our projected P/E at year-end of 12.6x applied to 2012 consensus operating EPS of $113. (We assume that 2012 consensus remains unchanged from now until December 31.)

Grey Skies. In our Grey Skies scenario, we project that the S&P 500 would end 2011 at 1,100, applying a forward P/E of 11.7x to projected 2012 consensus of $94. In this scenario, we project that the S&P 500 would trough in 1Q12 at 1,000 applying a trough P/E of 11.0x to forward consensus earnings of $91.

Black Skies. In our Black Skies scenario, we project that the S&P 500 would end 2011 at 900, applying a forward P/E of 11.3x to projected 2012 consensus of $79. In this scenario, we project that the S&P 500 would trough in 3Q12 at 775 applying a trough P/E of 10.5x to forward consensus earnings of $74.

Exhibit 33: S&P 500 Price, Earnings and Valuation Estimates S&P 500 Price Level Base Case Change Grey Change Black Change

Current (at 8/12/2011) 1179 1179 11792011 Year-End Target Price 1425 20.9% 1100 -6.7% 900 -23.7%

Market Trough Target Price 1000 -15.2% 775 -34.2%Market Trough Date 1Q12E 3Q12E

UBS - Operating EPS Base Case Growth Grey Growth Black Growth2010 Actual 85 37.3% 85 37.3% 85 37.3%2011 Estimate 99 16.2% 87 1.6% 85 -0.2%NTM Estimate 106 72 652012 Estimate 108 8.7% 74 -14.8% 60 -29.8%

Market Trough Fwd Est. 78 64

Consensus - Operating EPS Base Case Premium Grey Premium Black Premium2011 Estimate (at 8/12/2011) 99 99 99NTM Estimate (at 8/12/2011) 108 108 1082012 Estimate (at 12/31/2011) 113 4.6% 94 26.9% 79 32.7%

Market Trough Fwd Est. (1Y Prior) 91 16.3% 74 16.3%

Forward P/E on Consensus Current Yr End Current Yr End Current Yr Endon Consensus 2011 EPS 11.9x 11.9x 11.9xon NTM Consensus EPS 10.9x 10.9x 10.9xon Consensus 2012 EPS 10.4x 12.6x 12.6x 11.7x 14.8x 11.3x

Market Trough Fwd P/E 11.0x 10.5x

Source: S&P, Thomson Financial, Bloomberg, FactSet and UBS

Current target: 1,425

Grey Skies year-end target: 1,100

Black Skies year-end target: 900


UBS 27

Market Leadership While investors would love to build a portfolio of undervalued stocks, with strong global franchises, employing little financial leverage, and experiencing strong upward revisions, in reality these and other investment characteristics fall in and out of favor throughout the investment cycle.

To this purpose, we regularly monitor a variety of factors including Size, Valuation, Growth, Earnings Revisions, Volatility, and more, to ascertain their behavior under different market conditions. We have dubbed these “UBS Return Drivers.” We calculate these factors on a sector neutral basis. Please see Appendix B for details.

In the exhibit below, we break the investment cycles into three distinct phases, with a focus on which investment characteristics and sectors lead at each particular stage.

Exhibit 34: UBS Market Leadership Framework

Valuation

Earnings Fundamentals

Op Leverage

Non-Cyclicals

Cyclicals

I. Early Phase II. Middle Phase III. Late Phase

Volatility Quality

Source: UBS

Early Phase: In the initial phases of the investment cycle, investors reward the most volatile and economically-sensitive companies, and cyclical sectors outperform.

Middle Phase: During the middle innings, earnings fundamentals and valuations become more important to investors. At the sector level, cyclicals and non-cyclicals tend to perform in-line with one another.

Late Phase: The investment cycle usually ends with a recession or a significant economic slowdown. In such environments, investors rotate toward quality characteristics and less cyclical stocks.

Each investment characteristic behaves differently throughout the cycle


UBS 28

The stark difference between defensive and cyclical leadership is highlighted in the exhibit below which shows the relative performance of these investment characteristics.

Exhibit 35: Performance of UBS Return Drivers

7.84.5 2.8

-7.7-9.4

20.2

9.9

-7.0-9.6 -10.4

ROE FwdPE

EarnRev

OpLevg

PriceVol

PriceVol

OpLevg

FwdPE

EarnRev

ROE

Feb'08 - Feb'09Defensive Leadership

Feb'09 - Feb'10Cyclical Leadership

Source: S&P, Compustat, Thomson Financial, Worldscope, FactSet and UBS

Leadership Since February Slowdown In contrast to the cyclical leadership during the S&P 500's bounce in 2010 and 2011, the tone of the market has turned much more recessionary since February. As the exhibits below highlight, Early Phase characteristics have rolled over and Late Phase characteristics are once again leading. This would indicate that the market is already discounting continued economic weakness.

Exhibit 36: Price Volatility and Operating Leverage Return Drivers

-4%

-2%

0%

2%

4%

Jan-10 Apr-10 Jul-10 Oct-10 Jan-11 Apr-11

◄ Price Vol

◄ Op Levg

3-Month Moving Avg


Defensive characteristics led the market during the 2008 recession

Cyclical characteristics led during the recovery


UBS 29

Exhibit 37: ROE Return Driver

-4%

-3%

-2%

-1%

0%

1%

2%

Jan-10 Apr-10 Jul-10 Oct-10 Jan-11 Apr-11

ROE ►

3-Month Moving Avg


Under our Base Case we would expect more speculative stocks to lead the market higher. For those that are convinced — as we are — that this outcome is the most likely case, we recommend tilting portfolios toward Early Phase characteristics such as Volatility and Operating Leverage.

In the event of a downturn, Late Phase characteristics such as ROE and Dividend Yield should do well. Our colleagues David Jessop and Berry Cox, heads of Global and U.S. Quantitative Research, also highlight low debt-to-enterprise value, high free cash flow yield, and high ROIC as additional defensive characteristics. Details of their work can be found in Appendix C.

Current market leadership is consistent with a recession


UBS 30

Stock Selection: By Scenario As previously detailed, our analysts have calculated valuations in our base case and two recession case scenarios. In this section we have utilized those valuations to screen for the stocks with the most upside or most downside in each scenario, plus ran a screen which blends the three macroeconomic outcomes based on the probability we believe the market is already discounting. In the vast majority of cases the results below are in sync with the analyst write-ups in the last section of the report.

A common theme running through all modeled scenarios, with the exception of the least optimistic “Black Skies”, is UBS analysts’ search for Beta amongst the “Most Upside” stocks. The message here is that in many cases, the broad market selloff that began in early July has taken economically sensitive shares to a price level where UBS analysts view the potential reward as being extremely attractive under all but the most dire global economic backdrop.

Base Case. We screened for the stocks in UBS US coverage that offer both the Most and Least upside to the Analysts’ current price target in percentage terms. The stocks with the most downside are a diverse cross section of Neutral and Sell rated shares, which include two utilities, ED and DTE, typically considered defensive. The stocks with the most upside are somewhat skewed toward industrials which have had large absolute and relative price declines during the risk reduction episode of July-August. Notable is that 6 of the 10 stocks with the most upside in the Base Case have Raw Betas in excess of 2.00. The Base Case stocks with the most upside can be monitored and traded via UBS Global Synthetic Equity Basket, Bloomberg ticker UBSBASEM, while the Base Case stocks with the most downside are available under ticker UBSBASEL.

Exhibit 38: Base Case Scenario: Most Upside and Most Downside

Ticker Company AnalystRaw

BETAAdj

BETACurrent

PricePrice

Target UpsideMost Upside

GNW Genworth Financial Kligerman 2.03 1.69 $6.67 $22.00 229.84%GGC Georgia Gulf Corp Cash 2.15 1.76 $19.29 $43.00 122.91%MU Micron Technology Orji 2.02 1.68 $6.48 $14.00 116.05%ANR Alpha Natural Resources Gershuni 2.31 1.87 $34.07 $71.00 108.39%TXT Textron Strauss 2.21 1.81 $17.14 $35.00 104.20%HIG Hartford Financial Kligerman 1.93 1.62 $20.70 $42.00 102.90%NAV Navistar International Kirn 1.60 1.40 $42.03 $85.00 102.24%ACI Arch Coal, Inc. Gershuni 2.27 1.85 $21.32 $42.00 97.00%F Ford Motor Co Langan 1.55 1.37 $11.35 $22.00 93.83%UAL United Continental Crissey 1.57 1.38 $18.26 $35.00 91.68%Most Downside

NFLX Netflix Inc Pitz 1.03 1.02 $246.28 $210.00 -14.73%CREE Cree Inc Chin 1.30 1.20 $37.11 $32.00 -13.77%AN Autonation Langan 1.27 1.18 $35.80 $31.00 -13.41%DLR Digital Realty Trust Nussbaum 0.83 0.88 $58.80 $51.00 -13.27%PSA Public Storage McElroy 0.93 0.96 $119.82 $112.00 -6.53%WLK Westlake Chemical Cash 2.05 1.70 $43.42 $41.00 -5.57%ESI ITT Educational Sokol 0.70 0.80 $74.05 $70.00 -5.47%WSO Watsco Inc Barry 0.86 0.90 $56.94 $54.00 -5.16%ED Consolidated Edison von Riesemann 0.46 0.64 $54.79 $52.00 -5.09%DTE DTE Energy von Riesemann 0.73 0.82 $48.36 $46.00 -4.88% Source: UBS Note: Current Price as o f market close 8/15/2011

Grey Skies. The upside potential and downside risk to the current market price was calculated relative to the UBS Analysts’ “Grey Skies” Valuation. While the


UBS 31

stocks with the most upside are largely cyclical, pharmaceutical companies Warner Chilcott and Valeant Pharmaceuticals screened as businesses largely resistant to a Grey Skies scenario. As with the Base Case list of stocks with the most upside, analysts were still comfortable in reaching for Beta, with 5 of 10 stocks scoring a Raw Beta exceeding 2.0. The stocks with the most downside generally skew toward energy, consumer and specialty finance, and technology. These businesses can be expected to come under pressure due to pricing and demand issues. The Grey Skies stocks with the most upside can be monitored and traded via UBS Global Synthetic Equity Basket, Bloomberg ticker UBSGREYM, while the Grey Skies stocks with the most downside are available under ticker UBSGREYL.

Exhibit 2: Grey Skies Scenario: Most Upside and Most Downside


BETAAdj

BETACurrent

Price Valuation UpsideMost Upside

GNW Genworth Financial Kligerman 2.03 1.69 $6.67 $15.34 129.91%GGC Georgia Gulf Corp Cash 2.15 1.76 $19.29 $42.00 117.73%ANR Alpha Natural Resources Gershuni 2.31 1.87 $34.07 $58.00 70.24%HIG Hartford Financial Services Kligerman 1.93 1.62 $20.70 $34.36 65.98%LNC Lincoln National Kligerman 1.88 1.59 $22.83 $36.85 61.41%WLT Walter Energy Gershuni 2.39 1.93 $84.98 $137.00 61.21%ACI Arch Coal Inc Gershuni 2.27 1.85 $21.32 $34.00 59.47%WCRX Warner Chilcott Goodman 1.04 1.03 $17.38 $27.00 55.35%HUN Huntsman Corp Cash 1.91 1.60 $14.30 $22.00 53.85%VRX Valeant Pharmaceuticals Goodman 1.00 1.00 $40.07 $61.00 52.23%Most Downside

RVBD Riverbed Technology Theodosopoulos 1.67 1.45 $26.13 $14.17 -45.76%MTD Mettler-Toledo International Arias 1.10 1.07 $155.49 $90.06 -42.08%ACAS American Capital Choksi 2.46 1.97 $8.66 $5.25 -39.38%CHK Chesapeake Energy Featherston 1.30 1.20 $32.29 $19.71 -38.97%PLCM Polycom Inc Monti 1.22 1.15 $26.21 $16.74 -36.14%ARCC Ares Capital Corp Choksi 1.19 1.13 $14.82 $9.50 -35.90%TDG Transdigm Group Strauss 1.07 1.05 $89.04 $58.46 -34.34%OHI Omega Healthcare Investors Nussbaum 1.17 1.11 $17.74 $12.00 -32.36%MDR McDermott Fisher 2.02 1.68 $15.16 $10.30 -32.06%SWKS Skyworks Solutions Agarwal 1.65 1.43 $23.11 $16.00 -30.77% Source: UBS Note: Current Price as o f market close 8/15/2011

Black Skies. In the “Black Skies” scenario, UBS analysts’ valuations represented the least optimistic outcome modeled. The stocks with the most upside include a few cyclical businesses where UBS analysts believe the current selloff has overdiscounted a negative economic scenario, as well as companies such as Validus Re whose business is assessed to be largely independent of economic fluctuation. As “Black Skies” factors in a stark global economic picture, it should be no surprise that there are only 2 stocks with Raw Betas over 2.0 in the stocks with the most upside. Additionally, both Validus Re and Lincare score below 1.0 – indicating a preference for safety and an element of capital preservation. The stocks with the most downside in the Black Skies scenario include those that could come under both pricing and liquidity pressures should a global recession take hold. The Black Skies stocks with the most upside can be monitored and traded via UBS Global Synthetic Equity Basket, Bloomberg ticker UBSBLCKM, while the Black Skies stocks with the most downside are available under ticker UBSBLCKL.


UBS 32

Exhibit 3: Black Skies Scenario: Most Upside and Most Downside


BETAAdj

BETACurrent


GGC Georgia Gulf Corp Cash 2.15 1.76 $19.29 $40.00 107.36%VRX Valeant Pharmaceuticals Goodman 1.00 1.00 $40.07 $60.00 49.74%WCRX Warner Chilcott Goodman 1.04 1.03 $17.38 $26.00 49.60%MHK Mohawk Industries Goldberg 1.57 1.38 $47.10 $69.29 47.10%VR Validus Holdings Meredith 0.67 0.78 $25.85 $38.00 47.00%WLT Walter Energy Gershuni 2.39 1.93 $84.98 $119.00 40.03%HUN Huntsman Corp Cash 1.91 1.60 $14.30 $20.00 39.86%LNCR Lincare Holdings Shankman 0.58 0.72 $22.13 $30.27 36.76%HOT Starwood Hotel & Resorts Farley 1.96 1.64 $45.83 $62.52 36.42%DOW Dow Chemical Cash 1.87 1.58 $30.08 $41.00 36.30%Most Downside

DYN Dynegy Dumoulin-Smith 1.08 1.05 $4.34 $0.50 -88.48%ACI Arch Coal Inc Gershuni 2.27 1.85 $21.32 $6.00 -71.86%SNDK SanDisk Corp Orji 1.82 1.55 $38.20 $12.00 -68.59%AVT Avnet Inc Passi 1.42 1.28 $28.61 $9.00 -68.54%ACAS American Capital Choksi 2.46 1.97 $8.66 $3.00 -65.36%CBS CBS Corp. Janedis 1.68 1.45 $25.00 $9.04 -63.83%FLEX Flextronics International Passi 1.59 1.39 $5.71 $2.10 -63.22%BRCM Broadcom Corp Orji 0.95 0.97 $34.83 $13.00 -62.68%OHI Omega Healthcare Investors Nussbaum 1.17 1.11 $17.74 $7.00 -60.54%ARCC Ares Capital Corp Choksi 1.19 1.13 $14.82 $6.00 -59.51% Source: UBS Note: Current Price as o f market close 8/15/2011

Blended Scenario. In the Blended Scenario, we calculated the probability weighted valuations, applying a 60% weighting to the Base Case, a 30% weighting to the Grey Skies scenario and a 10% weighting to the Black Skies scenario for each stock. We then recalculated upside potential or downside risk relative to the weighted valuation. All the stocks with the most downside are either UBS Sell or Neutral rated, generally with at or near-market Raw Betas, while all the stocks with the most upside are UBS Buy rated with well above-market Raw Beta levels.

Exhibit 4: Blended Scenario: Most Upside and Most Downside


BETAAdj

BETACurrent


GNW Genworth Financial Kligerman 2.03 1.69 $6.67 $18.71 180.51%GGC Georgia Gulf Corp Cash 2.15 1.76 $19.29 $42.40 119.80%HIG Hartford Financial Kligerman 1.93 1.62 $20.70 $38.13 84.20%ANR Alpha Natural Resources Gershuni 2.31 1.87 $34.70 $62.20 79.25%WLT Walter Energy Gershuni 2.40 1.93 $84.98 $146.60 72.51%ACI Arch Coal, Inc. Gershuni 2.27 1.85 $21.32 $36.00 68.86%LNC Lincoln National Kligerman 1.88 1.59 $22.83 $38.55 68.86%MU Micron Tech Orji 2.02 1.68 $6.48 $10.90 68.21%MET MetLife Inc Kligerman 1.45 1.30 $34.42 $56.37 63.77%NAV Navistar International Kirn 1.60 1.40 $42.03 $68.30 62.50%Most Downside

CREE Cree Inc Chin 1.30 1.20 $37.11 $29.30 -21.05%AN Autonation Inc Langan 1.27 1.18 $35.80 $28.54 -20.28%NFLX Netflix Inc Pitz 1.03 1.02 $246.28 $199.50 -18.99%DLR Digital Realty Trust Nussbaum 0.83 0.88 $58.80 $48.10 -18.20%LSI LSI Corp Agarwal 1.23 1.15 $7.20 $6.00 -16.67%ESI ITT Educational Services Inc Sokol 0.70 0.80 $74.05 $63.70 -13.98%WSO Watsco Inc Barry 0.86 0.90 $56.94 $49.50 -13.07%PLCM Polycom Inc Monti 1.22 1.15 $26.21 $23.08 -11.94%OHI Omega Health Investors Nussbaum 1.17 1.11 $17.74 $15.70 -11.50%STLD Steel Dynamics Inc Gershuni 1.69 1.46 $13.04 $11.60 -11.04% Source: UBS Note: Current Price as o f market close 8/15/2011


UBS 33

UBS Cyclical and Defensive Baskets In our July 11 report Positioning for Slowdown or Recovery, we analyzed stock performance around periods of economic acceleration and deterioration. The report detailed the construction of two UBS baskets, UBSECYC and UBSEDEF, with the first designed to capture the market’s upside should the economy strengthen and the other to provide protection on the downside should conditions weaken.

Historical Results As the back-test results below indicate, the cyclical portfolio outperformed 71% of the time in periods of economic acceleration, beating the benchmark by 1.1% on average.

Exhibit 39: Cyclical Portfolio Outperformance During Months of Economic Improvement

-4

-2

0

2

4

6

8

10

1 7 13 19 25 31

Outperformance During AccelerationAvg: 1.1%Max: 5.0% Min: -1.9%Months Outperforming: 25 of 35

Source: S&P, ISM, FactSet and UBS Note: Returns relative to S&P 500 Equal-Weighted Index

Likewise, in periods of deceleration, the defensive portfolio outperformed by 1.6%, beating the benchmark 80% of the time.

Exhibit 40: Defensive Portfolio Outperformance During Months of Economic Deceleration

-4

-2

0

2

4

6

8

10

1 7 13 19 25

Outperformance During DecelerationAvg: 1.6%Max: 10.5% Min: -2.2%Months Outperforming: 20 of 25

Source: S&P, ISM, FactSet and UBS Note: Returns relative to S&P 500 Equal-Weighted Index

UBS has created baskets that should outperform in economic recoveries (UBSECYC) or recessions (UBSEDEF)

When Economic Surprise and ISM have risen, the Cyclical List has outperformed by 1.1% per month

When Economic Surprise and ISM have fallen, the Defensive List has outperformed by 1.6% per month


UBS 34

Background While economic activity might drive corporate profits, economic surprises move stock prices. As such, it comes as no coincidence that the UBS U.S. Economic Surprise Index has among the highest correlations of any major economic indicator with the S&P 500.

Exhibit 41: Correlation of Economic Indicators and Stocks

Indl ISM UBS Econ Nonfarm S&P 500

Prod. ISM Non-Mfg Surp Payrolls Index

Industrial Production 1.00

ISM 0.11 1.00

ISM Non-Mfg 0.02 0.27 1.00

UBS Econ Surprise 0.18 0.25 0.16 1.00

Nonfarm Payrolls 0.52 -0.06 0.03 0.21 1.00

S&P 500 Index 0.08 0.25 0.28 0.47 0.20 1.00 Source: S&P, ISM, US Department of Labor, FactSet and UBS Note: Correlations based on monthly pct. changes in indicators vs. monthly S&P 500 returns over the past 10 years

As the exhibit above highlights, while the UBS U.S. Economic Surprise Index and Non-Manufacturing ISM have the highest correlations to stocks, they are not highly correlated with each other. As a result, the combination of these two indicators creates an even tighter fit to the S&P 500.

Exhibit 42: UBS U.S. Economic Surprise Index & Non-Manufacturing ISM versus Stocks

-40%

-20%

0%

20%

40%

99 00 01 02 03 04 05 06 07 08 09 10 11

-30%

-15%

0%

15%

30%

▼ S&P 500

US Econ Surprise &Non-Manufacturing ISM ►

Source: S&P, ISM, FactSet and UBS Note: Rolling 3-month change

Stocks are most highly correlated with the UBS U.S. Economic Surprise Index and Non-Manufacturing ISM

The combination of these indicators has an even greater correlation to movements in the stock market


UBS 35

Construction Methodology The cyclical basket is designed to outperform during periods of economic improvement as measured by UBS’s U.S. Economic Surprise Index and Non-Manufacturing ISM. Conversely, the defensive basket is structured to outperform during periods of decelerating economic activity. Each basket includes 30 equal-weighted stocks.

Cyclical Basket

A. Screen For Potential Candidates

1. Identify Periods of Economic Improvement/Deterioration. We define periods of economic improvement as those that have a positive change in both the UBS U.S. Economic Surprise Index and Non-Manufacturing ISM. We call these Acceleration Periods. We define Contraction Periods as those where both indicators fall.

2. Stocks Must Outperform in Acceleration Periods. We restrict the universe of potential holdings to those stocks which have outperformed the market in a clear majority of Acceleration Periods.

3. Stocks Must Underperform in Contraction Periods. Further, we restrict the universe of potential holdings to those stocks which have underperformed the market in a clear majority of Contraction Periods.

B. Select Holdings Based on Best Fit. We then select the 30 stocks most sensitive to the UBS U.S. Economic Surprise Index and the market.

Defensive Basket

A. Screen For Potential Candidates

1. Identify Periods of Economic Improvement/Deterioration. See above.

2. Stocks Must Outperform in Contraction Periods. We restrict the universe of potential holdings to those stocks which have outperformed the market in a clear majority of Contraction Periods.

3. Stocks Must Underperform in Acceleration Periods. Further, we restrict the universe of potential holdings to those stocks which have underperformed the market in a clear majority of Acceleration Periods.

B. Select Holdings Based on Best Fit. We then select the 30 stocks least sensitive to the UBS U.S. Economic Surprise Index and the market.


UBS 36

Appendix A: Additional Assumptions The assumptions below have been provided by our global economics, strategy, and sector teams.

Global Economic Assumptions

Exhibit 43: Global Economic Assumptions

Base Case Grey Black Base Case Grey BlackGDPGlobal 3.4% 2.9% 2.4% 3.8% 1.9% 0.0%US 1.8% 0.9% 0.8% 2.3% -1.0% -2.5%Eurozone 1.8% 1.4% 0.9% 2.0% 0.0% -2.3%UK 1.1% 0.7% 0.2% 2.1% 0.3% -1.6%Germany 2.6% 2.3% 0.2% 2.1% 1.9% -2.0%

2011 2012

Source: UBS

Commodity Price Assumptions

Exhibit 44: Commodity Price Assumptions Oil & GasBrent (bbl) Jon Rigby / Bill Featherston $103.90 $95.00 $85.00 $60.00WTI (bbl) Jon Rigby / Bill Featherston $95.25 $87.00 $70.00 $50.00NatGas Bill Featherston / Ron Baron $4.40 $4.90 $4.25 $3.75

CommoditiesGold (oz) Edel Tully / Julien Garran $1,500 $1,649 $1,749 $1,380 $2,000 $2,500Gold (Growth yoy) Edel Tully / Julien Garran 34.0% 42.0% 21.0% 43.0%Copper (c/lb) Julien Garran 414 385 375 370 250 150Copper (Growth yoy) Julien Garran 13.0% 2.4% -35.0% -57.0%

Urea (tonnes) Joe Dewhurst $463.00 $400.00 $333.00 $508.00 $400.00 $300.00Phosphate (tonnes) Joe Dewhurst $650.00 $600.00 $525.00 $575.00 $488.00 $400.00Potash (tonnes FOB Vanc) Joe Dewhurst $465.00 $420.00 $373.00 $575.00 $380.00 $300.00

Source: UBS

Key End Market Demand Assumptions

Exhibit 45: Key End Market Demand Assumptions TechnologySemiconductor Revenue (US$ bn) Uche Orji / Nick Gaudois $310 $292 $289 $326 $257 $231Semiconductors (Growth yoy) Uche Orji / Nick Gaudois 4.0% -2.0% -3.0% 5.0% -12.0% -20.0%Handsets (Unit Growth) Gareth Jenkins 9.1% 6.9% 4.6% 6.1% 3.1% -0.3%Handsets (Revenue Growth) Gareth Jenkins 20.5% 16.1% 11.7% 5.9% 1.8% -3.1%PC Growth Maynard Um 4.5% 3.8% 3.2% 10.1% 5.0% 0.0%

IndustrialsLg Commercial Aircraft Deliveries David Strauss 1,062 1,062 997 926World Air Traffic (Passenger volumeJarrod Castle 5.0% 4.0% 3.0% 5.0% 2.0% -2.0%Global Trade Dominic Edridge 9.0% 7.0% 4.9% 10.7% 2.8% -5.1%-Container Jarrod Castle 6.0% 4.5% 3.2% 7.6% 2.0% -3.6%-Airfreight Jarrod Castle 4.0% -2.0% -3.0% 6.0% -4.0% -8.0%Solar-Global Solar Demand (GW) Lu Yeung 21 20 19 22 21 19-Global Solar Module ASP ($/W) Lu Yeung $1.50 $1.40 $1.35 $1.30 $1.10 $1.00

ConsumerGlobal Auto Sales Philippe Houchois 3.0% 1.1% -0.9% 4.7% -0.5% -5.2%Global Autos Production Forecasts Philippe Houchois 4.9% 2.3% 0.1% 6.9% -1.8% -7.3%

Source: UBS


UBS 37

Appendix B: UBS Return Drivers We define market leadership by specific stock characteristics, such as Size (large vs. small), Valuation (expensive vs. cheap), Growth, Momentum, and Volatility. We track fourteen such characteristics, which we have dubbed “UBS Return Drivers.”

UBS Return Drivers

Size (Capitalization) Foreign Sales

Valuation (Forward P/E) Volatility

Earnings Growth Financial Leverage

Price Momentum Operating Leverage

Earnings Revisions Dividend Yield

Short Interest Return on Equity

Earnings Surprise Revenue Surprise Source: UBS

Computation Each Return Driver is calculated as a hypothetical long/short portfolio built around a single quantitative decision variable. Our calculations assume monthly rebalancing and no transaction or borrowing costs. For each Return Driver, the computation process has four steps:

(1) Break Stocks into Industry Groups. While our Return Drivers are reported at the sector and index level, our process starts by breaking the S&P 500 into its 24 GICS industry groups.

S&P 500 GICS Sectors and Industry Groups

Source: Standard and Poor’s and UBS

(2) Rank Based on Return Drivers. Within each industry group, stocks are ranked from top to bottom by the Return Driver in question (e.g., largest to smallest market capitalization). The list is then broken into three groups: top-third, middle-third, and bottom-third. Our calculations assume that the top-third of stocks are bought and the bottom-third of stocks are sold.

Ranking and Return Calculation Methodology

Top 1/3Buy (Top 1/3).Stock returns equal-weighted within industry group

Middle 1/3

Bottom 1/3Sell (Bottom 1/3).Stock returns equal-weighted within industry group

Source: UBS

Sectors Industry Groups

Energy Energy

Materials Materials

Industrials Capital Goods; Commercial & Professional Services; Transportation

Consumer Cyclicals Autos; Consumer Durables & Apparel; Consumer Services; Media; Retailing

Consumer Staples Food & Staples Retailing; Food Beverage & Tobacco; Household & Personal Products

Health Care Health Care Equipment & Services; Pharmaceuticals, Biotech & Life Sciences

Financials Banks; Diversified Financials; Insurance; Real Estate

Technology Software & Services; Hardware & Equipment; Semiconductors & Equipment

Telecom Telecommunication Services

Utilities Utilities


UBS 38

(3) Calculate Returns. Monthly returns are then calculated by subtracting the returns of the bottom-third (sells) from the top-third (buys). The result is then divided by two to put the outperformance in a long-only context. This analysis is done on an equal-weighted basis within each Industry Group.

Return Driver Calculation — Hypothetical Example Foreign Sales Calcualtion — Industry Group Example

Long: Highest Foreign Sales Stocks (Top 1/3) 9.8%Short: Lowest Foreign Sales Stocks (Bottom 1/3) 4.6%Difference 5.2%Divide by 2 ÷ 2Factor Result 2.6%

Source: UBS

(4) Aggregate Results. At the sector level, Returns Drivers are calculated as a weighted average of industry group returns based on S&P 500 index weights. S&P 500 index results are a weighted average of sector results. We also index monthly returns as a time series for further analysis.

GICS Sectors and Industry Groups — S&P 500

S&P 500

Sector Sector

Industry Group Industry Group

Cap-weighted result of Sector Average

Cap-weighted result of Industry Group Average

S&P 500

Sector Sector


S&P 500

Sector Sector


Cap-weighted result of Sector Average

Cap-weighted result of Industry Group Average

Source: Standard and Poor’s and UBS

(5) Analytics. There are several ways that UBS Return Drivers can be used in investment decision making. We have listed a few below:

Identify Winning Investment Characteristics. UBS Return Drivers identify which specific equity characteristics have outperformed and underperformed during a specific time period. This data is available at the industry group, sector, and index level. Additionally, investors can get a sense for the magnitude of outperformance or underperformance of Return Drivers relative to one another.

Track Historical Trends. In our analysis, we track the performance of each one of our Return Drivers over time. This allows us to identify the types of market environments in which each Return Driver tends to outperform or underperform.

Avoid Crowded Trades. Our work also helps identify over-loved and under-loved investment themes. For each UBS Return Driver, we track the valuation spread between the top-third of companies and the bottom-third of companies over time. As such, we can help identify points when particular portfolio tilts or trades appear to be “crowded” or “priced in.” Alternatively, we can also identify points when upside opportunities appear outsized.


UBS 39

Appendix C: U.S. Style Indices Note: This page is the work of the UBS Quantitative Team, led by David Jessop and Berry Cox.

High quality stocks are a traditional haven during recessions, along with those that have high free cash flow yield and those where their earnings are being revised up (or at least revised down the least) by analysts. Our measures of quality include low volatility, low debt to EV and high ROIC.

We approached our analysis by making the assumption that what worked during past recessions could be a guide for what will work this time around (so history at least rhyming) assuming our Black Skies scenario turns out to be the case.

The table below shows the performance of a selection of our US styles. These were chosen as those where the returns during recessions are positive and which did well during at least four out of the last five recessions. The quality styles that would have been consistently successful during economic downturns were: low volatility, low debt to EV and high ROIC. Low beta is also, perhaps unsurprisingly, a successful style during recessions.

We did look at the valuation of our quality styles, and unlike in Europe where quality is very expensive within the US the quality styles appear to be relatively fairly valued (and this is the case whether one adjusts for sector membership or not).

We should note that the styles in the table below are not created to be sector neutral and so part of their success could be due to selecting the right sectors during the downturns.

Average difference in monthly return to US styles, during the last 5 recessions

Style Not during a

recession During any recession

Jan '80 - Jul '80

Jul '81-Nov '82

Jul '90-Mar '91

Mar '01-Nov '01

Dec '07-Jun '09

High free-cash flow yield minus low free cash-flow yield 0.26% 1.05% -0.02% 0.88% 1.04% 2.44% 0.94%

High earnings revisions minus low earnings revisions 0.48% 0.59% 0.91% 1.42% 0.16% -0.54% 0.46%

High ROIC minus low ROIC 0.08% 0.61% 0.40% 0.10% 1.26% 1.22% 0.56%

Low beta minus high beta 0.04% 0.89% -0.46% 1.13% 0.02% 2.07% 1.02%

Low volatility minus high volatility -0.15% 0.51% 0.45% 1.71% 0.02% 0.21% -0.15%

Low debt to EV minus high debt to EV -0.14% 0.47% 0.33% 0.26% 1.12% 0.48% 0.38% Source: UBS Quantitative research, definitions of recessionary periods taken from the National Bureau of Economic Research


UBS 40

Intentionally Blank


UBS 41

Communications


UBS 42

Cable & Satellite / Telecom Services John C. Hodulik, CFA, 212-713-4226 Batya Levi, 212-813-8824

Within the telecom sector, we expect enterprise-focused companies to show revenue growth at GDP-like levels while companies with more exposure to wireless and consumer are likely subject to secular trends. In our scenario analysis, we assumed companies with the largest exposure to business trends (such as Level 3 Comm.) could see a swing similar to the GDP forecast by the UBS economics team, while companies with consumer exposure (cable/satellite, RLECs) and wireless exposure (AT&T, Verizon, Sprint) could see less of an impact on top-line trends. We believe accelerated smartphone penetration and the need for speed in broadband continue to be the main themes in our sector, offsetting some of the pressure from the weak macro environment. We believe the towers will see the least pressure due to the stability of their business models and cash flow generation. Under a grey/black skies scenario, we also believe defensive names with sustainable cash flow and attractive dividend yields will perform relatively better.

Our preferred stocks in this environment are American Tower (AMT), Verizon, and Comcast. We believe short-term declines in GDP growth will have the least impact on AMT’s revenue and EPS growth due to its multi-year contracts and built-in escalators. While AMT’s leverage of 3.4x is higher than that of the telcos, the company has minimal short-term debt maturities and low exposure to variable rates. At the current stock price, we believe AMT is trading at assumptions similar to a black skies scenario. We believe Verizon could also perform relatively better under this scenario, as it benefits from accelerating revenue growth in wireless, its 5.6% dividend yield, and leverage of just 1.3x. We believe Comcast, trading at just 4.6x 2012E EBITDA, is also factoring in black skies assumptions. In such an environment, we believe the company could still show revenue growth and expand margins while generating strong FCF as the capex cycle winds down, leaving room for shareholder-friendly returns.

Our least preferred names in this environment are Windstream, Level 3, and Sprint. We believe Windstream and Level 3 are susceptible to changes in the business cycle, which could lower top-line growth while limiting cost-cutting opportunities. Meanwhile, the capital intensity of their businesses continues to pressure FCF. These companies also have high leverage and higher exposure to variable-rate debt securities. We believe Sprint is falling behind AT&T and Verizon in grabbing share in the postpaid wireless market while it increasingly caters to low-end customers. This segment will likely see increased churn and lower revenue per user as the macro environment worsens. We believe Sprint also needs additional financing to support its 4G build-out, plans for which have not been finalized. With margins in the mid-teens and significant investment needs, we do not believe the company is well positioned to weather a downturn.


UBS 43

Table 46: Recession Scenario Analysis – Cable & Satellite / Telecom Services, John C. Hodulik, CFA and Batya Levi

Cable & Satellite / Telecom Services

'11 vs.'12 % Revenue Change '11 vs.'12 % EPS Change Scenario ValuationCurrent Recession Scenario Current Recession Scenario Current Recession Scenario

Name Ticker GDP View Grey Skies Black Skies GDP View Grey Skies Black Skies GDP View Grey Skies Black SkiesAmerican Tower AMT 9.5% 7.8% 7.1% 26.7% 19.4% 11.1% $60 $53 $47AT&T T 1.5% -0.5% -1.5% 8.8% -1.0% -4.3% $30 $26 $24Cablevision Systems CVC 1.7% 0.0% -0.7% 30.8% 5.0% 0.9% $28 $20 $16CenturyLink CTL -3.0% -5.5% -6.6% 7.9% -2.8% -11.3% $47 $39 $32Comcast CMCSA 5.1% 3.4% 2.7% 24.0% 16.6% 12.1% $30 $24 $19Crown Castle International CCI 10.3% 8.7% 7.9% 33.8% 21.7% 9.0% $47 $41 $34DirecTV DTV 8.7% 7.1% 6.3% 31.1% 23.4% 17.9% $55 $42 $35DISH Network DISH 5.0% 3.3% 2.6% 7.3% 3.6% 1.5% $33 $25 $19Frontier CZN -4.1% -6.6% -7.7% 51.1% 12.9% -9.7% $10 $7 $6Level 3 Communications LVLT 3.1% 0.6% -0.5% -11.6% -20.8% -36.5% $3 $2 $1MetroPCS PCS 6.9% 5.3% 4.5% 28.1% 3.4% -6.8% $15 $12 $8Sprint Nextel S 2.1% 0.2% -0.7% -27.3% -36.0% -40.0% $5 $4 $3Time Warner Cable TWC 4.1% 2.5% 1.7% 29.9% 18.8% 13.0% $82 $60 $45Verizon VZ 4.5% 2.4% 1.5% 20.5% 0.5% -8.1% $37 $30 $26Windstream WIN -0.9% -3.3% -4.5% 7.0% -1.0% -9.6% $13 $11 $9

GREY SKIES RECESSION SCENARIO

Top 3 Preferred StocksAmerican Tower AMTVerizon VZComcast CMCSA

Least 3 Preferred StocksWindstream WINLevel 3 LVLTSprint S

BLACK SKIES RECESSION SCENARIO

Top 3 Preferred StocksAmerican Tower AMTVerizon VZComcast CMCSA

Least 3 Preferred StocksWindstream WINLevel 3 LVLTSprint S

Source: UBS


UBS 44

Internet & Interactive Entertainment Brian Pitz, 212-713-9310 Brian Fitzgerald, 212-713-2851

Even through the 2008-09 recession, we continued to see two major secular trends underpinning Internet growth: 1) the gradual shift of both Commerce and Advertising dollars to online channels; and 2) the shift from physical to digital. At the onset of the last recession, broader-based online indicators troughed quicker and in a more acute fashion than the offline ecosystem, but recovered earlier – thus accelerating the shift from ‘atoms’ to ‘bytes’. We also note that the past recession had a smaller adverse effect on eCommerce growth than on offline retail growth. For many quarters now, eCommerce has been growing faster than brick-and-mortar as a percentage of total discretionary spending. Excluding autos, gas, and food/beverage, eCommerce grew roughly 3x faster (14% vs. 4%) than retail sales during Q211. The low-income segment (less than $50k/year) is exhibiting the strongest Y/Y growth in eCommerce activity since the last recession – up 23% Y/Y, on average, for the past five quarters, which is consistent with our view that eCommerce is one of the channels consumers utilize when confronted with limited budgets. According to comScore, 35% of consumers polled in July ‘11 said they are cutting shopping expenses by shopping online for deals.

Assuming similar trends from the last economic downturn, we estimate that the immediate impact on our names, in terms of revenue/EPS growth differential, will be approximately 3% to 6% in a modest recession (grey skies scenario) and about 9% to 11% in a deeper recession (black skies scenario). In terms of valuation impact, we take a more conservative stance, as we also expect a simultaneous margin and multiple compression in the sector – we estimate the valuation impact will be roughly 2x bigger than the revenue/EPS impact. As a result, we would expect this to translate into valuation adjustments of about 10% in a modest recession (grey skies scenario) and about 20% in a deeper recession (black skies scenario).

While most Internet and Interactive Entertainment companies are investing for top-line growth and innovation, during more austere times, the best-of-breed companies have demonstrated an ability to effectively manage operating expenses and temper investment to better protect bottom-line earnings relative to the broader markets. We have also seen traditional brick-and-mortar industries actually lean more heavily on their respective online channels during times of economic stress to clear inventory and optimize yields in a fast, efficient, and often opaque manner. This serves to protect their pricing (think of Online Travel Agencies such as Priceline.com, with “the price negotiator”). Negative impacts to Internet companies’ top lines are partially muted because macro pressures weigh on the consumer – who then leverages the Internet as a tool for: 1) product and price discovery; 2) comparison shopping; 3) free/discounted shipping; 4) daily deals/shopping clubs such as LivingSocial or Groupon; 5) tax breaks; and 6) finding an ideal vendor along the “price-availability-location” curve (by utilizing location-based, real-time inventory mobile eCommerce applications such as Red Laser).

During a downturn, we favor larger cap names/best-of-breed players with scale. In tough economic environments, large-scale retailers such as Amazon are better able to spend more on marketing incentives and discounts because of their increased influence on the supply chain. Per comScore, the top 25 retailers gained 420 bps of market share from smaller retailers in online sales during Nov.-Dec. ‘09 vs. Nov.-Dec. ‘08. In addition, advertisers also need to be present online to capture market share as ad spend shifts from other channels to online/mobile.

We believe several stocks within our coverage universe are better positioned for a downturn as digital channels continue to empower consumers to find the best prices, promotions, and discounts. The stocks that should weather a downturn best and go on to thrive are Google, Amazon, and eBay; we would expect the worst performance from Yahoo!, InterActive Corp, and Activision.


UBS 45

Table 47: Recession Scenario Analysis – Internet & Interactive Entertainment, Brian Pitz and Brian Fitzgerald

Internet & Interactive Entertainment


Name Ticker GDP View Grey Skies Black Skies GDP View Grey Skies Black Skies GDP View Grey Skies Black SkiesGoogle GOOG 21.5% 16.5% 11.5% 17.4% 12.4% 7.4% $800 $720 $640Amazon AMZN 23.9% 18.9% 13.9% 65.0% 60.0% 55.0% $215 $194 $172eBay EBAY 16.0% 11.0% 6.0% 17.4% 12.4% 7.4% $45 $41 $36Yahoo! YHOO 9.0% 4.0% -1.0% 13.5% 8.5% 3.5% $17 $15 $14Netflix NFLX 31.1% 26.1% 21.1% 41.1% 36.1% 31.1% $210 $189 $168Interactive Corp IACI 10.7% 5.7% 0.7% 18.7% 13.7% 8.7% $43 $39 $34LinkedIn LNKD 40.5% 35.5% 30.5% 73.0% 68.0% 63.0% $115 $104 $92Activision ATVI 14.1% 9.1% 4.1% 13.8% 8.8% 3.8% $14 $13 $11Electronic Arts ERTS 7.4% 2.4% -2.6% 32.9% 27.9% 22.9% $30 $27 $24


Top 3 Preferred StocksGoogle GOOGeBay EBAYAmazon AMZN

Least 3 Preferred StocksYahoo! YHOOInteractive Corp IACIActivision ATVI


Top 3 Preferred StocksGoogle GOOGeBay EBAYAmazon AMZN

Least 3 Preferred StocksYahoo! YHOOInteractive Corp IACIActivision ATVI

Source: UBS


UBS 46

Media & Entertainment John Janedis, CFA, 212-713-1064

Under our grey skies scenario, we assumed a 500 bp hit to our current ‘12E advertising growth assumptions by advertising medium and a 200 bp hit to our park revenue (Disney) growth assumption. We assumed no change to what we view as relatively stable, recession-resistant revenue streams (ie, affiliate fee, film, and circulation revenue). Under our black skies scenario, we assumed a greater 1000 bp hit to our current ‘12E advertising growth estimates by advertising medium and a 500 bp hit to our park revenue growth estimate. We then assumed a 20% to 60% decremental margin on the lost revenue, with advertising agencies on the low end, at 20%, and traditional advertising revenues on the high end (ie, local TV, newspapers, outdoor, and radio), at 60%. We used financial data from the past recession to arrive at our decremental margin assumptions, but we expect a somewhat smaller top-line decline, given the severity of the last recession, and fewer expense cuts, as most of the companies in our coverage universe significantly cut expenses less than three years ago.

Based on these assumptions, our least preferred names in a grey skies scenario are: 1) Interpublic; 2) Gannett; and 3) CBS. Not surprisingly, these names also have the highest exposure to advertising in our group, at 100%, 75%, and 64%, respectively. Our most preferred names in a grey skies scenario are: 1) Scripps Networks; 2) Discovery; and 3) Viacom. The majority of earnings from each of these companies, 100%, 99%, and 89%, respectively, come from their cable network businesses, which benefit from having recession-resistant affiliate fee revenue streams, in addition to advertising, to help support their cost structures. Our grey skies valuations assume a 10% cut, on average, to our current target multiples.

Under our black skies scenario, our least preferred names are the same as under our grey skies scenario: CBS; Interpublic; and Gannett. Our most preferred names in a black skies scenario are: 1) Discovery; 2) Walt Disney; and 3) Scripps Networks. Discovery and Scripps should be somewhat sheltered by their more stable cable network exposure, while Disney has less advertising exposure than most in our group (less than 20%), and we are assuming park revenue will not fall as much as advertising-related revenue. Our black skies valuations assume a 20% premium, on average, to the trough multiples reached in the most recent recession.


UBS 47

Table 48: Recession Scenario Analysis – Media & Entertainment, John Janedis, CFA

Media & Entertainment


Name Ticker GDP View Grey Skies Black Skies GDP View Grey Skies Black Skies GDP View Grey Skies Black SkiesGannett Co. GCI 0.9% -2.7% -6.4% 5.9% -8.1% -22.0% $14 $11 $6Interpublic Group of Cos. IPG 5.5% 0.5% -4.5% 13.9% 1.3% -11.2% $13 $9 $4CBS Corp. CBS 5.7% 2.4% -0.8% 21.1% 9.7% -1.6% $31 $26 $9Omnicom Group OMC 5.8% 0.8% -4.2% 12.7% 3.1% -6.6% $50 $42 $28Scripps Networks SNI 4.5% 1.1% -2.2% 12.1% 7.9% 3.8% $52 $49 $41Walt Disney Co. DIS 4.7% 3.1% 2.7% 14.4% 10.3% 5.2% $42 $37 $24Time Warner, Inc. TWX 2.4% 1.3% 0.3% 10.0% 6.8% 3.7% $36 $32 $19Viacom, Inc. VIA.B 6.7% 4.9% 3.2% 12.2% 9.4% 6.5% $56 $51 $28Discovery Comm. DISCA 6.0% 3.8% 1.6% 17.3% 14.8% 12.3% $42 $39 $34


Top 3 Preferred StocksScripps Networks SNIDiscovery Comm. DISCAViacom, Inc. VIA.B

Least 3 Preferred StocksInterpublic Group of Cos. IPGGannett Co. GCICBS Corp. CBS


Top 3 Preferred StocksDiscovery Comm. DISCAWalt Disney Co. DISScripps Networks SNI

Least 3 Preferred StocksCBS Corp. CBS Interpublic Group of Cos. IPGGannett Co. GCI

Source: UBS


UBS 48

Intentionally Blank


UBS 49

Consumer


UBS 50

Apparel, Footwear & Luxury Michael Binetti, 212-713-3805

To derive our revenue and EPS forecasts under the black skies scenario, we reviewed growth rates through the 2008/2009 global recession. We adjusted prior trough growth rates to reflect significant changes in the business models of the companies in the apparel & footwear universe since the onset of the 2008 recession. For example: 1) Polo has acquired its Asian operations from licensees; 2) Coach has a more significant percentage of revenues from its factory outlet channel (where fixed costs are lower than full priced stores); and 3) VF Corp has announced the acquisition of Timberland (pending closing in September 2011), which offers visible EPS upside from deal synergies.

We derive our black skies scenario target P/E multiples from the trough multiples these companies experienced in 2008. Our scenario valuations are simply black skies EPS estimates multiplied by the black skies target P/E. Our grey skies revenue and EPS estimates are approximated based on an average of our current base case estimates and our black skies scenario estimates (with adjustments for deleverage assumptions on a company-by-company basis), and our grey skies scenario target multiples are the average of our current base case P/E and our black skies scenario P/E.

Nike is our most preferred stock under both our black skies and grey skies scenarios. Nike has the highest exposure to emerging markets in the group, at ~33% of revenues. The company has also significantly streamlined its supply chain (eg, through consolidation around its most efficient manufacturing partners) since the 2008 downturn. Finally, the company has proven that it has a highly flexible cost structure relative to peers (Nike never reported a negative EPS year through the ‘08/’09 recession). Accelerating revenue contribution from high-growth markets, expanding market share in new categories (eg, a renewed focus on global apparel), a strong brand with pricing power, and a world class flexible supply chain leave Nike at the top of our list in an economic downturn. Polo is a preferred stock in a downturn due to its significant scale advantages (with leading global market share in large global apparel categories), premium brand positioning (which fosters price increases and share gains in existing and new categories), accelerating sources of international growth (eg, the recent acquisition of its Asia operations from licensees), and a flexible global supply chain (similar to Nike, Polo never reported a negative EPS year during the ‘08/’09 recession). Finally, we prefer VF Corp in a black skies scenario with large exposure to low-fashion-risk categories (eg, low-priced jeans) and relative EPS upside due to the pending acquisition of Timberland (with $0.90 in cost synergies expected in 2012).

We least prefer Under Armour in a black skies scenario. While Under Armour is a preferred long-term growth story, the company has been rapidly building out its sourcing, supply chain, and retail capacity in expectation of rapid consumer growth. A sudden consumer downturn could cause significant deleverage on recent growth investments. Further, a history of supply chain execution issues adds near-term risk to an otherwise good long-term growth story. Foot Locker is our second least preferred in a black skies scenario. Foot Locker has come a long way in improving the profitability of its retail fleet over the past year. That said, Foot Locker has a lower income core consumer, which we would consider a risk into an economic downturn (with a decelerating job growth outlook more than offsetting a household budget boost from lower gas prices). High fixed costs add EPS risk in a negative revenue scenario. The potential for an extended NBA lockout (basketball is a key category) or a deterioration in recently very strong new product innovation from brands add an element of uncertainty. A 3.9% current dividend yield offers some downside support (Foot Locker maintained its dividend through the 2008/2009 recession).


UBS 51

Table 49: Recession Scenario Analysis – Apparel, Footwear & Luxury, Michael Binetti

Apparel, Footwear & Luxury

Calendar '11 vs.'12 % Revenue Change Calendar '11 vs.'12 % EPS Change Scenario ValuationCurrent Recession Scenario Current Recession Scenario Current Recession Scenario

Name Ticker GDP View Grey Skies Black Skies GDP View Grey Skies Black Skies GDP View Grey Skies Black SkiesCoach Inc. COH 11.9% 8.9% 1.9% 15.9% 9.9% 1.9% $65 $44 $24Foot Locker Inc FL 3.7% -1.3% -6.3% 8.3% -3.7% -13.7% $26 $17 $9Nike Inc. (Cl B) NKE 11.4% 8.4% 3.4% 15.8% 11.8% 5.8% $103 $79 $56Polo Ralph Lauren Corp. RL 10.7% 7.7% 2.7% 20.6% 15.6% 8.6% $150 $108 $69Under Armour Inc. (Cl A) UA 21.6% 15.6% 9.6% 22.5% 12.5% 2.5% $78 $52 $30VF Corp. VFC 8.5% 4.5% -1.5% 11.5% 5.5% -0.5% $135 $106 $67


Top 3 Preferred StocksNike Inc. NKEPolo Ralph Lauren Corp. RLVF Corp VFC

Least 2 Preferred StocksUnder Armour UAFoot Locker FL


Top 3 Preferred StocksNike Inc. NKEPolo Ralph Lauren Corp. RLVF Corp VFC

Least 2 Preferred StocksUnder Armour UAFoot Locker FL

Source: UBS


UBS 52

Beverages Kaumil Gajrawala, 212-713-9318

To determine EPS forecasts under a black skies scenario, we used the worst company-specific EPS growth rates experienced during the downturn of 2008/2009. We then applied those black skies growth rates to our 2011 EPS estimates. In order to choose a black skies multiple, we used the six-month trough multiples seen in late 2008/early 2009. Our scenario valuations are simply the respective black skies EPS and black skies multiple. Our grey skies estimates and valuations are based on the average of our current estimates/target multiples and black skies estimates/multiples.

Under our grey skies scenario, we see Constellation Brands, PepsiCo, and Molson Coors as the top performing names. Our black skies analysis shows PepsiCo, Molson Coors, and Brown-Forman as our most preferred names. Constellation is in a better position today than when we entered the 2008 recession. The portfolio of brands is stronger with better margins, distributor restructuring is behind the company, and it operates in relatively stronger categories than other names. PepsiCo benefits from owning one of the world’s strongest packaged food businesses in Frito Lay and controlling its US bottlers, and, given the current multiple, we see less downside. Molson Coors volumes haven’t improved with the economy, but pricing remains very strong and rational. We assume many of the Molson Coors consumers haven’t improved in the last few years, so they have fewer gains to give back. Strong profit growth and an already depressed multiple limit downside. Brown-Forman enjoys strong brand equity in a category that is enjoying robust growth. Other segments are likely to be more affected than the spirits industry.

Under our grey skies and black skies scenarios, our least preferred names are Dr Pepper, Coca-Cola, and Hansen. The vast majority of Dr Pepper’s business is in the US and current EPS growth expectations are largely due to share repurchases, which will slow. The operational weakness in earnings growth would likely be punished if future operating profit generation is in doubt. Coca-Cola, while a strong company, currently has a robust multiple that would experience significant contraction to reach 2008 levels. With Hansen, investors are paying for top-line growth in excess of 20%. If growth were to slow to 10-12%, as it did during the recession, multiple contraction could be dramatic. While we think Hansen is in a strong place, given its balance sheet strength and ability to control most of its growth through distribution, for this exercise, we assumed the company’s worst period over the past few years as today’s black skies scenario.


UBS 53

Table 50: Recession Scenario Analysis – Beverages, Kaumil Gajrawala

Beverages


Name Ticker GDP View Grey Skies Black Skies GDP View Grey Skies Black Skies GDP View Grey Skies Black SkiesHansen Natural HANS 14.6% 11.3% 8.0% 22.1% 17.1% 12.0% $90 $66 $46Coca-Cola Company KO 5.1% -0.2% -5.5% 13.8% 5.3% -3.2% $78 $61 $49Coca-Cola Enterprises CCE 4.5% 2.3% 0.0% 12.2% 9.1% 6.0% $30 $25 $20PepsiCo Inc. PEP 5.6% 2.8% 0.0% 10.3% 5.6% 1.0% $79 $69 $60Dr Pepper Snapple DPS 3.9% 0.5% -3.0% 12.9% 5.9% -1.0% $40 $32 $25Molson Coors Brewing TAP 2.8% -1.1% -5.0% 10.9% 2.9% -5.0% $51 $43 $38Brown-Forman BFB 5.0% 1.0% -3.0% 8.4% 5.2% 2.0% $76 $65 $55Constellation STZ 4.4% -1.8% -8.0% 11.1% 2.1% -7.0% $28 $20 $13


Top 3 Preferred StocksConstellation Brands STZPepsiCo Inc. PEPMolson Coors TAP

Least 3 Preferred StocksDr Pepper Snapple DPSCoca-Cola Company KOHansen Natural HANS


Top 3 Preferred StocksPepsiCo Inc. PEPMolson Coors Brewing TAPBrown-Forman BFB

Least 3 Preferred StocksHansen Natural HANSDr Pepper Snapple DPSCoca-Cola Company KO

Source: UBS


UBS 54

Lodging, Cruise Lines and Leisure Robin Farley, 212-713-2060 Lodging

The recent market pullback, fears over a major macro-economic slowdown and declines in consumer confidence have led us to consider, as a theoretical exercise, a grey skies and black skies scenario analysis for the lodging sector. We believe corporate profitability is the most meaningful driver of hotel revenue growth for lodging coverage: Marriott, Starwood and Host Hotels. UBS estimates 300bps of change in US corporate profitability for every 1% change in GDP growth.

Our scenario analysis is based on lower revenue per available room (RevPAR) growth driven by reduced GDP forecasts in 2011 and 2012. Our reduced RevPAR estimates are based on a detailed statistical analysis of economic inputs, which we have been using to forecast US lodging demand.

Our current grey skies model calls for roughly 100bps reduction in annual GDP growth forecast in 2011 and 380bps of reduction in 2012 vs. current estimates, which equates to about an 80bp YOY North American RevPAR reduction in 2011 and a 460bps reduction in 2012 from our current estimates. Our black skies model estimates roughly 120bps and 640bps of reduction in gross domestic output for 2011 and 2012, respectively vs. current estimates, which equates to YOY North American RevPAR changes of 150bp and 820bp for 2011 and 2012, respectively. In short, our analysis sheds some light on who should fare better in the event of a slight or a more meaningful macro pullback.

While Marriott (MAR) is a more defensive stock vs. Starwood (HOT), as it remains more asset-light and has more exposure to upper upscale vs. luxury segments of the chain, we believe HOT remains the most attractive in our coverage universe, implying most upside at the current levels under both grey skies and black skies scenarios. HOT’s greater international exposure leaves it less exposed to a North American slowdown, as Starwood currently has ~50% of its rooms and 90% of its pipeline outside of North America, with roughly 20% of its exposure and 60% of its pipeline in Asia-Pacific. We believe HOT’s exposure to China could mitigate some RevPar declines. We estimate every 100bps of RevPAR change represents $0.06 in EPS for HOT vs. $0.04 for MAR and FFO of $0.03 for Host Hotels & Resorts (HST).

Our grey skies and black skies scenario analysis implies comparable downside risk, roughly -6% and -11% respectively, for both MAR and HOT from their respective price targets. The same analysis implies roughly 8% downside risk for HST under grey skies and about 14% downside risk under black skies. At current stock prices, HOT has the most upside under both scenarios among the three lodging names.

Our grey skies scenario analysis could take $4/share off of HOT's current price target of $70/share (6% reduction), $2/share from MAR's price target of $40/share (5% reduction) and $2/share for HST's $19/share (11% reduction). Our black skies scenario assumptions, which shock-test our estimates against a much gloomier economic outlook, take $7/share (10% reduction) from HOT's price target, $4/share from MAR's (10% reduction), and $3/share (16% reduction) from HST’s.

Lodging stocks with high exposure to the franchise business model like Choice Hotels (CHH) can be a more defensive stance while remaining exposed to the lodging industry. While franchise and management fees tend to be more resilient than earnings from owned hotels during a downturn, the higher operating and financial leverage of companies with significant property ownership (Starwood and lodging REITs like Host) normally offer the greatest upside during a recovery.

We note that supply growth remains at historic lows. Average daily rate (ADR) is becoming a more meaningful driver of RevPAR growth as it helps supporting margins.


UBS 55

Cruise Lines

For the cruise lines, our grey skies and black skies scenarios are based on lower net yields on reduced GDP forecasts and significantly lower fuel prices starting in 2012. Before getting further into the details, we note that material changes in FX could move yields, and thus revenues, significantly. However, that would be partially offset by FX impact on expenses as well, so that a net yield impact from FX fluctuations has only about 1/3 of the EPS impact that a net yield from real demand changes would have on EPS. As the booking window for cruises is 3-6 months forward, and given that consumers have historically been reluctant to cancel when within the deposit penalty period, we are making only slight adjustments to 2011 net yields in either scenario. For 2012 yields, we have modeled our grey analysis using yield conditions similar to those of 2010 for each company, given that our global forecast would call for Real GDP to be close to 2010 levels. We used the trough year in 2009 as a black skies case, as it was a recent local trough during a recession and a global crisis, and our global forecast would call for real GDP to be within ~1% of 2009 levels. For 2012, we estimate a 600bp decrease in yields vs. our current estimates in a black skies scenario, which nets to a 300bp decline in 2012 yields vs. 2011. For the grey skies scenario, we estimate a 450bp decline in 2012 yields vs. our current estimates, which nets a 150bp decline in 2012 yields vs. 2011. While the top line will be negatively impacted by net yield reductions, fuel prices could fall significantly, using the UBS assumption that WTI pricing could move to $70 and $50 per barrel in 2012 in the grey and black skies scenarios, respectively. Lower fuel prices could allow each company to recoup some EPS lost from lower top line.

We believe Carnival (CCL) is the more defensive stock in either scenario. Carnival has less operating and financial leverage, so every 1% move in constant currency net yield has a much more pronounced effect on Royal Caribbean’s (RCL) earnings than it does on Carnival’s. We estimate every 1% move in net yield represents $0.25 to RCL’s 2011 EPS and $0.15 to CCL’s 2011 EPS. Conversely, Carnival is more sensitive to movements in fuel prices. While Carnival does not hedge its fuel consumption, RCL currently has 58% of its 2011 consumption and 55% of its 2012 consumption hedged. Bottom line: Carnival is less negatively impacted from downward movements in top-line yield and more positively impacted by sharp decreases in fuel. Thus, it is the more defensive stock.

Interestingly, our scenario valuation for Carnival in both the grey and black skies scenarios would only take about $1 (or 2%) off our $44 price target, as the UBS estimated drop in fuel prices more than offsets the reduction in yield. Royal would not receive the full benefit of a drop in fuel prices given their hedged status, so we believe our scenario valuations could move to $28 (down 26%) and $25 (down 34%) in grey and black skies scenarios, respectively, compared with our current price target of $38.

Harley-Davidson

For Harley’s grey skies and black skies scenarios, although Harley shipments are not perfectly correlated with consumer expenditures and GDP, we believe the company could sustain shipment volume similar to what it experienced in the 2009 and 2010 trough years. We expect Harley may also experience volume-driven declines in gross profit margin in the black skies scenario, which the company has been steadily trying to optimize by 2013 through its extensive cost save program. Also, gross margin percentage reductions could be partly mitigated by lower commodity costs. Our grey skies scenario would yield a scenario valuation of $37 (14% reduction) while our black skies scenario would yield a scenario valuation of $31 (28% reduction) vs. our current price target of $43.


UBS 56

Table 51: Recession Scenario Analysis – Lodging, Cruise Lines & Leisure – Robin Farley

Gaming & Lodging and Leisure


Name Ticker GDP View Grey Skies Black Skies GDP View Grey Skies Black Skies GDP View Grey Skies Black SkiesCruise LinesCarnival CCL 7.7% 3.0% 1.5% 25.7% 31.2% 41.4% $44 $43 $43Royal Caribbean RCL 5.0% 0.4% -1.2% 13.8% -11.1% -15.3% $38 $27 $23

LeisureHarley Davidson HOG 16.9% -1.0% -6.3% 24.8% 14.4% -1.0% $43 $38 $31

LodgingStarwood Hotels & Resorts Worldwide HOT 5.1% 2.2% -1.0% 26.3% 14.2% 4.5% $70 $66 $63Marriott International Inc. MAR 12.9% 10.2% 8.0% 47.3% 37.2% 29.2% $40 $38 $36Host Hotels & Resorts Inc. HST 8.4% 4.0% 0.5% 36.6% 24.8% 15.4% $19 $17 $16


Top 3 Preferred StocksCarnival CCLStarwood Hotels & Resorts Worldwide HOTMarriott International Inc. MAR

Least 3 Preferred StocksRoyal Caribbean RCLHarley Davidson HOGHost Hotels & Resorts Inc. HST


Top 3 Preferred StocksCarnival CCLStarwood Hotels & Resorts Worldwide HOTMarriott International Inc. MAR

Least 3 Preferred StocksRoyal Caribbean RCLHarley Davidson HOGHost Hotels & Resorts Inc. HST

Source: UBS


UBS 57

Intentionally Blank


UBS 58

Hardline Retail Michael Lasser, 212-713-2440 For the Hardlines Retail sector, we used the guidelines on GDP and assumed that the challenging conditions result in weaker same-store sales for these companies. It is important to note that most of these stocks have been hit hard in the recent stock market volatility, so investors are already anticipating estimate reductions. Moreover, the companies that will be most impacted by a tough economic scenario are already trading at deeply discounted valuations (in many cases at distressed levels).

Our current grey skies and black skies scenarios are based on: 1) lower US GDP assumptions; and 2) lower target P/Es. However, we firmly believe the market will not apply trough multiples to trough earnings. Therefore, that should provide some support for the stocks.

Least Affected Subsectors in Both Grey Skies and Black Skies:

Auto Parts Retail

Pet Supply Retail

Our most preferred names for navigating through this more difficult environment include:

O’Reilly Automotive (ORLY)

Despite challenging comparisons in the second half, ORLY should continue to power ahead as it benefits from being over-indexed to the DIFM market and as it gains share in its legacy CSK locations. It is important to note that the company has never experienced an annual comp decline in the last 20+ years. The other element to the story is the burgeoning free cash flow that should grow at a 25% clip for the next several years even if its same store sales take a dip in a tough economic environment.

PetSmart (PETM)

PETM’s blend of having more than 50% of its sales derived from defensive, consumable items, along with the gentle inflationary benefit it will gain in the second half, means that it should hold up through a recessionary period. The drawback is the company’s discretionary sales could come under pressure, causing some gross margin erosion. We have assumed some of that in each scenario. Note that even during the depths of the last recession, the company’s comp never turned negative.

Home Depot (HD)

Home Depot is already operating at near a cyclically depressed level of earnings, is aggressively returning capital back to shareholders, has tangible asset value in the form of high real estate ownership (~90% of their stores), and has a deeply discounted valuation. In the last couple of years, the bulk of its sales have been for maintenance and repair related items, and that should continue. Also, it has some idiosyncratic gross margin drivers from the rollout of its recently completed distribution network. Plus, the stock has the added attraction of a 3.5% dividend yield.


UBS 59

Most Affected Subsectors in Both Grey Skies and Black Skies:

Office Supply Retail

Consumer Electronics

We believe the Office Supply and Consumer Electronics stocks face secular challenges that make them the most vulnerable to a slowing economic environment. These subsectors can experience an exacerbated impact from e-commerce, since their offerings face greater commoditization and price transparency. Further, they are very exposed to a downturn in consumer spending, as the office supply stores are losing relevance and the consumer electronics companies are heavily dependent on the discretionary spending backdrop.

The Office Supply subsegment is likely to be most negatively affected by a grey or black skies scenario, but the stocks are already priced for these potential outcomes, in our view. Plus, Office Depot and OfficeMax, which would see the most peril from a challenging economic environment, do not meet the minimum market cap thresholds of this analysis. Otherwise, our least preferred names in a grey or black sky scenario include:

Best Buy (BBY)

BBY is exposed to a downturn in consumer spending, as the share of wallet allocated to consumer electronics is highly discretionary. In addition, if we see a repeat of the last recession, the company’s sales will not be supported by the market share it gained when Circuit City closed. Finally, the channel shift to the online-only retailers such as Amazon could accelerate during a grey or black skies scenario.

Williams Sonoma (WSM)

We think that WSM faces risk in a slower consumer spending environment, as it sells discretionary, premium priced products. WSM’s EBIT margin is at a peak level and we believe further merchandise margin gains are limited, particularly given the rise in sourcing costs. The stock is trading at a premium PE valuation, which is at risk of contracting, given decelerating sales trends and margin pressure.

Bed Bath & Beyond (BBBY)

We think BBBY would be more impacted in a tougher spending environment than it was in the most recent downturn, as it will not realize the benefit from the collapse of a large competitor, such as Linens N’ Things. In addition, BBBY has merchandise margin risk, which was recently heightened in 1Q11 by the company’s 12.8% inventory growth rate versus sales growth of 9.7%, potentially leading to greater markdown risk in the coming quarters. The market is used to the company beating expectations, creating greater risk for the stock in the face of a spending slowdown.


UBS 60

Table 52: Recession Scenario Analysis – Hardline Retail, Michael Lasser

Hardline Retail


Name Ticker GDP View Grey Skies Black Skies GDP View Grey Skies Black Skies GDP View Grey Skies Black SkiesO'Reilly Automotive ORLY 7.7% 4.7% 3.7% 17.8% 10.2% 6.0% $70 $50 $44PetSmart PETM 5.8% 2.8% 1.8% 14.2% 5.8% 1.8% $52 $34 $30Home Depot HD 1.5% -0.5% -3.0% 20.1% 4.5% -1.9% $38 $27 $22Lowe's LOW 1.1% -2.9% -4.9% 14.3% -1.3% -8.4% $25 $17 $14Bed Bath & Beyond BBBY 5.2% 3.0% 1.0% 12.8% 9.1% 7.0% $59 $46 $41AutoZone AZO 4.5% 2.1% -0.9% 13.3% 7.8% 1.4% $305 $220 $189Best Buy BBY -1.0% -4.6% -6.6% -0.2% -12.1% -19.4% $34 $18 $14Staples SPLS 2.0% -0.8% -2.3% 14.1% -1.0% -15.2% $19 $12 $9Advance Auto Parts AAP 3.7% 1.9% -0.1% 9.3% 3.5% 0.1% $55 $44 $39Dick's Sporting Goods DKS 8.5% 6.5% 3.5% 18.3% 9.5% 3.4% $44 $26 $23Williams-Sonoma WSM 4.2% 2.2% 0.2% 9.1% 0.5% -5.7% $38 $26 $22


Top 3 Preferred StocksPetSmart PETMO'Reilly Automotive ORLYHome Depot HD

Least 3 Preferred StocksBest Buy BBYBed Bath & Beyond BBBYWilliams-Sonoma WSM


Top 3 Preferred StocksPetSmart PETMO'Reilly Automotive ORLYHome Depot HD

Least 3 Preferred StocksBest Buy BBYBed Bath & Beyond BBBYWilliams-Sonoma WSM

Source: UBS


UBS 61

Intentionally Blank


UBS 62

Household & Personal Care and Tobacco Nik Modi, 212-713-2204

Our current "grey" and "black" scenarios are based on: 1) lower US GDP assumptions; and 2) lower target P/E's. We fully acknowledge that our estimates could materially change depending on how the FX and commodities markets move. For instance, currently, Avon is one of the least affected names in our coverage due to its very low exposure to the US. However, if the Brazilian Real devalues versus the dollar, it could have a material impact on Avon's EPS power. Conversely, Clorox is currently one of the most negatively exposed companies under our scenarios. However, if the commodities markets sell off, Clorox could see significantly higher earnings power despite a slower top line.

For "black skies" we used the trough multiple from 2008, and for "grey skies" we used an average of the black skies multiple and our current target. In terms of the EPS impact, we assume sales and EPS come down by 100 bps for "grey skies" and 250 bps for "black skies" (in line with the decline in GDP).

As for specific companies, we believe US Tobacco stocks are the best option for investors worried about our grey and black skies scenarios. Tobacco stocks tend to outperform during risk averse periods, and we have significant confidence that all the companies can maintain their healthy dividend payouts. Importantly, given building cash flow, we believe Tobacco companies have the added upside of significant buybacks in the event of large sell-offs. Lorillard remains our preferred name.

We see Clorox, Estee Lauder and Energizer as the most exposed stocks on a negative side. Clorox and Energizer have significant exposure to the US market, and slowing category growth could weigh on sales and margins. However, we note that our estimates for Energizer imply significant EPS accretion from buy backs. While Estee remains the best fundamental story in our coverage, we believe the company's significant exposure to the high-income consumer could turn from a tailwind to a headwind (as sell-offs in the market typically impact high-income consumer confidence). With that being said, we believe Estee still has a lot of flexibility on costs, which could cushion a slowdown in revenues.


UBS 63

Table 53: Recession Scenario Analysis – Household Products & Personal Care and Tobacco, Nik Modi

Household Products & Personal Care and Tobacco


Name Ticker GDP View Grey Skies Black Skies GDP View Grey Skies Black Skies GDP View Grey Skies Black Skies

HPCProcter & Gamble Co. PG 6.0% 5.0% 3.5% 7.0% 6.0% 4.5% $72 $59 $47Colgate-Palmolive Co. CL 6.0% 5.0% 3.5% 10.0% 9.0% 7.5% $84 $77 $71Estee Lauder Cos. EL 8.0% 7.5% 7.0% 20.0% 15.0% 10.0% $118 $81 $47Avon Products Inc. AVP 5.0% 4.5% 4.0% 13.0% 12.5% 12.0% $33 $26 $20Church & Dwight Co. CHD 5.0% 4.5% 4.0% 12.0% 11.0% 10.0% $41 $37 $33Energizer Holdings Inc. ENR 4.0% 3.0% 1.5% 26.0% 21.0% 16.0% $92 $64 $39Clorox Co. CLX 3.0% 2.0% 0.5% 9.0% 7.0% 6.0% $75 $62 $49

TobaccoAltria Group Inc. MO 3.0% 3.0% 2.5% 9.0% 9.0% 8.5% $30 $24 $18Lorillard Inc. LO 4.0% 4.0% 3.5% 9.0% 9.0% 8.5% $124 $105 $85Reynolds American Inc. RAI 4.0% 4.0% 3.5% 7.0% 7.0% 6.5% $42 $31 $20


Most Preferred Stocks

HPCChurch & DwightAvon

TobaccoLorillard Reynolds AmericanAltria

Least Preferred Stocks

HPCCloroxProcter & Gamble

TobaccoN/A



HPCChurch & DwightAvon

TobaccoLorillard Reynolds AmericanAltria


HPCCloroxProcter & Gamble

TobaccoN/A

Source: UBS


UBS 64

Packaged Food David Palmer, 212-713-9315

To project the performance of our covered companies under a “black skies” scenario, we first determined trough revenue, EPS growth, and NTM P/E multiples by analyzing the performance of each company during the previous recession. We then applied these levels to our current 2011 projections to arrive at our black skies EPS, P/E, and implied valuation. More specifically, we applied each company’s trough EPS growth rate (currency-neutral) to our current 2011E EPS to arrive at our black skies 2012 EPS forecast. We then calculated the black skies implied valuation by applying 2008-2009 trough P/E multiple to our black skies EPS forecast.

To determine our “grey skies” scenario we averaged our current 2012E EPS, revenue, and P/E multiples with our black skies projections. We then applied our grey skies EPS to the average of our current 1-year target multiple and our black skies multiple for each company.

Under our grey and black skies scenarios, we believe Hershey and Ralcorp will be the top performing names.

Hershey’s products have a low unit price and tend to be viewed as an affordable luxury—even during difficult times. In addition, Hershey's industry leading demand growth underscores its fundamental brand momentum heading into potentially darker skies. Hershey was down only slightly in 2008 relative to peers, and we believe that Hershey would once again prove to be a relatively safe haven in a black skies scenario.

We believe that the prospect of darker economic times may encourage consumers to seek out private label and companies to seek out M&A partners. Ralcorp is a play on both of these themes—please see our notes dated 8/9 and 8/10 for details.

In a grey or black sky scenario, we believe Campbell Soup and Heinz have relatively higher downside.

Already, Campbell Soup seems to have a private label problem, and consumers reduced soup consumption during the last recession. Prior to the 2008/2009 recession, many believed that soup was a recession-proof food category. However, soup proved to be vulnerable as lower end consumers cut out side dishes or traded down to private label. We believe that Campbell will be striving to improve the quality and packaging of its soups to increase relevancy, and this may help minimize Campbell’s volume risk in a grey or black sky scenario.

While Heinz has a diverse global business, it does have some relatively pro-cyclical segments. We believe that Heinz’s frozen entrees and US food services businesses are somewhat sensitive to US employment and consumer confidence. In addition, we believe that Heinz faces relatively high private label exposure in Europe.


UBS 65

Table 54: Recession Scenario Analysis – Packaged Food, David Palmer

Packaged Food



Kraft KFT 4.9% 2.5% 0.0% 12.0% 7.0% 2.0% $42 $33 $29General Mills GIS 9.5% 2.0% -0.5% 8.6% 5.0% -5.0% $39 $35 $30Kellogg K 4.2% 3.0% 1.0% 8.4% 7.0% 1.0% $63 $53 $45Heinz HNZ 6.3% 0.0% -4.0% 11.5% 1.0% -3.0% $62 $46 $38Hershey HSY 4.5% 3.0% 1.5% 10.2% 8.0% 3.0% $58 $54 $48Campbell CPB 1.3% -2.0% -6.0% 2.4% -3.0% -8.0% $36 $28 $23ConAgra CAG 5.0% 1.0% -1.0% 9.6% 4.0% 0.0% $30 $21 $18Ralcorp RAH 7.6% 8.8% 10.0% 12.2% 8.0% 10.0% $91 $79 $71


Top 2 Preferred StocksHershey HSYRalcorp RAH

Least 2 Preferred StocksCampbell CPBHeinz HNZ


Top 2 Preferred StocksHershey HSYKraft KFT

Least 2 Preferred StocksCampbell CPBHeinz HNZ

Source: UBS


UBS 66

Restaurants David Palmer, 212-713-9315

To project the performance of our covered companies under a “black skies” scenario, we first considered trough currency-neutral revenue growth, currency-neutral EPS growth, and NTM P/E multiples by analyzing the performance of each company during the previous recession. We then adjusted prior trough growth rates to reflect significant changes in the businesses of the companies since the onset of the 2008 recession. For example: 1) Starbucks has revived its brand, reduced its unit growth, and launched its consumer products group (CPG) growth effort; 2) Wendy’s has been improving its sales trends through core menu improvements, and recently divested its underperforming Arby’s concept.

To determine our “grey skies” scenario we averaged our current 2012E EPS, revenue, and P/E multiples with our black skies projections. We then applied our grey skies EPS to the average of our current 1-year price target multiple and our black skies multiple for each company.

Our most preferred stocks under a grey skies/black skies scenario are McDonald’s and Yum! Brands. Both are strong global franchises offering attractive value tiers allowing them to deliver consistent EPS growth in a variety of economic conditions. As an example, over the past eight years, McDonalds’ worst annual EPS growth was 8%. For Yum! Brands, its worst annual EPS growth over the same time period was 13%. During 2008, MCD stock rose 6%, while YUM stock declined 18%, outperforming the S&P’s 38.5% decline. This performance also underscores the relatively stable stock and business performance during a downturn. Please see our May 16th report “YUM & MCD: Better Global Businesses?” for more detail.

Darden Restaurants (DRI) and Brinker International (EAT) are our least preferred stocks under a grey skies/black skies scenario. Relative to their fast food cousins, casual dining stocks can be more sensitive to economic downturns, given a higher proportion of company-owned units and higher average tickets. Should a severe recession ensue, we would expect an increasingly competitive environment as casual diners revisit the heavy promotional activity seen during the last recession. Although productivity enhancements may provide Brinker with some margin protection, we expect investors to penalize the multiple of both casual dining names amid declining job growth and reduced consumer discretionary spending.


UBS 67

Table 55: Recession Scenario Analysis – Restaurants, David Palmer

Restaurants



McDonald's MCD 5.7% 2.0% 0.0% 12.4% 7.1% 1.8% $97 $85 $77Yum Brands YUM 6.0% 2.0% 0.0% 13.3% 9.1% 4.8% $63 $48 $35Starbucks SBUX 13.6% 4.0% 2.0% 26.9% 16.0% 11.0% $47 $36 $30Darden Restaurants DRI 6.1% 3.5% 1.0% 13.2% 5.0% -4.0% $54 $46 $37Wendy's WEN 3.5% 1.5% -1.0% 170.0% 115.0% 60.0% $6 $5 $4Brinker Int'l EAT 2.5% 1.0% -2.0% 17.8% 8.0% -2.0% $30 $20 $17


Top 3 Preferred StocksMcDonald's MCDYum! Brands YUMStarbucks SBUX

Least 3 Preferred StocksDarden Restaurants DRIWendy's WENBrinker Int'l EAT


Top 3 Preferred StocksMcDonald's MCDYum! Brands YUMStarbucks SBUX

Least 3 Preferred StocksDarden Restaurants DRIWendy's WENBrinker Int'l EAT

Source: UBS


UBS 68

Toys Robert Carroll, 212-713-2434

During the recession of 2008/2009, due to a highly fragmented US toy market and a strong product cycle, Hasbro (HAS) revenue and earnings growth outpaced that of Mattel (MAT) and the overall industry. Looking forward into potential grey and black skies scenarios in 2011/2012 for the US and global economies, we would expect these roles to reverse. MAT now benefits from a strong product cycle and lower cost structure, while HAS is negatively impacted by higher fixed costs associated with recent long-term investments and a product cycle that is currently struggling at retail.

The profile of the overall toy industry is attractive during a recession due to the high FCF generation, low capital intensity, and high value/price equation of products manufactured by toy companies. However, under both the grey and black skies scenarios, we prefer MAT over HAS shares due to company-specific issues that will alter the operating leverage of each P&L versus what was seen during the recession of 2008/2009. The US toy industry has proven resilient during prior recessions due to the hit-based nature of the industry, allowing product cycles to drive share gains in a very fragmented market and a general lack of willingness among parents to enforce austerity measures on their young children unless absolutely necessary. That said, to evaluate the downside potential of the stocks in this exercise, we assume that for each percentage point change in US GDP, our 2012 revenue estimates for each company are adjusted downward by a similar magnitude. This reduction in revenue growth adversely impacts HAS more than MAT due to recent long-term investments that will leave Hasbro with an inflated cost structure near term, which would be difficult to reduce in the face of slowing sales. Additionally, due to a strong entertainment slate during 2012 that will drive the boys toy category, we could see these lower profitability products cannibalize sales of Hasbro’s core brands within the boys category (~34% of HAS 2010 sales). Alternatively, MAT has recently implemented a cost reduction plan that is heavily geared toward 2012, reducing its operating leverage at a time when sales could be under pressure and providing a stable base for EPS growth.

To determine downside risk for both companies, we took our 2012 EPS estimates reached under a black skies scenario and applied the relative premium/discount that each stock traded at relative to the S&P500 between October 2008 and April 2009 and applied it to the current S&P500 2012E market multiple of 10.6x to reach a black skies multiple for MAT of ~9x and for HAS of ~10x. Our grey skies valuation is based on the average of our current target multiple for each company (~15x) and our black skies multiple applied to adjusted 2012E EPS.


UBS 69

Table 56: Recession Scenario Analysis – Toys, Robert Carroll

Toys


Name Ticker GDP View Grey Skies Black Skies GDP View Grey Skies Black Skies GDP View Grey Skies Black SkiesMattel, Inc. MAT 2.1% 1.1% -2.5% 14.1% 11.1% 8.5% $33 $29 $21Hasbro, Inc. HAS 5.2% 4.2% -1.0% 3.8% 0.0% -7.5% $46 $40 $31


Top 2 Preferred StocksMattel, Inc. MATHasbro, Inc. HAS

Least Preferred StocksN/A


Top 2 Preferred StocksMattel, Inc. MATHasbro, Inc. HAS


Source: UBS


UBS 70

Intentionally Blank


UBS 71

Energy


UBS 72

Electric Utilities & IPPs Jim von Riesemann, 212-713-4260 Julien Dumoulin-Smith 212-713-9848

How does the utility sector perform during recessionary times? Not surprisingly, quite well leading into and during it, both on a relative and absolute basis, as the low-beta defensive characteristics of the group are evident. This is driven principally by the state and Federal regulatory compact that allows a utility to recover its costs of service plus a reasonable profit. In most cases, the earnings power of each company is determined largely by underlying sales volumes and maintaining sound cost controls.

In our black and grey skies scenarios, we assume various assumptions (described more fully below) to determine the potential underlying revenue, EPS, and scenario valuation changes. At the highest level, the key drivers in our two scenarios changes are commercial and industrial sales volumes, and where appropriate, assumed commodity prices.

For the regulated utilities, we calculate an average revenue change (2012 vs. 2011) of 2.9% and 2.2% for grey and black skies scenarios, respectively. The corresponding EPS changes are 6.2% and 3.4%, respectively. For the scenario valuations, our methodology is to use a baseline forward P/E multiple of 11.0x, which is consistent to the multiples experienced during the last three recessions, and then apply current relative P/E relationships off our scenario EPS figures.

How does the group perform during turbulent times? Our work indicates that the group exhibits relative outperformance to the S&P500 during the three- and six-month periods prior to economic contraction and relative underperformance during the same three and six, and twelve months following recessions.

The companies that would be the preferred choices in both grey skies and black skies scenarios are PG&E Corp. and Consolidated Edison. PG&E Corp. and Consolidated Edison are not surprises, as their regulated operations are delevered to underlying economic swings. PG&E’s only exposure is its Federal Energy Regulatory Commission (FERC) authorized businesses, and those have some revenue exposure due to electricity sales volumes. Natural gas transportation volumes also have some volumetric and hence earnings risk. We believe this exposure is approximately ten cents of lost earnings power, or less than 3% of the consolidated figure, in a black skies scenario. ConEd is also decoupled, and while it has a small unregulated business, it represents about 5% of the earnings power under a same worst case scenario.

DTE Energy is decoupled as well but still has some exposure to unregulated businesses. Under a sum of the parts or relative multiple P/E scenario, it falls outside of our criteria for preferred status. Unlike PG&E, ConEd, and DTE, Scana’s decoupling mechanism is limited to a weather normalization clause, leaving it still exposed to volumetric risk.

TECO Energy stands out well in this grey skies environment. Its regulated utility operations account for 80% of the underlying EPS and cash flow, while its coal production makes up most of the rest. Given these two disparate businesses, we value TECO under a sum of the parts basis. The combination of using the revised baseline P/E multiple and a lower commodity price deck produces muted downside. However, under a black skies scenario, where the downturn in coal price assumptions is more severe, TECO fares as one of the poorer positioned amongst the utilities.

American Electric Power (AEP) and Westar Energy do not stack well in either a grey or black skies scenario. AEP has significant industrial exposure, given its Ohio valley service territory and the loss of one large industrial customer given a high fixed cost structure. Kansas-based Westar faces the same issue but on a smaller scale.

Importantly, we believe all of the dividends of these companies would be safe under both grey and black skies scenarios presuming our underlying assumptions.


UBS 73

Our preferred commodity-exposed companies under a black skies scenario include PPL Corp and Calpine. We believe PPL’s relatively more regulated earnings base provides stability to its overall earnings profile. Calpine has relatively less exposure to a prolonged period of depressed natural gas prices, and its substantially hedged position in 2011 and 2012 provides limited downside to EBITDA. We believe a key risk to our power thesis, should there be a prolonged black skies scenario, is the delay in implementation of EPA regulations, which could lead to disproportionate underperformance in the sector. However, we continue to believe that even under the context of a recession, EPA regulations will largely go forward as proposed. Our least preferred name would be Dynegy, as it is relatively more exposed among its peers to any prolonged downturn, given its need to restructure debt and structural limitations regarding interest payments under its new restricted payments basket.


UBS 74

Table 57: Recession Scenario Analysis – Electric Utilities, Jim von Riesemann

Electric Utilities



American Electric Power AEP 4.7% 0.9% 0.9% 5.2% -2.0% -2.0% $37 $32 $29Consolidated Edison ED 4.0% 3.7% 3.3% 5.1% 4.9% 4.7% $52 $48 $46DTE Energy DTE 2.2% 2.1% 1.8% 5.2% 5.3% 5.5% $46 $42 $40Duke Energy DUK 2.6% 2.2% 1.7% 1.6% -0.3% -1.7% $19 $16 $15Northeast Utilities NU 2.1% 1.9% 1.6% 3.3% 4.1% 2.0% $36 $29 $28PG&E PCG 2.7% 2.1% 1.4% 4.9% 3.5% 10.8% $42 $38 $36Pinnacle West Capital PNW 3.2% 2.3% 2.1% 17.6% 11.3% 10.4% $43 $34 $33Progress Energy PGN 1.0% 1.6% 1.1% 2.0% -0.4% -9.4% $47 $39 $36SCANA Corp SCG 5.8% 5.2% 4.5% 4.0% 2.0% -0.5% $40 $33 $31Southern Company SO 2.9% 2.7% 2.4% 7.7% 6.5% 5.1% $41 $36 $34TECO Energy TE 5.2% 2.9% -1.6% 31.8% 18.2% -8.4% $19 $16 $14Westar Energy WR 6.6% 5.1% 4.8% 17.7% 17.2% 17.2% $26 $21 $20Wisconsin Energy WEC 5.0% 4.7% 4.4% 10.2% 10.2% 10.3% $35 $27 $26


Top 3 Preferred StocksPG&E Corp PCGSouthern Company SOTECO Energy TE

Least 3 Preferred StocksWestar Energy WRPinnacle West PNWProgress Energy PGN


Top 3 Preferred StocksPG&E Corp PCGConsolidated Edison EDWisconsin Energy WEC

Least 3 Preferred StocksAmerican Electric Power AEPPinnacle West Capital PNWWestar Energy WR

Source: UBS


UBS 75

Table 58: Recession Scenario Analysis – Electric Utilities & IPPs, Julien Dumoulin-Smith

Electric Utilities and IPPs



Ameren AEE 1.7% -0.5% -2.5% -3.9% -30.9% -41.1% $28 $27 $24Constellation Energy CEG 0.2% 0.1% -0.5% -25.0% -26.1% -36.3% $42 $40 $38Entergy ETR -0.7% -1.6% -2.0% -12.5% -19.0% -22.2% $71 $63 $57Exelon EXC -24.5% -5.0% -6.2% -26.5% -30.8% -34.4% $50 $44 $41PPL Corp PPL 1.4% -0.9% -1.5% -10.4% -12.5% -16.2% $28 $25 $22PSEG PEG -23.7% -25.0% -27.1% -5.0% -13.0% -18.1% $35 $33 $30Calpine CPN 2.2% 2.2% 2.2% -234.6% -348.3% -390.0% $19 $15 $14Dynegy DYN -24.4% -27.6% -31.5% 8.6% 18.7% 29.6% $6 $5 $1GenOn GEN 2.4% -1.7% -6.5% 148.6% 213.7% 327.9% $4 $2 $2NRG NRG -24.3% -30.0% -35.0% 125.7% 48.3% -47.7% $26 $21 $16


Top 3 Preferred StocksAmeren AEEConstellation Energy CEGPSEG PEG

Least 3 Preferred StocksNRG NRGDynegy DYNGenOn GEN


Top 3 Preferred StocksPPL Corp PPLCalpine CPNPSEG PEG

Least 3 Preferred StocksNRG NRGGenOn GENDynegy DYN

Source: UBS


UBS 76

Independent Refiners Craig Weiland, 212-713-3654

Our grey skies scenario encompasses a view that US composite refining margins decline to the mid-point between our present forecasts and trough levels reached in 2009. We expect margins to fall materially for all regions of the country, but estimate PADD 2 (Mid Continent) margins continue to remain supported by an historically wide WTI-Brent crude price differential of $15/Bbl in 2012. We forecast 2012 composite margins to average $10.49/Bbl, with regional margins averaging the following: East Coast ($8.76/Bbl); Mid Continent ($19.75/Bbl); Gulf Coast ($4.93/Bbl); and West Coast ($15.83/Bbl). Our grey skies scenario essentially represents a double-dip environment for gasoline and distillate demand: we forecast gasoline demand to decline 1.6% YoY in 2012 and distillate demand to fall 6.8% YoY. For reference, our 2012 refining margin forecasts are as follows: composite ($11.63/Bbl); East Coast ($9.63/Bbl); Mid Continent ($22.25/Bbl); Gulf Coast ($5.50/Bbl); West Coast ($17/Bbl). We forecast 2012 gasoline and distillate demand to grow a respective 1.3%, and 2.8%.

We believe VLO shares offer the least downside risk—and conversely, the most upside potential—in our grey skies scenario. Shares are currently trading near $20, well below our grey skies valuation of $29. VLO shares have underperformed independent refiner peers by 37% year-to-date and 116% over the last 12 months. Under our grey skies scenario, shares trade at 3.1x 2012E EV/EBITDA and 0.6x P/B (which is below the average through valuation of 0.7x achieved during 2009). We note that the smaller YoY decline in VLO’s EPS relative to peers is attributable to the expected contribution of its announced Pembroke, UK refinery acquisition. VLO’s $4.1 billion of cash on the balance sheet ranks the highest amongst any refiner in our coverage universe and provides for financial flexibility. Its portfolio of 14 refineries (including the impending close of its Pembroke refinery acquisition) provides diversification and meaningful exposure to both attractive Mid Continent refining margins and the Gulf Coast distillate export theme. We

are watching for signs of improvement to capture rates, operating costs, and utilization rates over the next 6 quarters as its series of economic improvement projects reach completion.

Our black skies scenario encompasses a view that US composite refining margins decline through levels observed during 2009 for all regions of the country except PADD 2 (Mid Continent). We expect Mid Continent refining margins to be supported by a still historically wide WTI-Brent crude price differential of $10/Bbl in 2012. We forecast 2012 composite margins to average $9.36/Bbl, with regional margins averaging the following: East Coast ($7.90/Bbl); Mid Continent ($17.25/Bbl); Gulf Coast ($4.35/Bbl); and West Coast ($14.65/Bbl). Our black skies scenario essentially represents a recession-like environment for gasoline and distillate demand: we forecast gasoline demand to decline 2.4% YoY in 2012 and distillate demand to fall 7% YoY.

We also highlight VLO as our most preferred refiner equity in our black skies scenario for the reasons outlined above. Under a black skies scenario, we value VLO shares at $26 and estimate shares trade at 3.7x 2012E EV/EBITDA. From a P/B basis, shares also trade at 0.6x—below the trough level achieved during 2009.


UBS 77

Table 59: Recession Scenario Analysis – Independent Refiners, Craig Weiland

Independent Refiners

'11 vs.'12 % Revenue Change* '11 vs.'12 % EPS Change Scenario ValuationCurrent Recession Scenario Current Recession Scenario Current Recession Scenario


Valero VLO NA NA NA 16.2% -1.1% -21.1% $31 $29 $26Tesoro TSO NA NA NA -11.6% -32.5% -56.7% $25 $22 $20HollyFrontier HFC NA NA NA 7.0% -18.3% -32.7% $87 $76 $66

*UBS does not forecast revenues for refiners


Most Preferred StockValero VLO



Most Preferred StockValero VLO


Source: UBS


UBS 78

Integrated & Regulated Natural Gas Ronald Barone, 212-713-3848 Christopher P. Sighinolfi, CFA, 212-813-2239

We think the impact of both a grey skies and a black skies type recession should be somewhat muted on the Integrated and Regulated Natural Gas groups. Of course, a black skies type recession would have a more profound impact on the earnings of both groups than a grey skies recession. Pipelines are well insulated against volumetric declines in throughput, as the Federal Energy Regulatory Commission (FERC) uses a rate-making methodology under which 85-95% of revenues are in the demand change portion of customers’ bills. Hence, negative recessionary impacts on pipeline operations should be minimal.

That said, most pipelines have diversified into exploration and production and/or midstream operations (gathering and processing). Either a grey skies or a black skies type recession result would likely create lower natural gas, oil, and natural gas liquids (NGL) prices. We forecast a grey skies recession would result in 2012 NYMEX natural gas prices of $4.25/MMBtu and WTI prices of $70/Bbl, while a black skies type of recession would result in 2012 NYMEX natural gas prices of $3.75/MMBtu and WTI prices of $50/Bbl. NGL prices are expected to decline in tandem with oil prices under both scenarios.

The Regulated Natural Gas group consists of gas distribution companies that are regulated by local state commissions. Most gas distribution companies are fairly well insulated from volumetric change, as these companies, with changed regulatory approval, have implemented de-coupling mechanisms that de-couple volume sales from revenue. A number of the gas distribution companies have relatively safe and attractive yields with a long-standing commitment to their dividends.

The company that we believe would be the most affected under these recessionary scenarios would be QEP Resources. QEP is a pure exploration and production company with midstream operations. Approximately 60% of 2012’s estimated natural gas production and 85% of 2012’s estimated oil production is unhedged. In addition, the company’s liquids midstream operations would also be impacted by lower NGL prices.

We think the company that would be the least affected under either recessionary scenario would be Questar Corp. (STR). The largest component of this company is Wexpro, a regulated exploration and production company that sells gas to its affiliated distribution company (Questar Gas) at prices that net Wexpro an unlevered, after-tax return of 19-20%. Questar Pipeline is FERC regulated and somewhat volume-change insulated by the previously mentioned rate-making methodology. Given these strong fundamentals, contracted growth projects completed in 2011, and a newly authorized $100 million share repurchase program, we project Questar Corp. EPS to grow ~7% year over year from 2011 to 2012 in both recessionary scenarios. Additionally, as the payout ratio moves toward a stated 60% target, we project dividend growth in excess of 8%.

Master Limited Partnerships (MLP)

The MLP group can be divided into five sub-sectors: 1) Energy Infrastructure; 2) Liquids Transportation & Storage; 3) Natural Gas Transportation & Storage; 4) Natural Gas Gathering & Processing; and 5) Exploration & Production.

Energy Infrastructure

Both a grey skies and a black skies recession would have a negative earnings impact for all MLPs in the Energy Infrastructure subsector, with a black skies recession having a much more severe impact. The impact on the individual MLPs would vary depending on the diversity of their businesses.


UBS 79

Liquids Transportation & Storage

We believe the Liquids Transportation & Storage business would be impacted, as there would be a lower demand for refined products.

Natural Gas Transportation & Storage

Natural Gas Transportation & Storage would be the least impacted subsector, in our view, as major components of earnings are derived from interstate transportation and, as described in the Integrated/Regulated Natural Gas Group section, pipelines are well insulated against volumetric declines in throughput because FERC uses a rate-making methodology under which 85-95% of revenues are in the demand charge portion of customers’ bills.

Natural Gas Gathering & Processing

The Natural Gas Gathering & Processing subsector would be impacted materially by both types of recessions, as NGL prices move in tandem with oil prices and we believe WTI crude pricing would decline to $70/Bbl under a grey skies scenario and $50/Bbl in a black skies scenario. Moreover, the demand for NGLs would also fall due to a global slowdown in manufacturing activity.

Exploration & Production

Finally, the impact of these recessionary scenarios on the Exploration & Production MLPs would depend on the relative level of commodity hedges in place for 2012 production. For unhedged production, we forecast a NYMEX natural gas price of $4.25/MMBtu under a grey skies scenario and $3.75/MMBtu under a black skies condition; as previously noted, WTI crude prices are also expected to decline.

Aside from direct earnings implications, we note that MLPs are reliant on external financing to fund future growth projects, as they pay out a large portion of cash flow annually in distributions. As such, it is important to highlight that we do not envision a shut-down in the capital markets, as was the case in the 2008-2009 recession, and also note that balance sheets are, in general, improved from that period. However, we also point out that MLPs are largely held by retail/individual investors and trading liquidity is limited; hence, unit prices are likely to gap down in periods of market turmoil due to liquidity constraints.

Most Affected Name

Based on our forecasts and projections, Targa Resources (NGLS) would be the most negatively impacted by either recession scenario due to its extensive natural gas processing operations.

Least Affected Name(s)

Conversely, under either grey skies or black skies conditions, we think El Paso Pipeline Partners (EPB) would be significantly insulated from adverse earnings pressures, as its FERC-regulated natural gas transmission, storage, and LNG businesses are contracted under long-term demand charge arrangements with investment-grade counterparties. As such, EPB’s earnings and cash flows are largely insensitive to declines in throughput volumes. Furthermore, we highlight a strong balance sheet, robust distribution coverage (~1.35x), and a strong commitment to distribution growth ($0.02/quarter average increases over the previous six quarters).

Although investor perception may be to discard units of Linn Energy (LINE) due to its operations in exploration and production, we highlight that the company is 100% hedged on its forecast natural gas production through 2015 (30% with put contracts) and 80% hedged on its planned oil production over the same period. Hence, its earnings and cash flows are relatively insensitive to anticipated recession-driven commodity price declines.


UBS 80

Table 60: Recession Scenario Analysis – Integrated & Regulated Natural Gas, Ronald Barone and Christopher P. Sighinolfi, CFA

Integrated & Regulated Natural Gas



AGL Resources AGL 3.6% -0.8% -11.5% 3.5% -0.6% -5.4% $42 $41 $38Atmos Energy Corp ATO -3.0% -7.7% -18.6% 9.7% 6.2% 1.8% $33 $31 $29Centerpoint Energy CNP 3.3% -0.2% -12.0% 8.3% 2.8% -3.7% $21 $21 $20El Paso EP 9.0% 6.1% 3.8% 20.9% 10.6% 2.5% $25 $25 $25Energen Resources EGN 9.6% 6.1% -4.0% 6.9% -12.4% -16.9% $72 $70 $67EQT Corp EQT 27.7% 14.9% 4.4% 30.6% -1.1% -18.1% $72 $69 $64National Fuel Gas Corp NFG 19.9% 14.3% 8.7% 17.9% 3.7% -8.3% $80 $79 $77NiSource Inc NI 3.7% 0.2% -11.6% 5.2% -2.2% -9.6% $20 $19 $18QEP Resources QEP 9.0% -7.3% -14.6% 29.1% -15.2% -25.6% $53 $50 $47Questar Corp STR 10.2% 9.2% 5.0% 7.1% 7.1% 7.1% $19 $19 $19Spectra Energy Corp SE 2.9% 0.9% -1.6% -1.7% -12.1% -23.0% $31 $29 $27UGI Corp UGI -1.1% -4.5% -15.7% 18.1% 15.7% 12.4% $38 $38 $38Williams Cos. WMB -5.4% -9.5% -13.7% 6.7% -8.8% -21.4% $39 $36 $32


Top 3 Preferred StocksQuestar Corp STREl Paso EPWilliams Cos. WMB

Least 3 Preferred StocksNiSource Inc NISpectra Energy Corp SEQEP Resources QEP


Top 3 Preferred StocksQuestar Corp STREl Paso EPWilliams Cos. WMB

Least 3 Preferred StocksNiSource Inc NISpectra Energy Corp SEQEP Resources QEP

Source: UBS


UBS 81

Intentionally Blank


UBS 82

Integrated Oil / Oil & Gas E&P William A. Featherston, 212-713-9701

Our current UBS forecasts assume Brent oil prices of $95.00/Bbl in 2012, with WTI benchmarks averaging $87.00 in 2012. Underpinning our price estimates are expectations of global crude oil demand growth slowing to +0.8% in 2012 (vs. +1.6% in 2011). We forecast non-OECD demand to remain strong in 2012, at +3.1%, while the OECD should return to a modest decline of 1.4% in 2012.

Grey skies: We assume Brent oil prices of $85.00/Bbl in 2012, with WTI benchmarks averaging $70.00/Bbl in 2012. This is based on: 1) 2012 global oil demand of +0.6%; and 2) OECD demand falling -1.7% in 2012, with non-OECD unchanged versus our current estimates.

Black skies: We assume Brent oil prices of $60.00/Bbl in 2012, with WTI benchmarks averaging $50.00/Bbl in 2012. This is based on: 1) 2012 global oil demand of +0.5%; 2) OECD demand falling -1.9% in 2012, with non-OECD unchanged versus our current estimates. For reference, WTI averaged $62/Bbl in 2009 during the depth of the Great Recession.

With respect to natural gas, we currently forecast 2012 NYMEX prices of $5.00/MMBtu. Our forecast assumes robust production growth is driven by increased drilling efficiency in the development of domestic gas shale plays. Our grey skies scenario assumes a moderate fall in demand versus our current forecasts of 71 Bcfd in 2012, resulting in a NYMEX gas price of $4.25/Mcf. Our black skies scenario price of $3.75/Mcf assumes a more pronounced decline in demand, in line with 2009 levels, when gas demand slumped -1.6% YoY.

Given the share declines in both the E&P and Integrated sectors over the last two weeks, we believe both subsectors reflect valuations near a grey skies scenario. In fact, we still see price upside for several large cap E&Ps and three out of the four majors using grey skies prices. In an economic environment with greater risk toward lower oil and gas prices, we prefer companies that currently have strong FCF generation (and are, therefore, less vulnerable to cutting capex and growth targets), superior return on capital employed (ROCE), and attractive valuation compared to peers. We prefer Anadarko Petroleum, Noble Energy, and Occidental Petroleum, which offer a combination of financial discipline and attractive asset bases supporting visible long-term growth outlooks. Under a black skies scenario, we see more value in gas-weighted E&Ps, given less relative downside in natural gas prices relative to oil. As natural gas prices are already depressed, given an oversupplied market, we see a 25% decline from our base price forecast under a black skies scenario versus a nearly 40% decline in oil price. We favor Southwestern Energy and Range Resources among the gas-weighted names, given their high-quality asset base and low cost structure in a black skies scenario. Additionally, we see the gas resource plays as potential takeout candidates in a low price environment, putting a soft floor on share prices. We also prefer majors Chevron and ExxonMobil in a low price scenario, given their strong balance sheets, material FCF generation, and cheaper valuation compared to the E&Ps.

To minimize risk in a falling oil and gas price environment, we would avoid companies with high net debt to capitalization ratios and aggressive spending programs resulting in negative FCF even at high commodity price scenarios. We note that E&Ps with above-average financial leverage underperformed peers in 2008-2009, when investors fled from companies at risk of breaking debt covenants, and were more susceptible to capex cuts and reductions in growth forecasts. We believe companies with newly acquired acreage may be at an even higher financial risk due to the need to drill to hold acreage, preventing producers from cutting back on capital programs even under lower price scenarios. We highlight Chesapeake Energy, SandRidge Energy, and EOG Resources with the most downside under both grey skies and black skies scenarios.


UBS 83

Table 61: Recession Scenario Analysis – Integrated Oil, William A. Featherston

Integrated Oil



Hess HES NA NA NA -15.4% -54.3% -124.0% $90 $64 $35Chevron CVX NA NA NA -9.1% -26.6% -59.8% $127 $92 $77ConocoPhillips COP NA NA NA -13.5% -40.3% -81.7% $77 $62 $39ExxonMobil XOM NA NA NA -7.7% -22.2% -50.4% $90 $71 $66


Top 2 Preferred StocksChevron CVXExxonMobil XOM

Least 2 Preferred StocksConocophillips COPHess HES


Top 2 Preferred StocksChevron CVXExxonMobil XOM

Least 2 Preferred StocksConocophillips COPHess HES

Source: UBS


UBS 84

Table 62: Recession Scenario Analysis – Oil & Gas Exploration and Production, William A. Featherston

Oil & Gas Exploration and Production



Anadarko Petroleum APC 12.4% -5.0% -27.9% 7.2% -54.1% -131.6% $100 $74 $43Apache APA -1.3% -11.3% -28.7% -17.5% -36.7% -69.1% $146 $124 $85Chesapeake Energy CHK 9.5% -13.7% -35.7% -6.7% -48.8% -89.0% $36 $20 $15Devon Energy DVN 12.9% -3.8% -19.1% 14.9% -21.3% -54.8% $90 $63 $57EOG Resources EOG 15.5% -1.7% -20.7% -4.3% -76.5% -157.2% $110 $80 $49Marathon Oil MRO 0.6% -13.4% -37.1% -11.8% -51.7% -110.4% $38 $28 $23Murphy Oil MUR 3.5% -12.2% -36.0% -20.4% -65.2% -132.9% $68 $54 $32Newfield Exploration NFX 11.8% 3.9% -19.0% 9.7% -10.0% -66.8% $81 $63 $39Noble Energy NBL 17.0% 3.7% -14.5% 17.3% -17.0% -63.9% $113 $88 $53Occidental Petroluem OXY -5.1% -20.3% -43.4% -5.6% -32.5% -72.5% $121 $95 $57Pioneer Resources PXD 13.7% 3.3% -12.9% 3.8% -30.8% -84.7% $96 $76 $46Oasis OAS 84.1% 56.4% 18.4% 93.7% 32.7% -50.7% $33 $28 $20Range Resources RRC 29.5% 24.9% 23.4% 51.7% 33.2% 27.2% $65 $59 $50SandRidge Energy SD 29.7% 17.2% 4.8% nmf nmf nmf $10 $7 $4Southwestern Energy SWN 25.8% 14.4% 6.6% 26.8% -0.1% -18.5% $52 $45 $39Ultra Petroleum UPL 6.9% -10.0% -22.3% -5.4% -37.3% -60.3% $45 $35 $28


Top 3 Preferred StocksAnadarko Petroleum APCNoble Energy NBLOccidental Petroluem OXY

Least 3 Preferred StocksChesapeake Energy CHKSandRidge Energy SDEOG Resources EOG


Top 3 Preferred StocksSouthwestern Energy SWNRange Resources RRCAnadarko Petroleum APC

Least 3 Preferred StocksChesapeake Energy CHKSandRidge Energy SDEOG Resources EOG

Source: UBS


UBS 85

Intentionally Blank


UBS 86

Oil Services & Drilling Angie Sedita, 212-713-3587

Our scenario analysis for revenue and margin assumptions is largely driven by E&P spending assumptions. Under a grey skies scenario, we forecast North American capex declines of 20%-25%, with a 5% pull-back internationally. For a black skies scenario, we forecast North American capex declines of up to 45%, with a 7%-10% reduction internationally. Our scenario analysis reflects the following 2012 commodity price assumptions: grey skies $70/Bbl WTI, $4.25/Mcf natural gas and black skies $50/Bbl WTI and $3.75/Mcf natural gas.

For the oil service companies, we have used the recent downturn in 2008 to forecast the impact of a black skies scenario, assuming a more significant decline in North American activity than international. Notably, our down-cycle forecasts for 2012 use our current 4Q11 estimates as a starting point. As such, given the sharp ramp in revenues/earnings during 2011 (particularly NAM), the revenue/earnings decline for our forecast scenarios is relatively muted.

For the offshore and land drillers, we lowered our forecast dayrate assumptions to recent lows, as well as assuming a number of rigs would become idle under a black skies scenario. However, again, the forecast decline in revenues/earnings is muted by the addition of newbuild rigs entering the fleets in late 2011/2012.

Our top three preferred stocks in a market downturn are Schlumberger, Transocean, and Baker Hughes. We think Schlumberger has by far the most protection in a down-cycle, given its size and global scale, a strong balance sheet, and market leading position across most of its product lines. Most importantly, the company is the least leveraged to the North American market and the most exposed to the international markets (international at 70% of 2012E revenues). In a market downturn, the North American land markets would be the most impacted. We would anticipate North American E&P spending to decline 20%-45% (grey skies to black skies scenarios), while international and deepwater E&P spending would only decline 5%-10% (some areas likely flat). Transocean would also be relatively well protected, given its strong FCF backlog ($10.9bn) and 6% dividend yield. Baker Hughes would be our third preferred stock in a downturn, given an even balance between North American and international revenues.

Our least preferred stocks would be Weatherford, Patterson-UTI, and Nabors Industries. Weatherford would be the most impacted by a downturn, given its high operating leverage, as well as its high debt load, at 42% net debt to capitalization. Patterson-UTI and Nabors would also be highly impacted, given the high leverage to the more volatile North American land markets. In the US, the E&P companies will spend within cash flows. We would anticipate a sharp drop in E&P cash flow under a black skies scenario, given the need for higher commodity prices to drive break-even (or attractive) field economics.


UBS 87

Table 63: Recession Scenario Analysis – Oil Services & Drilling, Angie Sedita

Oil Services & Drilling



Oil ServicesBaker Hughes BHI 15.5% 0.5% -14.9% 34.2% 11.1% -32.0% $102 $62 $48Halliburton HAL 15.7% -0.6% -16.8% 28.2% 7.5% -35.0% $68 $45 $34Schlumberger SLB 21.1% 9.7% -5.0% 42.5% 28.4% -10.0% $110 $80 $65Weatherford Internatio WFT 18.7% 4.5% -9.6% 94.8% 49.5% -30.0% $28 $17 $12

Offshore DrillersDiamond Offshore DO -3.0% -5.0% -13.2% -13.6% -19.0% -35.1% $82 $64 $49ENSCO International ESV 50.4% 45.4% 37.6% 61.2% 46.8% 32.1% $62 $48 $37Noble Corporation NE 32.3% 27.9% 21.7% 135.7% 114.2% 94.0% $50 $31 $24Rowan Companies RDC 51.2% 40.5% 26.8% 117.7% 76.5% 40.9% $50 $34 $27Transocean RIG 12.0% 9.4% 2.9% 72.0% 56.9% 31.1% $72 $58 $44

Land DrillersHelmerich & Payne HP 20.4% 10.9% 4.0% 24.4% 8.9% -30.0% $75 $53 $43Nabors Industries NBR 22.6% 15.0% -1.0% 68.9% 2.0% -35.0% $27 $17 $14Patterson-UTI Energy PTEN 20.5% 5.0% -5.0% 28.5% -10.0% -55.0% $36 $21 $16


Top 3 Preferred StocksSchlumberger SLBTransocean RIGBaker Hughes BHI

Least 3 Preferred StocksWeatherford WFTPatterson-UTI Energy PTENNabors Industries NBR


Top 3 Preferred StocksSchlumberger SLBTransocean RIGBaker Hughes BHI

Least 3 Preferred StocksWeatherford WFTPatterson-UTI Energy PTENNabors Industries NBR

Source: UBS


UBS 88

Intentionally Blank


UBS 89

Financials


UBS 90

Brokers and Universal Banks William Tanona, CFA, 212-713-2325

While the Brokers and Universal banks are extremely sensitive to macro trends and would likely suffer in either a black or grey skies scenario, the companies are far better positioned in terms of capital and liquidity than prior to the financial crisis. Therefore, we would see both scenarios as earnings events rather than capital-threatening situations. Both scenarios would have a greater earnings impact on the universal banks, which would likely return to building loss reserves on top of higher charge-offs. We expect that in a grey skies scenario, charge-offs would move up slightly towards the end of 2011 and would increase approximately 100bps in 2012, while in a black skies scenario we expect that 2012 charge-off levels could return to near their 2009/2010 peak levels. However, the banks are substantially better reserved than prior to the financial crisis, so the increased credit losses are likely to be manageable. Additionally, in the face of continued low interest rates, net interest margin (NIM) is likely to remain challenged through 2012, and companies with wealth management operations are likely to face lowered management fee income as a result of declining AUM balances.

We expect both investment banking (IB) and trading revenues would be pressured in either scenario, as lowered confidence levels would lead clients to pull back on transaction levels, although trading volumes could increase above the dismal levels seen earlier this summer. We estimate that in a black skies scenario, IB revenues could decline approximately 35% in 2012, with trading revenues down approximately 20%. Due to the already lowered market conditions, most of our companies have already announced cost-reduction plans, which we would expect to be accelerated in either a grey or black skies scenario. However, as the banks and brokers have increased their fixed cost structures, their ability to reduce costs will be more constrained than in prior downturns.

We expect that JPMorgan and Goldman Sachs would navigate these scenarios more effectively than peers, as these companies have the strongest capital markets operations and fewer legacy overhangs from the credit crisis. We see Bank of America facing the most concerns in these scenarios, with a downturn likely leading to further mortgage losses and exacerbating the bank’s recent troubles. Morgan Stanley is still in the early stages of rebuilding its fixed income, currency and commodities (FICC) franchise and integrating Morgan Stanley Smith Barney (MSSB), and we expect the firm’s turnaround would be challenged in a downturn scenario.


UBS 91

Table 64: Recession Scenario Analysis – Brokers and Universal Banks, William Tanona, CFA

Brokers and Universal Banks


Name Ticker GDP View Grey Skies Black Skies GDP View Grey Skies Black Skies GDP View Grey Skies Black SkiesBank of America BAC 19.4% 10.7% 2.5% nmf nmf nmf $11 $8 $5Citigroup C 6.6% 3.8% -0.1% 30.9% -19.3% -62.4% $56 $36 $25Goldman Sachs GS 10.0% 3.4% -5.5% 58.4% 49.0% 22.2% $200 $175 $120JPMorgan JPM 6.6% 1.6% -3.5% 15.4% -21.7% -59.4% $54 $33 $26Morgan Stanley MS 15.7% 6.0% 0.0% 46.1% 16.5% -10.8% $25 $19 $14


Top 2 Preferred StocksJP Morgan JPMGoldman Sachs GS

Least 2 Preferred StocksBank of America BACMorgan Stanley MS


Top 2 Preferred StocksJP Morgan JPMGoldman Sachs GS

Least 2 Preferred StocksBank of America BACMorgan Stanley MS

Source: UBS


UBS 92

Consumer & Specialty Finance Dean Choksi, CFA, 212-713-2382

To formulate our grey skies and black skies scenario analysis for Ares Capital and American Capital, we looked at how their portfolios performed from a credit and mark to market perspective during the 2008 and 2009 financial crises. Our black skies scenario was based on similar performance as in 2008 and 2009, while our grey skies scenario was approximately 50% “as bad” as our black skies analysis based on the cumulative GDP decline of 4.5% under a black skies scenario and 2% under a grey skies scenario. For American Capital we assumed non-accruals were higher than during the last recession since its current non-accruals are still elevated. Our non-accruals and mark to market assumptions for Ares Capital were also worse than its performance during the 2008-2009 recession, since we factored the greater deterioration that Allied Capital experienced on the remaining Allied assets in the current Ares Capital portfolio.

We were more optimistic in our scenario valuation/multiple assumptions. During the 2008-2009 recession business development companies (BDCs) traded as low as 0.3x book value. We believe part of the reason the sector traded at such steep discounts to book value was because of near-term debt maturities (for American Capital) and solvency issues at several large commercial banks that provided revolving credit facilities to the BDCs. As a sector, BDCs have extended their weighted average debt maturities, and our scenario valuation multiples implicitly assume the market does not price in the failure/liquidation of commercial banks with exposure to the sector.


UBS 93

Table 65: Recession Scenario Analysis – Consumer & Specialty Finance, Dean Choksi, CFA

Consumer & Specialty Finance


Name Ticker GDP View Grey Skies Black Skies GDP View Grey Skies Black Skies GDP View Grey Skies Black SkiesAmerican Capital ACAS 9.0% -31.0% -38.0% 0.0% -57.0% -72.0% $12 $5 $3Ares Capital ARCC 21.0% -8.0% -19.0% 15.0% -13.0% -38.0% $19 $10 $6


Most Preferred StockAres Capital ARCC

Least Preferred StockN/A


Most Preferred StockAres Capital ARCC

Least Preferred StockN/A

Source: UBS


UBS 94

Exchanges and E-Brokers Alex Kramm, CFA, 212-713-4060

Exchanges

Transaction volume represents the most significant top-line driver for exchanges. In the short term activity levels are driven by a variety of factors, such as volatility and price level of the underlying instrument, which can have both positive and negative implications on volumes. Not surprisingly, the events of the last few weeks have demonstrated that exchanges can actually perform very well in challenging times, as heightened volatility and uncertainty has driven record volumes for many markets recently. Many exchanges also delivered strong earnings during the financial crisis of late 2008, which makes it difficult to have high conviction in forecasting transaction volumes in our grey skies and black skies scenarios. That said, we believe there is a decent relationship between macroeconomic activity and volumes in the medium and long term. Capital markets have historically grown at a rate of ~2x GDP in the US, and therefore, we would expect a period of macroeconomic declines to take a toll on the exchanges’ most important revenue driver. Our base-line assumptions for annual volume declines are 5% and 12.5% for grey skies and black skies scenarios, respectively. We have also adjusted these volume assumptions based on the underlying product type. For example, we expect commodities volume to be much more levered to macroeconomic activity than other markets.

E-Brokers

E-Brokers are extremely sensitive to macro trends and would likely suffer in either a grey skies or black skies scenario. The companies’ most significant top-line drivers include retail trading volume, market performance, and net interest margins (NIMs). We believe all of these drivers would likely be negatively impacted by a period of macroeconomic declines. Increased uncertainty would likely drive retail traders to the sidelines (grey skies: -5%, black skies: -12.5%), market declines would erode portfolio values, and a low-rate environment would continue to challenge NIMs.

We expect defensive exchange operators to outperform in a period of macroeconomic declines. With only ~30% of revenue coming from transaction-related businesses, we believe NDAQ is best positioned in the exchange group if volumes are significantly challenged. The company is also trading at the lowest forward multiple in the group, which should keep multiple compression to a minimum. As the most diversified derivatives exchange, we also view CME Group (CME) as defensively positioned for a downturn. Commodities-heavy IntercontinentalExchange, Inc. (ICE) could be challenged. We prefer TD Ameritrade (AMTD) to Charles Schwab Corp. (SCHW) in a downturn scenario. AMTD has lower leverage to interest rates and client assets, while its significant trading operation is driven primarily by active traders who have been resilient during challenging periods.


UBS 95

Table 66: Recession Scenario Analysis – Exchanges and E-Brokers, Alex Kramm, CFA

Exchanges and E-brokers


Name Ticker GDP View Grey Skies Black Skies GDP View Grey Skies Black Skies GDP View Grey Skies Black SkiesChicago Board Options Exchange CBOE 17.6% 4.2% -7.4% 30.2% 9.5% -11.1% $25 $18 $12CME Group CME 11.7% -4.4% -11.3% 17.8% -6.9% -18.3% $325 $218 $164IntercontinentalExchange ICE 13.0% -3.3% -8.8% 16.5% -7.9% -19.4% $140 $89 $67NASDAQ OMX Group, Inc. NDAQ 7.7% -3.3% -7.7% 15.2% -6.5% -17.8% $28 $20 $16NYSE Euronext NYX 7.8% -4.8% -10.5% 13.7% -16.2% -33.6% $48 $21 $15TD Ameritrade Holding Corp. AMTD 11.1% 0.8% -6.2% 25.6% 6.0% -13.3% $21 $15 $10The Charles Schwab Corp. SCHW 24.9% -2.2% -15.0% 59.0% -3.8% -34.7% $22 $10 $6LPL Investment Holdings LPLA 14.5% 2.5% -8.5% 30.3% 4.5% -20.2% $37 $25 $16Apollo Global Management LLC APO 79.1% 207.8% 14.6% 107.4% 639.1% nmf $21 $11 $6


Top 3 Preferred StocksTD Ameritrade Holding Corp. AMTDNASDAQ OMX Group, Inc. NDAQLPL Investment Holdings LPLA

Least 3 Preferred StocksChicago Board Options Exchange CBOEIntercontinentalExchange ICEThe Charles Schwab Corp. SCHW


Top 3 Preferred StocksNASDAQ OMX Group, Inc. NDAQCME Group CMETD Ameritrade Holding Corp. AMTD

Least 3 Preferred StocksThe Charles Schwab Corp. SCHWChicago Board Options Exchange CBOELPL Investment Holdings LPLA

Source: UBS


UBS 96

Homebuilders & Building Products David Goldberg, 212-713-9427

In estimating the impact to homebuilder results in this scenario, we assumed revenues decline 10%, with units and price each down 5%. Given that new home prices have declined nearly 20% from the peak, builders would be unable to reduce them much more and still generate a minimal profit. We assume builder operating margins under grey skies retreat back to 2009-2010 levels. We believe the decline in revenues anticipated—coupled with builders’ efforts to further adjust their cost structures—would help minimize the impact to profits. Further, this assumption is in line with the economic backdrop outlined by UBS’ Chief U.S. Economist Maury Harris and his team, given that growth over this time (2009-2010) was similar to that assumed under the grey skies scenario. Regarding impairments, our analysis assumes impairments would equal 5% of inventories, in line with our projected price decline. In order to come up with our scenario valuations, we applied our current multiples to the adjusted book values (to reflect the additional impairments that would be incurred).

For black skies, we expect revenues to decline 15%, with units down 5% and price down 10%. The increased severity of the economic conditions in this scenario would likely cause greater pricing pressure in the existing home market, which would force builders to implement further price declines/incentives. We assume builder operating margins under black skies would retreat back to levels seen during the depths of the downturn (in 2008-2009). Our black skies analysis assumes impairments would equal 15% of inventories. Regarding valuation, we applied our current multiples to the adjusted book values (to reflect the additional impairments that would be incurred).


UBS 97

Table 67: Recession Scenario Analysis – Homebuilders & Building Products, David Goldberg

Homebuilders & Building Products

'11 vs.'12 % Revenue Change '11 vs.'12 % EPS Change Scenario ValuationCurrent Recession Scenario Current Current Recession Scenario

Name Ticker GDP View Grey Skies Black Skies GDP View Grey Skies Black Skies GDP View Grey Skies Black SkiesDR Horton DHI 13.9% -10.0% -15.0% nmf nmf nmf $13 $12 $11Lennar Corp LEN 15.8% -10.0% -15.0% 100.2% nmf nmf $21 $17 $17Masco Corp MAS 1.9% -3.0% -10.0% nmf nmf nmf $8 $6 $5Mohawk Industries MHK 5.1% -3.0% -10.0% 39.2% -2.0% -83.0% $75 $71 $69PulteGroup Inc. PHM 14.7% -10.0% -15.0% nmf nmf nmf $8 $7 $7Toll Brothers TOL 13.9% -10.0% -15.0% nmf nmf nmf $25 $24 $22


Top 3 Preferred StocksToll Brothers TOLLennar Corp LENDR Horton DHI

Least 2 Preferred StocksMasco Corp MASPulte Group PHM


Top 3 Preferred StocksToll Brothers TOLMohawk Industries MHKDR Horton DHI

Least 2 Preferred StocksMasco Corp MASPulte Group PHM

Source: UBS


UBS 98

Insurance (Life) Andrew Kligerman, 212-713-2492

The operating revenues/earnings of the U.S. life group are relatively resilient during recessions because the majority of their top/bottom lines comes from in-force business. Other macro factors—namely equity markets and, to a lesser extent, new money yields—likely will have a more immediate earnings and book value impact. a) For equity markets, our grey skies scenario assumes the S&P500 falls to 1,075 by year-end 2011 (from 1,321 at 2Q11-end), then rises to 1,275 by year-end 2012. Our black skies scenario assumes the S&P500 drops to 1,075 by year-end 2011, then falls further to 800 by 2Q12 before rising to 900 by year-end 2012. Potential equity market-driven deferred acquisition cost and variable annuity reserve true-ups are not reflected in our operating EPS projections, but have been factored into our book value forecasts. b) We assumed that low new money yields would continue to exert pressure on our life insurers. More specifically, we assumed that the average of Moody’s Corporate Aa and A bond yields would fall and remain at 4.75% and 4.25% under our grey skies and black skies scenarios, respectively. We also assumed that life insurers would err on the side of prudence by halting their share repurchase plans under both scenarios.

We favor life insurers with stronger capital positions because of their ability to weather challenging economic, equity market, interest rate, and credit conditions. During the last financial crises, it was the better-capitalized insurers that were better able to take advantage of acquisition and market share gain opportunities arising from distress at less-well-capitalized competitors.

Our most preferred U.S. life stocks under the grey and black skies scenarios are Reinsurance Group of America, Ameriprise Financial, and MetLife—given their solid excess capital levels, sound investments, relatively favorable combined sensitivity to lower equity markets, interest rates, and U.S. GDP growth, as well as geographical diversification.

Our least preferred stock under these scenarios is Principal Financial, given its relative weakness on the factors mentioned above and a less compelling valuation proposition. Although Genworth Financial’s earnings are the most vulnerable under a recessionary scenario due to its U.S. mortgage insurance unit, we think downside risk is mitigated by its extremely low current valuation of just ~0.25x trailing BVPS (ex-AOCI) and our belief that the market has already priced in a highly negative outlook, given questions about the solvency of its mortgage insurer competitor PMI Group.


UBS 99

Table 68: Recession Scenario Analysis – Insurance (Life), Andrew Kligerman

Insurance (Life)


Name Ticker GDP View Grey Skies Black Skies GDP View Grey Skies Black Skies GDP View Grey Skies Black SkiesAFLAC Inc. AFL 3.4% 1.9% 1.4% 4.9% 2.0% 1.5% $50 $46 $41AIG AIG 5.0% 3.6% 2.3% -3.3% -11.2% -18.6% $30 $26 $21Ameriprise AMP 8.5% 1.8% -8.7% 16.7% 2.5% -7.1% $76 $54 $44Genworth Financial GNW -0.6% -2.3% -3.8% 185.4% 154.4% 91.7% $22 $15 $9Hartford Financial HIG 2.3% -0.5% -5.6% 35.6% 26.9% 13.4% $42 $34 $26Lincoln National LNC 5.4% 3.8% 1.1% 1.2% -4.6% -12.3% $41 $37 $29MetLife MET 6.5% 3.1% 2.0% 11.3% 4.8% 1.6% $60 $52 $47Principal Financial PFG 6.3% 1.2% -7.1% 15.1% 5.2% -10.2% $33 $28 $22Prudential Financial PRU 5.3% 2.4% -0.8% 13.9% 4.1% -4.7% $77 $67 $56Reinsurance Group of America RGA 6.7% 2.5% 1.7% 10.1% 8.6% 8.0% $75 $74 $64


Top 3 Preferred StocksAmeriprise Financial AMPMetLife METReinsurance Group of America RGA

Least Preferred StockPrincipal Financial PFG


Top 3 Preferred StocksAmeriprise Financial AMPMetLife METReinsurance Group of America RGA

Least Preferred StockPrincipal Financial PFG

Source: UBS


UBS 100

Insurance (Non Life) Brian Meredith, 203-719-2899

The property casualty insurance industry is relatively insensitive to economic activity, with recessions having a modest impact on top-line growth and minimal impact on profitability. Inflation is generally a bigger concern for property casualty insurers’ profitability, and the low interest rate environment will continue to pressure investment yields and ROEs. For the personal lines insurers (Allstate and Progressive), we have taken a half a point/one point off personal auto premium growth for the grey/black skies scenarios, as consumers reduce the amount of coverage they purchase in a recession. As far as profitability, there is little correlation with insured losses and economic growth. A decline in oil prices can result in an increase in miles driven (resulting in more accidents); however, the weaker economy and higher unemployment will have a depressing impact on miles driven. For commercial lines insurers (ACE Ltd., Arch Capital, Axis Capital, Chubb, Travelers, W. R. Berkley, and XL Group), we have reduced our premium growth assumptions more for companies with larger workers’ compensation insurance exposure (which is sensitive to employment levels) and surety exposure (which is sensitive to construction activity). Additionally, it is less likely that casualty insurance pricing will improve in a recession. Like personal lines, there is not much evidence of changes in insured loss activity during a recession, so our changes in profitability are minimal. Finally, the reinsurers (PartnerRe, EverestRe, RenaissanceRe, and Validus Holdings) have little, if any, impact from economic activity; therefore, we have not changed revenue growth and profitability assumptions.

The insurance brokers (Aon Corp, Marsh & McLennan, and Willis Group Holding) are more sensitive to economic activity. Revenues will be impacted to the same extent as commercial lines insurance premiums; however, profitability is more impacted, as brokers have a fairly large fixed cost base, with lower revenues impacting margins. Additionally, Aon and Marsh & McLennan have consulting businesses that make up more than 40% of revenues and are more impacted by a recession.

The least preferred stocks in a recession would be the insurance brokers, with Marsh & McLennan and Aon being the most impacted due to a heavy mix of consulting businesses. The most preferred are the property reinsurers, Validus and RenaissanceRe, which are largely insensitive to an economic slowdown.


UBS 101

Table 69: Recession Scenario Analysis – Insurance (Non-Life), Brian Meredith

Insurance (Non-Life)

'11 vs.'12 % Revenue Change* '11 vs.'12 % EPS Change Scenario ValuationCurrent Recession Scenario Current Recession Scenario Current Recession Scenario

Name Ticker GDP View Grey Skies Black Skies GDP View Grey Skies Black Skies GDP View Grey Skies Black SkiesACE Limited ACE 3.7% 2.5% 1.1% 14.5% 13.3% 12.2% $77 $77 $76Allstate Corp. ALL 5.0% 4.7% 4.4% 185.6% 182.1% 178.4% $33 $33 $33AON Corp. AON 3.0% 1.7% 0.6% 11.6% 9.9% 5.8% $62 $61 $59Arch Capital ACGL 3.9% 3.5% 3.1% 45.0% 44.5% 44.0% $36 $36 $36Axis Capital AXS 3.8% 3.6% 3.4% nmf nmf nmf $39 $39 $39Chubb Corp. CB 2.2% 1.6% 1.0% 9.5% 9.3% 7.2% $73 $73 $73Marsh & McLennan MMC 5.5% 3.7% 2.0% 18.6% 13.0% 7.5% $33 $32 $30Progressive Corp. PGR 5.1% 4.6% 4.1% 13.8% 13.4% 13.0% $22 $22 $22PartnerRe Ltd. PRE -0.7% -0.7% -0.7% nmf nmf nmf $79 $79 $79Everest Re Group RE 2.6% 2.4% 2.0% 580.0% 578.0% 576.0% $106 $106 $106RenaissanceRe Holdings RNR 3.6% 3.6% 3.6% nmf nmf nmf $77 $77 $77Travelers Cos. TRV 3.0% 2.4% 1.8% 53.7% 52.7% 52.0% $66 $66 $66Validus Holdings VR 9.4% 9.4% 9.4% 287.0% 287.0% 287.0% $38 $38 $38W R Berkley Corp. WRB 6.4% 5.5% 4.0% 10.5% 10.2% 9.9% $33 $33 $33Willis Group WSH 4.5% 3.5% 2.8% 13.1% 11.0% 8.0% $42 $41 $40XL Capital XL 4.6% 4.0% 3.5% 63.2% 62.0% 61.0% $23 $23 $23

* for P&C re/insurers, revenues = net premium written


Top 3 Preferred StocksValidus Holdings VRAxis Capital AXSRenaissanceRe Holdings RNR

Least 3 Preferred StocksMarsh & McLennan MMCAON Corp. AONWillis Group WSH


Top 3 Preferred StocksValidus Holdings VRAxis Capital AXSRenaissanceRe Holdings RNR

Least 3 Preferred StocksMarsh & McLennan MMCAON Corp. AONWillis Group WSH

Source: UBS


UBS 102

REITs Ross Nussbaum, 212-713-2484

For the grey skies scenario, we generally assumed a more modest downturn in commercial real estate demand fundamentals than what was experienced during the recession of 2008-2009. Primary changes to demand assumptions included: 1) 50-100 bp occupancy declines; 2) 0-5% declines in market rental rates; and 3) residual impacts to reduced occupancy (ie, lower recoveries for retail REITs). We also assumed a +0-50 bp rise in capitalization (cap) rates in our NAVs, highly dependent on quality of real estate (flat cap rates for the highest quality), to reflect the impact of higher lending spreads (and debt costs) on private market values.

For the black skies scenario, we generally assumed a downturn in commercial real estate demand fundamentals consistent with what was experienced during the recession of 2008-2009. Primary changes to demand assumptions included: 1) 200-300 bp occupancy declines; 2) 5-10% declines in market rental rates; and 3) higher residual impacts to reduced occupancy (ie, lower recoveries for retail REITs). We also assumed a +50-100 bp rise in cap rates in our NAVs, highly dependent on quality of real estate (+50 bp cap rates for the highest quality), to reflect the impact of higher lending spreads (and debt costs) on private market values.

As the landlord to the economy, commercial real estate fundamentals are tied to underlying macroeconomic conditions. Slowdowns or reductions in job growth, consumer spending, and manufacturing would negatively impact occupancy and rental rates. However, due to the longer term nature of most REITs leases, the impact to cash flows occurs over time, which mitigates the immediate hit from economic changes. A decline in property level cash flows could also have negative valuation implications as investors require higher going-in yields to compensate for reduced growth prospects.

Under a grey skies scenario, our most preferred stocks are as follows:

Tanger Outlets (SKT) – We favor Tanger’s defensive portfolio of outlet centers, which proved an ability to continue to generate positive property-level net operating income (NOI) growth throughout the recession of 2008-2009. Retailer demand for outlets remains very strong, and we would expect a focus on value to remain through a recession scenario.

American Campus Communities (ACC) – We believe shares of student housing REIT ACC to be an attractive defensive play on the economy, given the relatively stable and visible cash flows on highly occupied assets achieving 3-4% annual rent increases. The macro factors supporting traditional multifamily demand (notably lack of supply) are also benefiting student housing fundamentals. Meanwhile, an estimated 1.1% annual increase in enrollments over the next several years should also help support demand and pricing trends. ACC’s assets are mostly located on or near college campuses with some of the highest enrollment growth in the US.

Camden Property Trust (CPT) – We believe CPT is an attractive way to play the recovery in the apartment sector, as shares trade at a relative discount to peers. Camden’s portfolio is primarily focused in the Sunbelt market (Washington, DC, Houston, Charlotte, Atlanta, etc.), which should continue to benefit from a declining homeownership rate and historically low turnover.


UBS 103

Our least preferred stocks under a grey skies scenario are as follows:

Digital Realty (DLR) – As DLR is a global owner/operator of data centers, we would be concerned about a slowdown in leasing velocity in a recession scenario, which could lead to a reduction in cash flow projections and funds from operations per share (FFOPS) estimates. This would likely result in valuation compression, as DLR is currently valued as a growth stock.

DuPont Fabros (DFT) – As DFT is an owner/operator of data centers throughout the US, we would be concerned about a slowdown in leasing velocity in a recession scenario, which could lead to a reduction in cash flow projections and FFOPS estimates. This would likely result in valuation compression, as DuPont is currently valued as a growth stock.

DCT Industrial (DCT) – As DCT is a Class B, secondary-market owner of industrial assets, we are concerned about the dividend in a recession scenario. DCT is not currently covering its dividend with cash flows and, as such, we would be concerned about a cut and lower yield.

Under a black skies scenario, our most and least preferred stocks remain almost the same as under a grey skies scenario, with the exception of Simon Property Group (SPG) replacing Camden Property Trust as a most preferred. SPG has proven an ability to continue to grow cash flows through even the worst of times, managing to generate positive same-store NOI growth during the “great recession.” This is a testament not only to management’s capabilities and the quality and strength of the mall portfolio, but also to the defensive nature of the company’s outlet/value portfolio (Chelsea Premium Outlets and Mills), which comprises 40% of Simon’s portfolio NOI.


UBS 104

Table 70: Recession Scenario Analysis – REITs, Ross Nussbaum

REITs'11 vs.'12 % Revenue Change '11 vs.'12 % EPS Change Scenario ValuationCurrent Recession Scenario Current Recession Scenario Current Recession Scenario

Name Ticker GDP View Grey Skies Black Skies GDP View Grey Skies Black Skies GDP View Grey Skies Black SkiesOffice REITsAlexandria Real Estate ARE 4.3% 2.9% 0.7% 5.8% 3.8% 1.1% $80 $72 $63Biomed Realty Trust BMR 3.2% 2.1% -0.6% 8.6% 6.6% 1.6% $20 $17 $14Boston Properties BXP 1.0% 0.1% -0.9% 7.0% 5.9% 4.8% $104 $98 $91Brandywine Realty BDN 0.8% -0.8% -3.6% -1.1% -5.4% -12.6% $12 $10 $7Brookfield Office Properties BPO 3.6% 3.0% 2.6% 6.9% 5.6% 4.8% $19 $18 $16Douglas Emmett Inc DEI 1.2% -0.1% -3.1% 0.8% -1.1% -4.9% $20 $16 $13Kilroy Realty KRC 7.6% 6.5% 4.3% 13.4% 11.5% 7.8% $45 $42 $38Mack-Cali Realty CLI 0.8% -0.8% -3.6% 1.4% -1.1% -5.4% $36 $32 $27Parkway Properties PKY 0.8% -0.7% -2.7% 31.8% 25.1% 15.8% $18 $15 $11SL Green SLG 8.0% 6.9% 6.1% -10.1% -11.7% -12.9% $85 $77 $70Vornado Realty VNO 0.0% 1.8% 1.2% 2.3% 2.2% 1.3% $105 $96 $91

Industrial REITsDCT Industrial Trust Inc DCT 2.7% 1.0% -1.5% 5.4% 2.1% -2.8% $6 $5 $4Duke Realty DRE 0.2% -1.0% -3.0% 3.7% 1.4% -2.8% $15 $12 $10EastGroup Properties EGP 2.5% 1.0% -1.3% 3.5% 1.1% -2.4% $47 $38 $32Liberty Property LRY 0.8% -0.6% -3.1% 1.7% -0.5% -4.4% $35 $31 $26ProLogis PLD 24.1% 22.4% 18.7% 17.3% 15.6% 11.8% $37 $34 $32STAG Industrial STAG 2.1% 0.4% -2.5% 6.0% 3.5% -0.7% $13 $12 $10

Data CentersDigital Realty Trust DLR 6.1% 2.1% -1.1% 7.3% 5.0% 1.1% $51 $45 $40Dupont Fabros Technology DFT 2.6% 2.0% 1.1% 12.9% 9.1% 6.9% $22 $20 $19

Student HousingAmerican Campus ACC 2.3% -2.5% -4.2% 11.1% 7.7% 5.2% $40 $33 $30Education Realty Trust EDR 4.9% -1.9% -3.9% 15.5% 9.8% 3.8% $10 $9 $8

MultifamilyAIMCO AIV 3.4% -0.8% -1.4% 22.4% 17.3% 13.8% $26 $20 $19AvalonBay AVB 7.2% -1.8% -2.7% 21.9% 17.5% 15.3% $130 $113 $92BRE Properties BRE 5.5% -0.9% -1.8% 12.1% 9.9% 7.7% $50 $43 $40Colonial Properties CLP 5.2% -0.7% -1.3% 9.3% 7.1% 5.3% $21 $20 $20Camden Property CPT 6.1% -0.9% -1.5% 29.9% 27.1% 25.5% $71 $62 $57Equity Residential EQR 4.8% -1.2% -2.1% 17.4% 14.4% 11.9% $63 $54 $48Essex Property ESS 6.2% -1.1% -1.9% 12.6% 10.2% 7.8% $140 $120 $107Home Properties HME 4.1% -0.7% -1.2% 12.1% 10.2% 8.7% $62 $55 $50Post Properties PPS 4.7% -0.8% -1.4% 5.9% 3.7% 1.9% $42 $38 $37UDR, Inc UDR 6.6% -0.7% -1.8% 12.4% 10.7% 8.1% $25 $23 $21

HealthcareHealth Care REIT HCN 12.2% -1.8% -9.2% 12.7% 9.1% -7.9% $57 $41 $27HCP, Inc. HCP 3.0% -1.4% -7.8% 10.1% 8.1% 1.2% $36 $34 $27Ventas, Inc. VTR 18.4% -1.7% -5.5% 8.5% 6.7% -1.0% $56 $46 $39Senior Housing Properties SNH 2.3% -1.8% -10.1% 8.2% 5.0% -8.3% $23 $21 $16Omega Healthcare Investors OHI 1.4% -5.0% -20.0% 3.6% -3.1% -23.0% $19 $12 $7Healthcare Realty HR 2.3% -1.0% -2.2% 17.2% 16.0% 14.8% $21 $15 $14

Regional MallsCBL & Associates CBL 0.8% -0.9% -3.5% -0.9% -4.2% -9.6% $18 $16 $13General Growth GGP 2.0% 0.5% -1.7% 8.1% 4.4% -1.2% $15 $15 $13Macerich Co. MAC 2.7% 1.7% -0.5% 9.4% 8.1% 5.2% $52 $52 $47Tanger Factory SKT 3.2% 2.1% 0.0% 7.5% 5.8% 2.6% $29 $28 $26Simon Property SPG 2.7% 1.7% 0.0% 5.4% 3.9% 1.2% $125 $123 $112Taubman Centers TCO 3.7% 2.4% 0.5% 7.2% 5.1% 1.7% $60 $59 $53

Shopping CentersDevelopers Diversified DDR 3.7% 1.6% -1.6% 10.5% 6.7% 1.1% $16 $15 $13Federal Realty FRT 3.3% 2.4% 0.2% 5.6% 4.1% 0.5% $89 $87 $80Kimco Realty KIM 2.7% 1.0% -2.6% 3.9% 1.8% -1.5% $20 $18 $17Regency Centers REG 2.2% 0.6% -2.1% 6.4% 3.5% -1.2% $46 $42 $38Weingarten Realty WRI 4.7% 2.7% -0.3% 3.1% -0.7% -6.5% $25 $23 $20

Self-StoragePublic Storage PSA 2.7% -0.1% -3.3% 5.4% 3.2% -0.3% $112 $105 $97

Net LeaseRealty Income O 14.4% 11.8% 9.3% 7.6% 4.8% 2.0% $33 $31 $30National Retail Properties NNN 12.6% 8.4% 4.2% 5.3% 0.0% -6.2% $26 $25 $24


Top 3 Preferred StocksTanger Outlets SKTAmerican Campus Communities ACCCamden Property Trust CPT

Least 3 Preferred StocksDigital Realty DLRDuPont Fabros DFTDCT Industrial DCT


Top 3 Preferred StocksTanger Outlets SKTAmerican Campus Communities ACCSimon Property Group SPG

Least 3 Preferred StocksDigital Realty DLRDuPont Fabros DFTDCT Industrial DCT

Source: UBS


UBS 105

Healthcare


UBS 106

Biotechnology Matthew Roden, PhD, 212-713-2491

The business model for biotechnology companies is to create cutting-edge life-saving technologies for devastating diseases for which currently available treatment approaches are lacking. Examples include novel cancer therapies, such as Celgene’s (CELG’s) Revlimid, which has added years of disease-free survival time for patients with multiple myeloma, and Gilead Sciences’ (GILD’s) all-in-one HIV therapies, which have enabled HIV+ individuals to lead a normal life with no detectable virus in the bloodstream. Because these treatment approaches are relatively non-discretionary, economic downturns tend to have little effect on operating results for the established large-cap biotech group. Accordingly, the large-cap group dramatically outperformed the broader markets leading into the troughs of 2008 and 2009 (big biotech: +10% in 2008 vs. the S&P500: down 38%), although being counter-cyclical, the group underperformed in the recovery. Revenues and EPS continued to grow despite the Great Recession and, according to our discussions with biotech management teams, the damage was limited to those who lost insurance coverage as unemployment rose and healthcare utilization decreased.

Under grey skies and black skies scenarios, we assume that each percentage point decrease in GDP results in a decrease in specialty drug demand by 1.3% based on the KGI for healthcare utilization. Therefore, a loss of nearly 2pp of GDP growth under a grey skies scenario translates into approximately 2.5% lower revenue in 2012 (ex-price increases), while a black skies scenario’s loss of nearly 4pp of growth translates into approximately 5% lower revenue in 2012. Despite high operating margins, we assume that EPS will be hit disproportionately under these scenarios, as the loss of the ability for patients to afford co-pays, or loss of insurance altogether, would result in lower realized price and an increase in free drug given, which negatively impacts margins. Therefore, we assume a 4% and 7% EPS hit, respectively. In terms of valuation, we’ve added a half-point (grey) or full point (black) to our DCF discount rates to account for increased risk and uncertainty, which corresponds well to a multiple-based analysis whereby 2012E EPS is reduced by 4% and 7%, accordingly.

Our preferred stocks in a grey skies scenario are CELG, GILD, and Pharmasset (VRUS). CELG is the highest quality name in our space and has several catalysts in 1H12 that should keep investors engaged. Underlying demand for Revlimid has been growing steadily and was marginally impacted in the 2008-09 trough. GILD and VRUS have significant value-creating catalysts in 2H11, which we expect to drive outperformance relative to the group under a challenging environment. We see risk to Amgen (AMGN) (few catalysts), Seattle Genetics (SGEN) (upside depends on insurance coverage of off-label drug usage, which is tough in a constrained environment), and Vertex Pharmaceuticals (VRTX) (demand could be impacted for the Incivek launch).

Our preferred stocks in a black skies scenario are the most defensive names, while our least preferred are those that will need to raise capital in the coming 1-2 years. The most defensive names: AMGN; Alexion Pharmaceuticals (ALXN); and CELG; the most in need of capital, in our view, in an extremely challenging environment: Incyte Pharmaceuticals (INCY); SGEN; and VRUS.


UBS 107

Table 71: Recession Scenario Analysis – Biotechnology, Matthew Roden, PhD

Biotechnology



Amgen AMGN 5.7% 3.0% 0.0% 9.7% 5.0% 2.0% $58 $55 $53Biogen BIIB 2.9% 0.0% -2.0% 5.0% 1.0% -2.0% $110 $105 $101Celgene CELG 11.2% 8.0% 6.0% 15.5% 11.0% 7.0% $71 $68 $66Gilead GILD 10.6% 8.0% 5.0% 14.4% 10.0% 7.0% $48 $47 $45Alexion ALXN 30.3% 27.0% 24.0% 39.4% 34.0% 30.0% $57 $53 $49Incyte INCY 209.6% 202.0% 134.0% nmf nmf nmf $22 $21 $19Seattle Genetics SGEN 259.6% 251.0% 242.0% nmf nmf nmf $21 $15 $14Pharmasset VRUS 909.1% 884.0% 859.0% nmf nmf nmf $160 $151 $142Vertex VRTX 140.1% 134.0% 128.0% nmf nmf nmf $56 $54 $52


Top 3 Preferred StocksCelgene CELGGilead GILDPharmasset VRUS

Least 3 Preferred StocksAmgen AMGNSeattle Genetics SGENVertex VRTX


Top 3 Preferred StocksAlexion ALXNAmgen AMGNCelgene CELG

Least 3 Preferred StocksIncyte INCYSeattle Genetics SGENPharmasset VRUS

Source: UBS


UBS 108

Healthcare Distribution Steven Valiquette, 203-719-2347

In general, the Pharmaceutical Services sector is relatively shielded from an economic downturn, with little change in overall prescription volumes in past economic downturns.

By subsector, we believe the drug distributors have the least amount of impact, followed by the pharmacy benefit managers (PBMs). Then, the retail drug chains have a little more cyclical exposure, as “front-end” sales become negatively impacted by a slowdown in consumer sentiment (linked to a slowdown in GDP).

The stock in our overall coverage universe least affected by a change in GDP is AmerisourceBergen (ABC, which is a pharma pure-play), while Cardinal Health (CAH) and McKesson (MCK) have modest medical distribution exposure.

By contrast, the Medical Distribution companies and Clinical Labs in our coverage universe have more cyclical exposure than the Pharmaceutical Services companies. In previous downturns, we have witnessed volumes negatively impacted by a rise in unemployment, which is a byproduct of lower GDP. Moreover, practitioners tend to dramatically curtail purchases of equipment when patient volumes start to slow. Thus, the company most impacted in our coverage universe is Patterson Companies (PDCO), followed closely by Quest Diagnostics (DGX).

In our methodology, we assume some slowdown in revenue for most companies, with a slightly larger negative impact to EPS for each company due to the negative operating leverage associated with the fixed cost/scale dynamics for most of these businesses. Since every company in our coverage universe is valued using P/E (with the exception of Rite Aid), we assume every company would still take some hit on valuation in conjunction with overall market weakness (consistent with historical patterns). We assume one P/E multiple point compression under a grey skies scenario and two P/E multiple point compression under a black skies scenario.


UBS 109

Table 72: Recession Scenario Analysis – Healthcare Distribution, Steven Valiquette

Healthcare Distribution


Name Ticker GDP View Grey Skies Black Skies GDP View Grey Skies Black Skies GDP View Grey Skies Black SkiesAmerisourceBergen Corp. ABC 4.0% 4.0% 3.5% 10.1% 10.1% 9.1% $46 $43 $40Cardinal Health Inc. CAH 4.3% 3.8% 3.3% 18.9% 17.9% 16.9% $51 $47 $44McKesson Corp. MCK 5.3% 4.8% 4.3% 15.3% 14.3% 13.3% $96 $88 $81Express Scripts ESRX 5.4% 4.9% 4.4% 31.7% 30.7% 29.7% $67 $62 $57Medco Health Solutions MHS 0.7% 0.2% -0.3% 15.2% 14.2% 13.2% $71 $66 $61SXC Health Solutions SXCI 27.1% 26.6% 26.1% 28.7% 27.7% 26.7% $61 $59 $56Omnicare Inc. OCR 1.0% 1.0% 0.5% 14.2% 14.2% 13.2% $31 $29 $26CVS Caremark CVS 5.6% 4.6% 3.6% 14.3% 12.8% 11.3% $45 $41 $37Walgreen Co. WAG 4.6% 3.1% 1.6% 14.3% 12.3% 10.3% $51 $47 $43Henry Schein Inc. HSIC 6.1% 4.6% 3.1% 11.7% 8.7% 5.7% $76 $70 $63Patterson Companies PDCO 4.2% 2.7% 1.2% 9.0% 6.0% 3.0% $36 $33 $30Laboratory Corp. America LH 5.0% 3.5% 2.0% 12.8% 9.8% 6.8% $101 $91 $82Quest Diagnostics Inc. DGX 3.0% 1.5% 0.0% 13.5% 10.5% 7.5% $58 $52 $46


Top 3 Preferred StocksCardinal Health Inc. CAHMcKesson Corp. MCKExpress Scripts ESRX

Least 2 Preferred StocksQuest Diagnostics Inc. DGXPatterson Companies PDCO


Top 3 Preferred StocksCardinal Health Inc. CAHMcKesson Corp. MCKExpress Scripts ESRX

Least 2 Preferred StocksQuest Diagnostics Inc. DGXPatterson Companies PDCO

Source: UBS


UBS 110

Healthcare IT Stephen Shankman, 212-713-8973

We believe the non-cyclical Healthcare IT sector is somewhat insulated from an economic downturn due to positive tailwinds provided by the Health Information Technology for Economic and Clinical Health (HITECH) Act. The HITECH Act earmarked over $30 billion to incentivize US hospitals and physicians to adopt electronic health records (EHR). With current EHR “meaningful use” adoption levels low, even under grey or black skies scenarios, we believe there will still be demand in the EHR marketplace during 2012. That said, an economic downturn could negatively impact healthcare utilization and ultimately pressure capital available to adopt or upgrade EHR; purchasing decisions may also be put on hold due to the economic uncertainty. While not directly contemplated in this exercise, we believe possible Medicare cuts (i.e., debt ceiling reduction) could potentially have a greater impact on healthcare distribution and IT companies than an economic downturn.

As such, we model 1.5% (grey skies) and 3% (black skies) reductions in revenue for hospital/physician EHR players (Allscripts [MDRX] and Cerner [CERN]) and slightly greater reductions for Quality Systems’ (QSII) physician-focused EHR business. We believe Lincare Holdings’ (LNCR) home oxygen business is more correlated to patient demographics and The Centers for Medicare & Medicaid Services (CMS) competitive bidding than economic conditions; thus, we assume a more muted impact to Lincare Holdings’ (LNCR) revenue under our recession scenario analysis. As a result of these revenue reductions and the fixed cost infrastructure needed to support these businesses, we assume a larger negative impact to EPS for all companies. Our primary valuation methodology is P/E, and consistent with prior downturns, we estimate increasing multiple contraction as the growth outlook dims. We assume a greater negative multiple impact for QSII due to its physician-focused business and lack of formal guidance and less of a multiple impact for LNCR, as it is already trading near trough valuations.


UBS 111

Table 73: Recession Scenario Analysis – Healthcare IT, Stephen Shankman

Healthcare IT


Name Ticker GDP View Grey Skies Black Skies GDP View Grey Skies Black Skies GDP View Grey Skies Black SkiesAllscripts MDRX 9.9% 8.4% 6.9% 16.2% 13.2% 10.2% $25 $22 $19Cerner CERN 13.1% 11.6% 10.1% 21.2% 18.2% 15.2% $65 $59 $53Quality Systems QSII 17.6% 15.6% 13.6% 22.4% 18.4% 14.4% $88 $76 $64Lincare LNCR 7.8% 7.3% 6.8% 18.6% 17.6% 16.6% $35 $33 $30


Top 3 Preferred StocksAllscripts MDRXLincare LNCRCerner CERN

Least Preferred StockQuality Systems QSII


Top 3 Preferred StocksAllscripts MDRXLincare LNCRCerner CERN

Least Preferred StockQuality Systems QSII

Source: UBS


UBS 112

Healthcare Providers/Hospitals Justin Lake, CFA, 212-713-2765

Under a more challenging macroeconomic backdrop, we see the greatest potential earnings headwind for the Hospital sector coming from: 1) lower overall patient volumes, with hospital utilization historically dampened in periods of high unemployment (although typically with a 1-2 year time lag); and 2) deteriorating commercial patient mix due to the lower number of commercially insured lives.

For our analysis of the potential earnings impact of lower overall patient volumes, we assume that every 1% change in unemployment represents -1.1x hospital volumes (in line with unemployment/admissions relations over the prior 20 years); and, while historically, there has been a 1-2 year time lag, we base our estimated impact off our 2012 estimates.

Relative to commercial payer mix deterioration, we assume that the uptick in unemployment would have a 1:1 relationship for commercial non-elderly adult patient volumes but less so for children, given utilization patterns. Furthermore, we assume that the majority of the lost commercial volumes would be replaced by Medicaid volumes (where hospital reimbursement is considerably lower), with the remainder shifting to uninsured patient mix (where hospitals do not collect the vast majority of billed revenues).

Under a grey skies scenario, we estimate the average EBITDA headwind here to be 4-5% (although again, we note that given the historical time lag between slowing economy and hospital utilization, the impact would likely be more modest for 2012). We estimate the average EPS impact to be much more pronounced, at approximately 12%, given the group’s significant financial leverage, with Community Health Systems Inc. (CYH; -18%), Tenet Healthcare Corp. (THC; -15%), and HCA Inc. (HCA; -13%) estimated to have the largest potential EPS exposure.

Under a black skies scenario, we estimate the average EBITDA impact to be closer to 7-8%, with an average EPS impact of approximately 20%.

From a valuation perspective, our grey skies scenario assumes a 15% average discount for the group versus the assumed 11x S&P multiple, while our black skies scenario embeds a 15% average discount versus the 10x S&P multiple.

For dialysis service provider DaVita, we would expect treatment volumes to be largely unchanged despite potential pressure on the broader economy, given the life-sustaining nature of dialysis care. Instead, we would expect the main risk here to be a deteriorating patient mix due to lower commercially insured patients (representing significantly higher revenues/margins versus Medicaid treatments). We estimate an EPS headwind of ~3% for DaVita under a grey skies scenario and -5% under black skies.


UBS 113

Table 74: Recession Scenario Analysis – Healthcare Providers/Hospitals, Justin Lake, CFA

Healthcare Providers/Hospitals


Name Ticker GDP View Grey Skies Black Skies GDP View Grey Skies Black Skies GDP View Grey Skies Black SkiesHCA Healthcare HCA 6.2% 4.0% 2.3% 6.1% -7.1% -17.1% $36 $22 $18Community Health Systems CYH 7.1% 5.0% 3.4% 9.6% -9.9% -24.5% $36 $20 $15Tenet Healthcare THC 4.4% 2.4% 0.9% 13.0% -3.1% -15.4% $9 $4 $3Universal Health Services UHS 6.9% 5.8% 5.0% 18.5% 10.1% 3.7% $65 $41 $35LifePoint Hospitals LPNT 5.4% 3.4% 1.9% 8.9% 0.1% -6.5% $49 $29 $25Health Management Associates HMA 6.5% 4.5% 2.9% 10.4% -0.9% -10.2% $14 $7 $6DaVita DVA 10.2% 9.8% 9.5% 29.9% 26.0% 23.1% $100 $79 $70


Top 3 Preferred StocksDaVita DVAUniversal Health Services UHSHCA HCA

Least 3 Preferred StocksTenet Healthcare THCCommunity Health Systems CYHLifePoint Hospitals LPNT


Top 2 Preferred StocksDaVita DVAUniversal Health Services UHS


Source: UBS


UBS 114

Large Cap Pharma, Specialty Pharma & Generics Marc Goodman, 212-713-1342 Ami Fadia, 212-713-3242

Healthcare is a relatively defensive sector during declines in real GDP, as prescription growth and healthcare utilization are relatively uncorrelated with GDP declines. Thus, for most of the stocks within our coverage, we would expect to see relatively modest hits to revenues and EPS based upon the revised GDP forecasts (about 1-2% in grey skies and 2-3% in black skies).

Importantly for pharma, the real concern isn’t slowing GDP but instead additional pricing pressure from the government (in the US, the government is about 45% of every pharma dollar, while in Europe, it’s closer to 100%). Thus, as governments are forced to address their debt, the major concern is that they will again look to pharma as an area to cut costs. For large pharma in the US, that negatively impacted revenues ~1-2% and EPS 3-5% in the last round (Obamacare). This uncertainty makes it easy for multiple contraction. However, generics and large diversified pharma generally should fare better, all else being equal.

There are a few companies that have relatively high cash pay businesses (Allergan at 30% and Medicis at 25%), which are more levered to consumer sentiment and thus consumer spending. In our analysis, we assumed these portions of the businesses were hit materially again, as they were in 2008. We would expect those names to have greater exposure to any GDP declines.

On the opposite end, large diversified pharma companies (such as Bristol, which is entering a new product cycle with strong pricing power based on new innovative products; and Pfizer, which, to a lesser extent, is a new product story; but both of which are also dramatically reducing government exposure through the loss of exclusivity of Plavix and Lipitor, respectively) are much better positioned to handle slowing growth. Generic drug makers (Watson, Teva, Perrigo, and, to a lesser extent, Mylan, which has much more exposure to European pricing pressure) are also much better positioned and could actually benefit from a slowing economy as insurers and patients look for cheaper drugs.


UBS 115

Table 75: Recession Scenario Analysis – Large Cap Pharma, Specialty Pharma & Generics, Marc Goodman

Large Cap Pharma, Specialty Pharma and Generics


Name Ticker GDP View Grey Skies Black Skies GDP View Grey Skies Black Skies GDP View Grey Skies Black SkiesBristol Myers BMY -15.0% -16.0% -17.0% -16.5% -18.5% -20.5% $30 $30 $29Merck MRK 1.0% 0.0% -1.0% 4.0% 2.5% 1.0% $42 $41 $40Pfizer PFE -4.0% -5.0% -6.0% 0.0% -1.0% -2.0% $23 $23 $22Eli Lilly LLY -6.0% -7.0% -8.0% -14.0% -16.0% -18.0% $38 $37 $36Valeant VRX 31.0% 30.0% 29.0% 43.0% 42.0% 41.0% $63 $61 $60Forest Labs FRX -31.5% -32.6% -33.7% -68.0% -68.5% -69.0% $40 $38 $36Allergan AGN 10.0% 4.0% 2.0% 15.0% 10.0% 5.0% $95 $80 $74Medicis MRX 13.0% 6.0% 4.0% 10.0% 2.0% -2.0% $37 $32 $28Endo Pharmaceuticals ENDP 22.0% 21.0% 20.0% 24.0% 23.0% 22.0% $50 $48 $45Warner Chilcott WCRX 1.0% 0.0% 0.0% 8.0% 7.0% 7.0% $28 $27 $26Mylan MYL 15.0% 13.0% 11.0% 20.0% 17.0% 16.0% $28 $26 $24Teva TEVA 22.0% 20.0% 18.0% 16.0% 14.0% 13.0% $64 $60 $57Watson WPI 16.0% 15.5% 15.0% 34.0% 33.0% 32.0% $78 $75 $73


Top 3 Preferred StocksWatson WPIBristol BMYPfizer PFE

Least 3 Preferred StocksAllergan AGNMedicis MRXEndo Pharmaceuticals ENDP


Top 3 Preferred StocksWatson WPIBristol BMYPfizer PFE

Least 3 Preferred StocksAllergan AGNMedicis MRXEndo Pharmaceuticals ENDP

Source: UBS


UBS 116

Table 76: Recession Scenario Analysis – Small-Mid Cap Specialty Pharma & Generics, Ami Fadia

Small-Mid Cap Specialty Pharma and Generics

'11 vs.'12 % Revenue Change '11 vs.'12 % EPS Change Scenario Valuation

Current Recession Scenario Current Recession Scenario Current Recession ScenarioName Ticker GDP View Grey Skies Black Skies GDP View Grey Skies Black Skies GDP View Grey Skies Black Skies

Perrigo PRGO 13.5% 13.3% 13.0% 15.5% 15.0% 14.5% $100 $92 $82


Top 3 Preferred StocksPerrigo PRGOAuxilium AUXLPar PRX

Least 3 Preferred StocksCadence CADXMomenta MNTAImpax IPXL


Top 3 Preferred StocksPerrigo PRGOAuxilium AUXLPar PRX

Least 3 Preferred StocksCadence CADXMomenta MNTAImpax IPXL

Source: UBS


UBS 117

Intentionally Blank


UBS 118

Life Sciences & Diagnostic Tools Daniel Arias, 212-713-2467 The life sciences sector is exposed to multiple end-market types, with varying degrees of sensitivity to GDP. Industrial customers (ie, chemicals, mining, materials sciences, petroleum) represent the segment most sensitive to macroeconomic cyclicality, while academic and government end-users, along with pharmaceutical and biotechnology customers, are somewhat less impacted due to more stable budgets for research tools. Within our analysis, we consider customer mix as it relates to changes in demand, as well as each company’s operational flexibility in response to top-line pressure.

In a grey skies scenario, we assume that companies focused primarily on the sale of capital equipment would see a low single-digit year-over-year decline in organic revenues, while consumables-focused companies post low to mid-single-digit growth, driven primarily by a material reduction in demand from industrial end market users. In a black skies scenario, we assume that companies selling life sciences tools see a more broad-based reduction in demand, with a sharp decline in sales to industrial customers, but also reduced spending from academic and government scientists resulting from federal spending cuts that put greater pressure on government research funding. We thus envision an organic revenue growth scenario similar to 2009, when instrument-focused tools companies averaged a mid-single digit decline (~6%), while growth for consumables-focused companies saw low single-digit growth of ~1%. We believe margins would see a greater degree of pressure than in 2009, due to leaner current operating models than those that existed prior to the recession, leaving less room for cost cutting. As such, we see earnings growth well below the levels in 2009, when many companies were able to partially offset top-line pressures with expense reductions.

On valuation: In a grey skies scenario, we assume stocks will trade at ~2 pts above their respective trough forward P/E multiples, or ~11.5x on average. In a black skies scenario, we assume stocks will trade at the trough multiples reached during 2009, or ~9.5x on average. Our scenario valuations for each company are determined by applying these multiples to the corresponding FY12 EPS estimates.

In both grey skies and black skies scenarios, we prefer companies with relatively low exposure to industrial end-markets, significant recurring revenue streams via the sale of consumables and services, and exposure to emerging market economies. Under a grey skies scenario, we most prefer Life Technologies (LIFE), Sigma-Aldrich (SIAL), and Thermo Fisher (TMO), and least prefer Mettler-Toldeo (MTD), Waters (WAT), and PerkinElmer (PKI). Under a black skies scenario, we most prefer LIFE, SIAL, and Illumina (ILMN), and again least prefer MTD, WAT, and PKI.


UBS 119

Table 77: Recession Scenario Analysis – Life Sciences & Diagnostic Tools, Daniel Arias

Life Sciences & Diagnostic Tools


Name Ticker GDP View Grey Skies Black Skies GDP View Grey Skies Black Skies GDP View Grey Skies Black SkiesIllumina ILMN 21.0% 18.0% 12.2% 34.9% 26.7% 22.7% $85 $51 $44Life Technologies LIFE 6.4% 0.3% -1.4% 13.9% 4.8% 0.8% $55 $37 $30Sigma-Aldrich SIAL 7.4% 4.1% 2.4% 10.0% 6.5% 4.3% $77 $53 $44Thermo Fisher Scientific TMO 7.0% -0.1% -3.0% 14.2% 7.1% -0.7% $72 $47 $35Bruker Corp. BRKR 7.7% 2.1% 1.0% 21.1% 15.7% 6.7% $21 $11 $9Waters Corp. WAT 8.2% -2.2% -4.4% 14.3% 4.2% 1.5% $99 $58 $46Mettler Toledo MTD 6.5% -6.5% -9.5% 17.5% 7.6% 3.1% $200 $90 $70PerkinElmer PKI 7.0% -4.2% -6.2% 17.4% 0.6% -9.1% $28 $17 $12


Top 3 Preferred StocksLife Technologies LIFESigma-Aldrich SIALThermo Fisher Scientific TMO

Least 3 Preferred StocksMettler Toledo MTDPerkinElmer PKIWaters Corp. WAT


Top 3 Preferred StocksLife Technologies LIFESigma-Aldrich SIALIllumina ILMN

Least 3 Preferred StocksMettler Toledo MTDPerkinElmer PKIWaters Corp. WAT

Source: UBS


UBS 120

Managed Care Justin Lake, CFA, 212-713-2765

For diversified Managed Care plans, we see the greatest potential impact of a more muted macroeconomic backdrop coming from a lower number in the commercially insured membership, with the 160 bp uptick in the projected unemployment rate in 2012 under a grey skies forecast representing a commercial membership headwind of -2.0% (280 bp unemployment uptick under black skies is estimated to represent a -3.5% commercial membership headwind). While plans with Medicaid business would likely see some membership gains from beneficiaries that otherwise would have been covered by employer-sponsored health insurance, given the lower revenues and assumed lower contribution margins, we estimate that the earnings benefit here would be limited (0.5% of EPS).

On average, for diversified Managed Care plans, we estimate that the EPS headwind would be 2% under a grey skies scenario, with Aetna (-3.4%) and WellPoint (-2.7%) seeing the largest impact, while Medicare-levered Humana would see the lowest impact (-0.5%). Under a black skies scenario, we estimate the EPS impact to be closer to -3.5%, on average.

From a valuation perspective, the diversified Managed Care group is currently trading at ~8x our 2012 EPS estimates, and our grey skies scenario assumes a 20% discount to the S&P multiple of 11x. Our black skies scenario embeds a 20% discount versus the S&P multiple of 10x.

With regard to government-focused Managed Care plans (HealthSpring and Amerigroup), we would expect the impact from a challenging macroeconomic backdrop to be neutral to positive. Specifically, for Medicare-levered HealthSpring, a rising unemployment rate would likely be mostly neutral to the company, given a lack of exposure to the commercially insured market. For Medicaid-focused Amerigroup, a rising unemployment rate would likely represent a revenue tailwind, given a corresponding increase in Medicaid membership rolls, although the impact on earnings is less clear, given the likely increased pressure on state budgets to potentially drive lower rates/margins and represent headwind here.


UBS 121

Table 78: Recession Scenario Analysis – Managed Care, Justin Lake, CFA

Managed Care


Name Ticker GDP View Grey Skies Black Skies GDP View Grey Skies Black Skies GDP View Grey Skies Black SkiesAetna AET 5.0% 3.8% 2.8% 4.3% 0.7% -1.9% $47 $39 $35CIGNA CI 7.8% 7.0% 6.4% 5.9% 3.6% 1.8% $59 $47 $42Coventry CVH 9.9% 9.3% 8.8% 9.8% 7.5% 5.7% $35 $26 $23Health Net HNT 0.4% -0.1% -0.5% 7.3% 5.9% 4.9% $33 $26 $23Humana HUM 7.9% 7.7% 7.5% 0.6% 0.1% -0.3% $88 $81 $74WellPoint WLP 2.6% 1.6% 0.9% 9.9% 6.9% 4.7% $90 $67 $59UnitedHealth UNH 6.1% 5.7% 5.4% 9.1% 7.4% 6.2% $60 $46 $41HealthSpring HS 10.5% 10.5% 10.5% 2.6% 2.6% 2.6% $52 $37 $34Amerigroup AGP 19.1% 22.6% 25.3% 8.6% 8.6% 8.6% $49 $46 $42


Top 3 Preferred StocksHumana HUMHealthSpring HSUnitedHealth UNH

Least 2 Preferred StocksCoventry CVHAetna AET


Top 3 Preferred StocksHumana HUMHealthSpring HSUnitedHealth UNH

Least 2 Preferred StocksCoventry CVHAetna AET

Source: UBS


UBS 122

Medical Supplies & Devices Rajeev Jashnani, CFA, 212-713-9127

Broadly speaking, in Med Tech, all companies under our coverage have exposure to surgical procedure volumes; therefore, they are impacted by overall unemployment, as health insurance is often provided at the employer level in the US. In Europe, continued economic weakness or worsening conditions may result in expanded austerity measures that would limit procedure volumes or mandate price cuts. That said, we can delineate between companies with greater economic sensitivity (eg, elective procedures that have come under increased pressure in the current downturn due to unemployment, higher co-pays, and worker reluctance to take time off work) and those with relative resiliency (eg, products used to treat chronic, symptomatic conditions). In addition, in the current US fiscal spending environment, we also consider the potential for Medicare funding cuts, which could become a factor in either the sequestration scenario or in the event that new government spending cuts are agreed upon. While it is not possible currently to determine the impact of these funding cuts on hospital profitability, those with significant hospital capex exposure may be at some risk, as well as those selling other high-margin products to hospitals.

Given the dynamics discussed above, in a black skies scenario, we would strongly prefer Abbott Laboratories (ABT). ABT trades at 9x forward earnings with a 12% free cash flow yield and offers a 4% dividend yield. ABT is the only large cap company in our space whose principal underlying end-market is materially accelerating (anti-TNFs). Further, ABT’s product in this market, Humira, is materially outgrowing the market. While utilization may decline in a worsening economy, the severe diseases treated by anti-TNF agents largely preclude substitution. Additionally, ABT has relatively low overall Medicare exposure (~5%) and relatively high emerging market exposure (>20%).

Conversely, Zimmer (ZMH) may be among the most exposed to deteriorating economic conditions. ZMH derives ~70% of revenues from hip and knee replacements, which have proven to be highly sensitive to current economic conditions. Also, declining hospital profitability could lead these institutions to ratchet up pricing pressure on input costs because improving their own efficiency is not a realistic near-term option. While ZMH can probably manage through this risk over the long term by implementing changes to its selling model, we believe there is limited opportunity to meaningfully revamp its cost structure in the near to intermediate term without sacrificing market share.


UBS 123

Table 79: Recession Scenario Analysis – Medical Supplies & Devices, Rajeev Jashnani, CFA

Medical Supplies and Devices


Name Ticker GDP View Grey Skies Black Skies GDP View Grey Skies Black Skies GDP View Grey Skies Black SkiesAbbott Laboratories ABT 4.4% 3.6% 3.0% 7.6% 6.1% 4.5% $59 $55 $52Baxter International Inc. BAX 4.5% 3.8% 2.6% 9.3% 8.1% 4.9% $67 $54 $50Boston Scientific Corp. BSX 0.8% -1.0% -2.0% 15.1% 11.0% 7.7% $8 $7 $7CareFusion Corp. CFN 3.2% 1.0% 0.0% 11.1% 6.1% 2.9% $26 $22 $22Edwards Lifesciences Corp. EW 21.1% 19.5% 18.0% 49.2% 46.4% 43.3% $92 $71 $64Johnson and Johnson JNJ 3.6% 2.9% 1.9% 5.5% 4.2% 2.0% $80 $62 $58Medtronic Inc. MDT 4.9% 2.5% 1.0% 5.7% 1.7% -1.5% $44 $37 $31St. Jude Medical Inc. STJ 6.3% 4.5% 3.0% 11.9% 9.0% 5.8% $60 $47 $40Stryker Corp. SYK 6.4% 4.5% 4.0% 11.3% 6.7% 5.4% $72 $53 $48Zimmer Holdings Inc. ZMH 4.2% 2.5% 1.5% 8.5% 4.7% 2.6% $68 $53 $50


Top 3 Preferred StocksBaxter International Inc. BAXAbbott Laboratories ABTJohnson and Johnson JNJ

Least 3 Preferred StocksZimmer Holdings Inc. ZMHMedtronic Inc. MDTBoston Scientific Corp. BSX


Top 3 Preferred StocksAbbott Laboratories ABTJohnson and Johnson JNJBaxter International Inc. BAX

Least 3 Preferred StocksZimmer Holdings Inc. ZMHMedtronic Inc. MDTBoston Scientific Corp. BSX

Source: UBS


UBS 124

Intentionally Blank


UBS 125

Industrials


UBS 126

Aerospace & Defense David Strauss, 212-713-6185

Under our grey skies scenario for the aerospace names, we assume production rates hold flat at current levels for both air transport and business jets while the aftermarket drops 5% from current levels. For air transport, overall production would be slightly higher as 787 comes through, although we see Airbus and Boeing cancelling announced production rate increases on their current in production models. While the aftermarket is still 5-10% below prior peak levels despite global flight hours being 10-15% higher, under our grey skies scenario we see the aftermarket dropping 5% as global airline capacity only grows low single digits. For defense, we assume the modernization budget declines 10% from current levels along with industry margins (pre-pension) moving 100bps lower from current peak levels to trough out around 10%.

Under our black skies scenario for the aerospace names, we assume air transport production rates decline 15% from current levels while business jets decline another 10%. For air transport, we assume in production models decline 20% partially offset by the ramp in 787. We assume the aftermarket falls back 15% under a black skies scenario, basically back to where it bottomed in late 2009/early 2010. For defense, we assume the modernization budget declines 25% from current levels along with industry margins moving 200bps lower from current peak levels to trough out around 9%.

As for the stocks, under our grey skies scenario, we see aerospace multiples moving up from current levels at roughly 11-12x (on current consensus expectations) to around 13x on average on lower earnings. Based on this we see very modest 5-10% downside for the stocks on average under our grey skies scenario. Rockwell Collins (COL), Goodrich (GR), and Spirit AeroSystems Holdings (SPR) are our preferred names under our grey skies scenario. Under our black skies scenario, we see aero multiples holding around 12x. Based on this we see 30-35% downside for the stocks on average under our black skies scenario. COL and United Technologies Corp. (UTX) are our preferred names under our black skies scenario. We see defense PE multiples troughing out around 7-8x in either scenario, modestly lower from current levels.


UBS 127

Table 80: Recession Scenario Analysis – Aerospace & Defense, David Strauss

Aerospace and Defense



Boeing BA 11.0% 0.0% -12.5% 27.9% -1.3% -22.5% $73 $48 $35Goodrich GR 8.5% -2.3% -13.0% 18.2% -4.1% -23.7% $110 $78 $58Rockwell Collins COL 8.0% -2.5% -11.0% 17.3% -2.8% -17.0% $76 $47 $37Precision Castparts PCP 14.3% -1.3% -12.3% 22.5% -1.3% -18.8% $165 $119 $91BE Aerospace BEAV 14.6% -0.5% -14.0% 25.2% -2.2% -28.8% $45 $28 $19Spirit Aerosystems SPR 18.0% 5.0% -15.0% 20.2% 7.5% -30.0% $29 $22 $13TransDigm Group TDG 7.0% -2.3% -13.3% 22.3% -2.6% -13.8% $105 $58 $48Triumph Group TGI 6.8% 0.5% -13.0% 17.1% 1.0% -20.0% $60 $40 $29Textron TXT 9.0% -10.0% -25.0% 66.7% -29.8% -100.0% $35 $15 $10United Technologies UTX 5.7% -2.0% -5.0% 16.4% 0.0% -10.0% $101 $65 $55General Dynamics GD 4.0% -10.0% -24.0% 25.5% -11.6% -29.9% $85 $50 $35Lockheed Martin LMT 0.0% -10.0% -25.0% 42.0% 5.8% -21.0% $80 $63 $41Northrop Grumman NOC 0.0% -10.0% -25.0% 15.0% -27.5% -48.5% $65 $40 $25Raytheon RTN 0.0% -10.0% -25.0% 25.3% -2.1% -25.6% $47 $40 $27


Top 3 Preferred StocksRockwell Collins COLGoodrich GRSpirit Aerosystems SPR

Least 3 Preferred StocksNorthrop Grumman NOCLockheed Martin LMTRaytheon RTN


Top 2 Preferred StocksRockwell Collins COLUnited Technologies UTX

Least 3 Preferred StocksNorthrop Grumman NOCLockheed Martin LMTRaytheon RTN

Source: UBS


UBS 128

Airfreight & Surface Transportation Rick Paterson, 212-713-7944 The two key macro assumptions used in our grey and black skies scenarios are: 1) US industrial production; and 2) oil prices.

Industrial production has the highest correlation to US transportation volumes of any of the macroeconomic metrics, with greater than an 80% correlation over time, including both the short and long term. Oil prices are obviously a fundamental input cost in the freight transportation sector—typically the second highest cost item after labor—and all companies try to pass through changes in fuel prices to customers via fuel surcharges, with varying degrees of success. Airfreight companies tend to be the most successful, with fuel surcharges recovering more than 95% of the change in fuel prices with an average six-week time lag. Railroads have the weakest coverage, typically recovering between 85-90% with a two-month lag. We’ve assumed $70 WTI in a grey skies scenario and $50 WTI in a black skies scenario, and these commodity price declines work to partially offset the damage to earnings from negative operating leverage as volumes fall.

The traditional pecking order of transportation stocks to avoid going into a recession is based on the degree of fixed costs and operating leverage in the business model. The high fixed cost “airline-like” characteristics of UPS and FedEx render their earnings most at risk, followed by the railroads, with their extensive infrastructure. At the other end of the spectrum are the pure non-asset-based brokers, specifically C.H. Robinson (CHRW) and Expeditors (EXPD). These freight brokers benefit from lower costs of purchased transportation in recessions relative to what they charge their own customers; hence, “net revenue” margins expand in recessions and compress in recoveries. In some cases (eg, CHRW in the 2009 recession), the expansion in margins can more than offset the decline in gross revenues and EPS can actually increase—albeit only marginally—in economic downturns. CHRW has demonstrated much more flexibility in this regard relative to EXPD. The truckers and asset-light companies such as JB Hunt and Hub Group fall between these fixed cost/freight broker extremes. The only change to this historical pecking order in recent times has come from the railroads, which have been able to extract secular pricing power since 2004, which acted as a partial shock absorber in the last downturn. Recent advances in IT have also allowed these companies to flex the 25% of costs that are truly variable in real time and get at the other 25% semi-variable costs faster than they have done in the past, which also limits the damage from economic downturns.

With regard to our most preferred and least preferred stocks, the list is the same under both scenarios. The natural flex in CHRW’s business model gives it the best chance of maintaining healthy earnings through a downturn. JB Hunt has the most powerful market share story—its intermodal unit, which managed to grow through the last recession and may be able to do so again. CSX is the railroad with the strongest pricing power and was the most adept at managing its resources/costs through the 2009 recession. In terms of least preferred, we think the two big airfreight companies, FedEx and UPS, in that order, are most vulnerable, given that they are, to a large degree, similar to fixed cost airlines. We also have railroad Kansas City Southern as a least preferred name due to its high valuation relative to peers and high beta, both of which would work against it in the event of a deterioration in macro fundamentals.


UBS 129

Table 81: Recession Scenario Analysis – Airfreight & Surface Transportation, Rick Paterson

Airfreight & Surface Transportation



Union Pacific UNP 9.0% 0.1% -12.0% 19.0% 6.0% -17.0% $113 $88 $64CSX CSX 7.7% -0.2% -12.2% 20.0% 4.8% -18.8% $31 $25 $17Norfolk Southern NSC 6.0% 0.4% -11.8% 14.0% 5.5% -20.2% $83 $72 $50UPS UPS 4.9% -4.0% -8.0% 16.0% 4.0% -32.0% $85 $60 $40FedEx FDX 8.9% -0.3% -12.3% 35.0% -3.0% -24.0% $112 $69 $40Kansas City Southern KSU 10.0% -1.9% -10.0% 22.0% -7.0% -24.0% $61 $40 $25Expeditors EXPD 15.0% -6.0% -16.0% 16.0% 0.0% -13.0% $62 $45 $34CH Robinson CHRW 14.0% 5.0% -5.0% 17.0% 10.0% 3.0% $92 $74 $61JB Hunt JBHT 12.0% 2.0% -7.0% 23.0% 9.0% -6.0% $55 $45 $34


Top 3 Preferred StocksC.H. Robinson CHRWJB Hunt JBHTCSX CSX

Least 3 Preferred StocksFedEx FDXUPS UPSKansas City Southern KSU


Top 3 Preferred StocksC.H. Robinson CHRWJB Hunt JBHTCSX CSX

Least 3 Preferred StocksFedEx FDXUPS UPSKansas City Southern KSU

Source: UBS


UBS 130

Airlines & OTAs Kevin Crissey, 212-713-3562

Under a grey skies scenario we estimate that revenue for the airlines would decline in the 4% to 5% range, which we approximated based on the industry’s revenue downturn during the 1990-1991 recession. That’s a negative 9% to 10% pt. swing to our current revenue growth forecast. Under a grey sky scenario, we would still forecast profits in 2012 for the carriers examined as earnings deterioration would be mitigated by lower fuel. Our fuel assumption of $70/bbl under grey skies is about $30 lower than what we’re currently using as a cost input in 2012. Under a black skies scenario, the forecasted 12% topline decline (based on 2008/2009 industry performance) would drive meaningful losses despite a $50/bbl oil assumption.

The counter-cyclicality aspects of the online travel agencies (OTAs) better enable them to deal with economic downturns. In a grey skies scenario, we still forecast earnings and revenue growth in the high single-digit range. While lower hotel rates and air fares would be a drag on topline and earnings, we estimate the OTAs would compensate with higher transaction volumes resulting from greater access to supplier (hotel and airline) inventory. Even under a black skies scenario, the OTAs are relatively well-positioned and we forecast they would still be able to produce mid-single digit topline and earnings growth.

In a grey sky scenario, we would favor Delta, Expedia and Priceline. Our grey sky valuation for DAL is $8 per share, which represents 20% upside to the stock’s current price. We also believe the high-growth rates and international diversity of the OTAs, in addition to potentially higher transaction volumes, better suits them in a grey sky economic downturn. Under a black sky scenario, we would migrate solely to the OTAs as long ideas for the same reason.

DAL’s market price would still trade at a discount to our reduced, grey skies scenario valuation of $8, which enables us to include it on our preferred list under that scenario. In general, however, given the high correlation between economic growth and airline profitability, we would shy away from the airline names under both grey skies and black skies scenarios. Under either scenario, lower oil price inputs are not enough to compensate for estimated revenue declines. A low to mid-single-digit decline in revenue would result in double-digit EPS declines for Southwest (LUV) and United Continental (UAL) under grey skies. Under black skies, revenue and earnings would decline more for the corporate-travel-oriented UAL and DAL compared with the leisure-focused LUV. However, it is likely all of the airline names would see sharper downward revisions from our current price targets than would the preferred OTAs.


UBS 131

Table 82: Recession Scenario Analysis – Airlines & OTAs, Kevin Crissey

Airlines & OTAs



Delta Air Lines DAL 3.6% -4.8% -12.0% 101.0% -6.0% -165.0% $12 $8 $5United Continental UAL 6.1% -4.3% -12.0% 33.0% -73.0% -185.0% $35 $17 $10Southwest Airlines LUV 5.6% -3.7% -8.4% 115.0% -47.0% -42.0% $9 $6 $5Priceline PCLN 12.0% 9.0% 6.7% 13.0% 10.0% 7.0% $575 $500 $425Expedia EXPE 16.0% 7.5% 3.0% 18.0% 8.4% 4.0% $33 $25 $22


Top 3 Preferred StocksExpedia EXPEPriceline PCLNDelta Air Lines DAL

Least 2 Preferred StocksSouthwest Airlines LUVUnited Continental UAL


Top 2 Preferred StocksExpedia EXPEPriceline PCLN

Least 3 Preferred StocksUnited Continental UALSouthwest Airlines LUVDelta Air Lines DAL

Source: UBS


UBS 132

Autos & Auto Parts Colin Langan, CFA, 212-713-9949

Under a black skies scenario, we estimate that US sales would fall from our current 2011 and 2012 estimates of 13.0m and 14.5m to 11.7m and 10.0m, respectively. The 2012 downside is slightly lower than 2009 sales of 10.5m, as we are excluding some of the 2009 cash for clunkers boost. The decline in sales would result in our 2011 and 2012 North American production estimates falling from 13.0m and 14.3m to 11.7m and 9.7m, respectively. Our 2012 downside estimate is higher than 2009 production of 8.6m, as inventories are currently near the ending levels in 2009, and therefore destocking would be limited. We also assumed that European production would fall from our current 2011 and 2012 estimates of 20.9m and 21.6m to 19.9m and 17.6m, respectively. Under a grey skies outlook, we assumed 2011 and 2012 US sales would fall to 11.9m and 11.25m, North American production would fall to 11.9m and 11.1m, and European production would fall to 20.5m and 19.0m, respectively.

The changes in global production would result in our 2012 sales estimates declining by 15% to 30%. We assume that the incremental lost profit on these sales would be about 15% for Johnson Controls, Lear, and Visteon and about 25% for BorgWarner. The incremental contribution margins for AutoNation are only 4% (consistent with 2009), as the higher margin parts and services sales may be positively impacted (repair vs. replace). We expect impact on the automakers would be more severe, as we estimate the incremental would be about 30% for Ford and 20% for General Motors (GM). The biggest driver is the estimate of $9,000/unit incremental contribution per vehicle in North America. The other factor that significantly impacts our valuation of the automakers is the cash burn. Automakers have a negative cash conversion cycle, as they get paid from dealers before they pay their suppliers. Consequently, we estimate under a black skies scenario that GM and Ford would burn at least $5bn in cash.


UBS 133

Table 83: Recession Scenario Analysis – Autos & Auto Parts, Colin Langan, CFA

Autos & Auto Parts


Name Ticker View Grey Skies Black Skies View Grey Skies Black Skies View Grey Skies Black Skies

Johnson Controls JCI 12.9% -1.7% -6.2% 38.0% -6.5% -15.3% $41 $30 $28BorgWarner BWA 15.5% 2.6% -6.6% 17.2% 0.0% -16.7% $87 $68 $60Lear LEA 9.6% -6.8% -10.6% 12.7% -37.2% -53.5% $68 $51 $43Visteon VC 8.0% -3.7% -8.1% 69.9% 31.5% -23.2% $88 $69 $53AutoNation AN 7.9% -3.8% -11.2% 4.0% -7.0% -14.3% $31 $25 $23Ford F 10.0% -3.2% -12.8% 32.4% -13.0% -64.3% $22 $11 $7GM GM 9.2% -9.1% -20.4% 15.9% -33.4% -100.0% $42 $30 $14


Top 3 Preferred StocksFord FVisteon VCGeneral Motors GM

Least 2 Preferred StocksAutoNation ANJohnson Controls JCI


Top 3 Preferred StocksVisteon VCLear LEABorgWarner BWA

Least 2 Preferred StocksAutoNation ANGeneral Motors GM

Source: UBS


UBS 134

Chemicals Andrew Cash, 212-713-2210

The chemical industry is an upstream process industry that converts raw materials such as gas, oil and a wide variety of ores into chemicals. These chemicals, in turn, are typically processed through a series of additional steps into a final product. In short, there is normally a long supply chain between the chemical producers and the ultimate consumer. When the economy is improving, especially from recessionary levels to a recovery phase, demand for chemicals increases much faster than the increase in real GDP because the chemical processors all along the supply chain become more optimistic and begin to increase their inventory as well as need more chemicals to meet the demand that accompanies the pick up in the economy.

Demand for chemicals and their cyclicality varies greatly from one product class to another. Generally speaking, it is typical for chemical demand to increase twice as much as real GDP during the first year or two of recovery and contract by a like amount relative to GDP during recessions. In our analysis of the grey skies and black skies scenarios we used this historical relationship as our guide.

Under a grey skies scenario our top 3 names are Mosaic, Huntsman and Dow Chemical, and our least preferred names are Olin, Kraton and Westlake. In the grey skies analysis our preferences are driven by the change in our earnings per share—because chemical stocks tend to react to changes in EPS over the short term.

In a black skies analysis our top 3 names are Mosaic, Westlake and LyondellBasel, and our least preferred names are Hunstman, Celanese and Georgia Gulf. The driver to our preferences was the balance sheet. In a very difficult economy as portrayed by a black skies scenario, we expect that investors will move to the strongest balance sheets, especially early in a downturn.


UBS 135

Table 84: Recession Scenario Analysis – Chemicals, Andrew Cash

Chemicals



Celanese CE -1.4% -6.0% -7.7% 4.8% -12.8% -26.7% $52 $43 $41Dow Chemical DOW 0.3% -4.2% -1.8% 16.9% -23.7% -58.3% $47 $44 $41Georgia Gulf GGC 18.0% 16.1% 15.1% 37.8% -27.6% -56.4% $43 $42 $40Huntsman HUN 0.8% -15.7% -31.8% 11.9% 2.4% -44.8% $23 $22 $20Kraton KRA 6.1% 3.8% -2.0% -35.9% -48.0% -77.6% $34 $34 $26LyondellBasell LYB 4.3% -10.3% -30.0% 1.1% -35.2% -59.5% $47 $42 $39Olin OLN 5.9% 2.1% 0.3% 41.2% -65.3% -97.6% $23 $17 $16Westlake WLK 8.3% -9.4% -29.1% -16.9% -45.8% -72.6% $41 $39 $35Mosaic MOS 25.0% 3.0% -11.8% 39.1% 2.8% -44.4% $80 $75 $72


Top 3 Preferred StocksMosaic MOSHuntsman HUNDow Chemical DOW

Least 3 Preferred StocksOlin OLNKraton KRAWestlake WLK


Top 3 Preferred StocksMosaic MOSWestlake WLKLyondellBassell LYB

Least 3 Preferred StocksHuntsman HUNCelanese CEGeorgia Gulf GGC

Source: UBS


UBS 136

Coal and Metals & Mining Shneur Z. Gershuni, CFA, 212-713-3974

Grey Skies

For our steel coverage, under this scenario, we assume low-volatility hard coking coal drops to $160 per ton (from forecast $195), iron ore drops to $120 per ton (from forecast $185), and the steel industry utilization rate decreases to 70% (in line with the slow recovery period of 2010). Based on this, we assume benchmark hot rolled coil (HRC) steel prices of $600 per ton. The average gross margin within our steel coverage drops from an estimated 19.3% (CLF forecast at 41%) to 9.4%, which reflects reduced pricing power on lower utilization and some fixed cost absorption. Our valuations apply average peak multiples from prior cycles to what we forecast to be a cyclical trough EBITDA.

Regarding coal, we assume pricing for eastern thermal coal drops to roughly $60/t from 3Q11 to 4Q12 (most companies have mostly contracted 2011; 2012 remains somewhat open for contract). Other regional prices are also assumed to fall, including the PRB ($11/t), Western Bit ($38/t), and ILB ($35/t). We assume met coal pricing falls to roughly $160/t for low-volatility hard coking coal. In the long term, we maintain our normalized pricing assumptions. Finally, our DCF-derived valuation was adjusted by increasing our market risk premium to 6% from 4%.

Black Skies

For our steel coverage, under this scenario, we assume low-volatility hard coking coal drops to $130 per ton (from forecast $195), iron ore drops to $90 per ton (from forecast $185), and the steel industry utilization rate decreases to 50%, which is in line with that experienced during late 2008 and early 2009. Based on this, we assume benchmark HRC steel prices of $450 per ton. The average gross margin within our steel coverage drops from an estimated 19.3% (CLF forecast at 41%) to 4.5%, which reflects diminished pricing power, very low volumes, and significant fixed cost absorption. As multiples in the most recent downturn are generally not meaningful, we reference trough pricing as a starting point for our downside scenario and compare expected operating performance against that realized in 2009.

Regarding coal, we assume pricing for eastern thermal coal drops to roughly $50/t over 3Q11 to 4Q12. Other regional prices are also assumed to fall, including the PRB ($9/t), Western Bit ($35/t), and Midwest ($30/t). We assume met coal pricing falls to roughly $130/t for low-volatility hard coking coal. In the long term, we reduced our normalized pricing assumptions to reflect investors pricing in weak prices into perpetuity. This includes eastern thermal coal at $65/t, PRB at $12/t, Western Bit at $40/t, and ILB at $35/t. We maintained our long-term $160/t low-volatility met price, as we believe this price will be supported by a structural supply shortage of met coal. Finally, our DCF-derived valuation was adjusted by increasing our market risk premium to 8% from 4%.

Company Analysis

In our steel coverage, we believe Nucor (NUE) has the least to lose in either a grey skies and black skies scenario. NUE’s stock price is not far from its trough realized in late 2008, and flexibility of operations (being able to quickly take steel production offline) is a critical advantage in a sharp downturn. Cliffs would appear to have the most to lose, as it currently trades at nearly 7x its 2009 trough (when iron touched $71/ton, below our black skies forecast for iron ore).

For coal, Walter Energy appears to have the least amount of downside risk under both scenarios. The company is globally diversified and, given our view that met coal pricing is set to sequentially decline as supply comes online, we believe there is limited downside to our current earnings estimates. We think Arch Coal presents the most amount of downside risk under a black skies scenario due to its leverage to eastern thermal coal, PRB coal, and met coal. With its recent acquisition of ICO, the company acquired a relatively open contract book for both eastern thermal and met coal, exposing it further to falling prices. Given the ever increasing cost of mining in Appalachia and impact on terminal reserve value, the company’s valuation suffers from both lower cash flow and lower terminal reserve value.


UBS 137

Table 85: Recession Scenario Analysis – Coal and Metals & Mining, Shneur Z. Gershuni, CFA

Coal and Metals & Mining


Name Ticker GDP View Grey Skies Black Skies GDP View Grey Skies Black Skies GDP View Grey Skies Black SkiesCoalArch Coal, Inc. ACI 31.6% 12.9% -0.6% 65.9% -40.0% -137.1% $42 $34 $6Alpha Natural Resources ANR 16.0% 2.6% -12.0% -38.5% -147.0% -290.4% $71 $58 $22CONSOL Energy, Inc. CNX 5.5% -4.7% -14.3% 9.0% -46.4% -102.1% $74 $61 $27Walter Energy Inc WLT 11.5% 1.2% -12.9% -5.0% -42.6% -95.6% $156 $137 $119

SteelU.S. Steel X 5.9% -26.6% -34.8% 223.0% -227.6% -508.8% $38 $26 $18Nucor NUE 7.8% -22.9% -31.5% 28.5% -93.0% -129.7% $35 $30 $28Steel Dynamics STLD 3.1% -32.5% -40.0% 3.3% -90.6% -133.2% $13 $10 $8

Iron OreCliffs Natural Resources CLF 14.7% -20.9% -39.0% 4.4% -84.8% -117.0% $122 $55 $40


Coal

Top 2 Preferred StocksAlpha Natural Resources ANR Nucor NUEWalter Energy WLT U.S. Steel X

Least 2 Preferred Stocks Least 2 Preferred StocksConsol Energy CNX Cliffs Natural Resources CLFArch Coal ACI Steel Dynamics STLD


Coal

Top 2 Preferred StocksWalter Energy WLT Nucor NUEAlpha Natural Resources ANR

Least 2 Preferred Stocks Least 2 Preferred StocksArch Coal ACI Cliffs Natural Resources CLFConsol Energy CNX U.S. Steel X

Top 2 Preferred Stocks

Most Preferred Stock

Steel/Iron Ore

Steel/Iron Ore

Source: UBS


UBS 138

Electrical Equipment & Multi-Industry Jason Feldman, 212-713-4309 We believe that the stocks in our sector are, on average, far better positioned for a recession than they were in late 2008 and 2009. Consequently, even in a black skies scenario, earnings should show greater resilience than during the last recession. That said, this group’s underlying businesses are inherently cyclical, and most stocks would probably see earnings decline in 2012 under both a grey skies or black skies scenario.

In conjunction with the scenarios provided by UBS economists, we used the 2008/2009 recession as a starting point for our analysis. For each company, we took into account changes in cost structures, the degree to which each company’s end markets have recovered (or not recovered), and changes to each company’s portfolio of businesses (eg, M&A post-2008).

Factors that we believe will result in greater earnings resilience in a potential recession (across our coverage, in general) include: (1) all companies in the sector improved their fixed cost structure during the last recession; (2) management teams learned valuable lessons during the last recession, which should enable them to respond more nimbly in the next recession; (3) balance sheets are in better shape today vs. late 2008, both in terms of total leverage, as well as debt structure and the restrictiveness of covenants; (4) we expect more aggressive cash deployment in the next downturn (both repurchases and M&A), as we believe that management teams gained confidence during the 2008/2009 downturn in their ability to manage cash flow in a deep recession; (5) many end markets—particularly residential and non-residential construction, and energy—are still at trough levels with fairly little room to fall further; (6) some companies have made substantial changes to reduce the cyclicality of their portfolios since 2009 (most notably Tyco’s partial divestiture of Electrical & Metal Products, Danaher’s acquisition of Beckman Coulter, and Emerson’s motors divestiture).

On average, it appears that the group is already pricing in a grey skies scenario similar to the one described in this report. However, in a black skies scenario, we believe all of the stocks in our sector have further downside. Based on current prices (considering most of these names have already sold off substantially), our preferred stocks in a grey skies or black skies scenario include Danaher (DHR), General Electric (GE), and Ingersoll Rand (IR), followed by Tyco (TYC) and Honeywell (HON). For a grey skies scenario, we believe this list of preferred stocks is already somewhat oversold. Each of these preferred stocks has one or more of the following three characteristics: (1) typically exhibits some degree of earnings resilience in a recession given substantial contribution from service, consumable, or aftermarket revenue; (2) primary end markets remain at or near “trough” levels; (3) recent portfolio changes (post-2009) materially reduced cyclicality, which may not be fully appreciated by investors who are using the 2008/2009 time period as a reference point when evaluating potential recession performance.

Least preferred stocks in a recession scenario include Rockwell (ROK), Emerson (EMR), Eaton (ETN), followed by Cooper (CBE). These stocks all had greater than average peak-to-trough sales and/or earnings decline during the last recession, and sales are primarily capital goods with limited service, consumables, and/or recurring revenue streams. Based on management’s commentary over the last two years, we note that Cooper is among the stocks most likely to deploy cash more aggressively during another recession (repurchases and/or M&A); if it does, our recession scenario earnings estimates may be overly bearish. Further, Rockwell arguably has the single strongest balance sheet in the group (net cash position), and Emerson and Eaton each have a reasonable amount of balance sheet flexibility. These stocks could also surprise to the upside if they use their balance sheet more aggressively than expected.


UBS 139

Table 86: Recession Scenario Analysis – Electrical Equipment & Multi-Industry, Jason Feldman

Electrical Equipment & Multi-Industry


Name Ticker GDP View Grey Skies Black Skies GDP View Grey Skies Black Skies GDP View Grey Skies Black SkiesGeneral Electric GE 0.0% -3.0% -5.0% 19.0% 0.0% -10.0% $23 $18 $133M MMM 7.0% -2.0% -8.0% 11.0% -6.0% -15.0% $103 $75 $58Emerson EMR 7.0% -5.0% -10.0% 11.0% -10.0% -20.0% $58 $38 $29Danaher DHR 17.0% 11.0% -1.0% 21.0% 11.0% -4.0% $60 $47 $38Honeywell HON 6.0% -3.0% -10.0% 11.0% -5.0% -15.0% $60 $45 $30Tyco TYC 5.0% 1.0% -4.0% 18.0% 5.0% -10.0% $50 $40 $30Eaton ETN 5.0% -7.0% -15.0% 13.0% -15.0% -35.0% $57 $42 $24Ingersoll Rand IR 6.0% -5.0% -10.0% 19.0% -15.0% -35.0% $45 $35 $23Cooper Industries CBE 7.0% -5.0% -12.0% 19.0% -10.0% -20.0% $70 $42 $28Rockwell Automation ROK 6.0% -7.0% -15.0% 19.0% -20.0% -35.0% $80 $45 $27


Top 3 Preferred StocksGeneral Electric GEDanaher DHRIngersoll Rand IR

Least 3 Preferred StocksEmerson EMRRockwell ROKCooper CBE


Top 3 Preferred StocksDanaher DHRGeneral Electric GEIngersoll Rand IR

Least 3 Preferred StocksRockwell ROKEmerson EMREaton ETN

Source: UBS


UBS 140

Engineering & Construction Steven Fisher, CFA, 212-713-8634 For a grey skies scenario, we assume that $70 oil, $2,000 gold, and $2.50 copper are sufficient to move most energy and mining projects forward, although deepwater and oil sands projects could get delayed. A generally slower pace of activity would reduce our estimates from current levels.

With these conditions, we think a relatively diversified business with a solid backlog, and low exposure to non-war-related government work is most preferred. Fluor and KBR fit this description. If we had to add a third, it would be Jacobs just based on valuation. Fluor: Diversified E&C, but currently driven by mining and upstream oil and gas. Highest backlog on record; assume no cancellations. KBR: Stable backlog from diversified sources and with increasing profits in backlog.

The least preferred would be companies with high non-war-related public sector exposure and high-cost oil projects (oil sands and deepwater). These stocks include URS and McDermott. URS generates roughly 70% of revenues from government sources, with little large oil/gas project exposure. McDermott is a pure play upstream oil and gas engineering and construction (E&C) firm, which would experience revenue declines and negative operating leverage in a $50 oil scenario.

For most preferreds, we assume a premium to the market P/E given still elevated oil prices and the potential that backlog could still grow, but below-mid-cycle is appropriate because there is still some earnings headwind and because the market multiple is low.

For least preferreds, we assume a depressed multiple due to higher risk premium and lower growth potential.

We generally don’t want to own E&C stocks in a black skies scenario; however, on a relative basis, at $50 oil, and $1.50 copper, we would reach the crossover point where public sector and smaller project exposure look attractive compared with large energy and mining project exposure.

Most preferred are AECOM, URS and Babcock and Wilcox. AECOM is a diversified engineering and construction management firm, with little large project risk and 2/3 revenue exposure to government. URS generates roughly 70% of revenues from government sources, with little large oil/gas project exposure. Babcock & Wilcox generates roughly half its profit from government sources.


UBS 141

Table 87: Recession Scenario Analysis – Engineering & Construction, Steven Fisher, CFA

Engineering & Construction



Fluor FLR 13.0% 0.0% -15.0% 19.0% -7.0% -25.0% $77 $52 $36Jacobs Engineering JEC 10.0% -4.0% -15.0% 15.0% -8.0% -20.0% $45 $32 $23KBR KBR -11.0% -15.0% -21.0% 0.0% -10.0% -24.0% $45 $34 $22Foster Wheeler FWLT 11.0% 5.0% -4.0% 27.0% 10.0% -7.0% $37 $22 $18McDermott MDR 15.0% -3.0% -25.0% 26.0% -5.0% -33.0% $23 $10 $7URS Corp URS 7.0% -5.0% -9.0% 10.0% -7.0% -12.0% $38 $30 $25AECOM ACM 6.0% -2.0% -5.0% 13.0% 0.0% -5.0% $31 $21 $18Shaw Group SHAW 7.0% 3.0% -4.0% nmf nmf nmf $37 $23 $19Babcock & Wilcox BWC 11.0% 5.0% -2.0% 44.0% 26.0% 17.0% $23 $20 $18


Top 2 Preferred StocksFluor FLRKBR KBR

Least 2 Preferred StocksURS URSMcDermott MDR


Top 3 Preferred StocksAECOM ACMURS URSBabcock & Wilcox BWC

Least 2 Preferred StocksMcDermott MDRFoster Wheeler FWLT

Source: UBS


UBS 142

Machinery Henry Kirn, CFA, 212-713-4895 We recognize companies in our coverage nearly all currently expect growth in 2012, so there is some risk that declines in demand under both grey and black skies scenarios could catch companies off guard (and decremental margins could be worse than expected). That said, Machinery companies generally outperformed our expectations in managing the 2009 downturn, and we believe management teams still have cost cutting levers at their disposal. In most cases, we estimate company results would give back the 2011 cyclical advancement in sales.

For our grey skies analysis, we considered a decline in US GDP of 1.0% and a slowdown in global real output growth to 1.9% in 2012 and looked to previous recessions, particularly 2002, as a reference point for our valuation methodology. In a grey skies scenario, we expect revenues to be well above 2009 levels, partly a result of stronger underlying economic demand and partly a result of stronger replacement demand (more difficult to age fleets across most capital goods categories in 2012 than it was in 2009). To arrive at earnings, we generally applied decremental margins as historically seen in weak recessions (as in 2002).

For our black skies analysis, we considered a decline in US GDP of 2.5% and a slowdown in global real output to 0% growth, and looked to the declines in late 2008 and early 2009 as a reference point for our valuation methodology. While we would expect sales to be weaker than 2010 levels in many cases, we would still expect sales above 2009 levels due to: 1) a now older fleet across many categories (as described above); and 2) likely more available financing in 2012 than in 2009. Additionally, we modeled decremental margins somewhat less severe than seen in 2009, as we believe management teams’ experience handling the recent downturn leaves them better equipped to cut costs faster in 2012 than they were able to in 2009.

We believe ITW and DE are among the best positioned stocks to weather either a grey or black skies scenario. ITW benefits from diversified end market exposures and is less likely to see as significant a decline in revenue and EPS as many OEMs would be likely to under either economic scenario. Deere benefits from still elevated agricultural commodity prices, which supports farmer balance sheets, coupled with favorable market share in North America (the highest margin geography for ag equipment) and European demand just beginning to recover from already depressed levels. Additionally, given 60% aftermarket exposure in its legacy business and a strong backlog as of 2Q11, we see JOYG as well positioned to weather a grey skies scenario.

We see CAT and KMT as among the stocks most impacted under either a grey or black skies scenario. Caterpillar’s recent acquisitions (Bucyrus, MWM, EMD) and investment demonstrate the company’s clear commitment to growth (which remains our base case). However, should that growth not materialize, the company’s management of decremental margins could be challenged by the level of recent capacity and cost additions. On Kennametal, we note that recessionary demand has historically been volatile and continued to fall throughout the previous downturn (rebounding at a lag to other equipment categories).


UBS 143

Table 88: Recession Scenario Analysis – Machinery, Henry Kirn, CFA

Machinery



AGCO AGCO 11.6% -7.3% -13.7% 16.9% -26.7% -45.7% $62 $43 $32Caterpillar CAT 19.1% -9.5% -14.5% 33.7% -28.4% -52.8% $114 $76 $57Cummins CMI 15.1% -12.8% -22.1% 13.9% -27.3% -44.6% $140 $100 $71CNH Global CNH 7.3% -8.2% -14.2% 7.3% -25.6% -53.4% $53 $41 $27Deere DE 8.1% -7.7% -15.2% 14.5% -14.8% -30.4% $115 $84 $69Illinois Tool Works ITW 9.1% -3.4% -7.3% 18.6% -8.0% -19.2% $63 $55 $47Joy Global JOYG 18.1% -2.5% -7.8% 25.5% -11.5% -26.6% $112 $91 $76Kennametal KMT 10.2% -11.6% -19.0% 22.7% -32.9% -49.5% $43 $29 $24Navistar NAV 20.0% -10.6% -21.4% 34.8% -29.4% -67.1% $85 $46 $35PACCAR PCAR 21.1% -11.9% -30.8% 50.9% -28.7% -79.6% $60 $39 $29Parker Hannifin PH 8.0% -3.2% -5.7% 13.9% -27.8% -44.2% $77 $67 $62


Top 3 Preferred StocksDeere DEJoy Global JOYGIllinois Tool Works ITW

Least 2 Preferred StocksCaterpillar CATKennametal KMT


Top 2 Preferred StocksDeere DEIllinois Tool Works ITW

Least 2 Preferred StocksCaterpillar CATKennametal KMT

Source: UBS


UBS 144

Paper & Forest Products Gail Glazerman, CFA, 212-713-3486

Our preferred stocks in the space under a grey skies scenario are KMB and MWV. We prefer KMB under a black skies scenario. Given the staple nature of KMB’s core products, the demand risk in a recession should be manageable. The company should benefit from cost relief if global pressure on commodities such as pulp/oil is easing. MWV has some modest underlying support from asset value and a fairly solid balance sheet. Their exposure to emerging markets should limit some of the pain from weaker domestic demand. They should also partially benefit from cost relief.

Our least preferred stocks in the space under both grey skies and black skies scenarios are PCL and WY. While we would expect US housing markets to weaken in a renewed downturn, PCL has some underlying support from its assets (c7mm acres of timberlands). They should maintain some income from continued/ongoing land sales, even during a downturn. WY has very heavy exposure to a turn in US housing and is at risk for material earnings pressure if the markets turn. However, their base of 6mm acres of high value timber should also provide some underlying support to shares.


UBS 145

Table 89: Recession Scenario Analysis – Paper & Forest Products, Gail Glazerman, CFA

Paper & Forest Products



MeadWestvaco MWV 2.7% -6.0% -13.5% 12.5% -35.0% -70.0% $37 $31 $28Plum Creek PCL 10.5% -7.5% -13.3% 13.0% -29.5% -43.0% $36 $35 $34Kimberly-Clark KMB 4.0% -3.0% -5.0% 9.5% -11.3% -14.0% $75 $65 $62Weyerhaeuser WY 4.0% -6.0% -15.0% 60.0% -45.0% -84.0% $18 $17 $16


Top 2 Preferred StocksKimberly-Clark KMBMeadWestvaco MWV

Least 2 Preferred StocksPotlatch PCLWeyerhaeuser WY


Most Preferred StockKimberly-Clark KMB

Least 2 Preferred StocksPotlach PCLWeyerhaeuser WY

Source: UBS


UBS 146

Small/Mid Cap Industrials Robert Barry, 212-713-7980

The small/mid-cap (SMID) industrial names we cover are all cyclical, and we think there would be a significant deceleration in revenue and earnings growth in the event of mild or severe US and/or global recessions. That said, we think some companies would fare better than others, and we think some would even see recession-driven growth opportunities (ie, W.W. Grainger Inc. [GWW] and Fastenal Co. [FAST]). In assessing downside scenarios we consider factors that include company-specific growth opportunities, end market downside risk, Return on Invested Capital (ROIC), revenue and margin cyclicality, and balance sheet strength, with revenue growth opportunities and ROIC ranking higher than the other criteria — especially in a black skies scenario. We should flag that all the names in our universe have strong balance sheets, many with 2010 or 2011E net cash positions, so we do not see any high-risk liquidity situations.

Our most preferred names in a black skies scenario are Flowserve (FLS), FAST and GWW. All have healthy firm-specific growth opportunities, especially FAST and GWW, each has a strong balance sheet with 2010/2011E net cash positions, and these three have the highest returns on capital in our universe. We’d flag GWW and FAST in particular as names with sizable share gain opportunities in a recession. Both operate in highly fragmented markets and have much greater financial and managerial resources than most of their smaller “mom & pop” competitors. Both saw sizable share gains through the last downturn, and we’d expect growth investments to remain strong — or even accelerate — in the face of another period of macro deceleration. In addition to the balance sheet and ROIC factors we mentioned, we also prefer FLS because 40% of its business is a high-margin, less cyclical aftermarket business that never turned down in the last recession.

In a grey skies scenario our most preferred names are FLS, Actuant Corp. (ATU) and IDEX Corp. (IEX). We swap out FAST and GWW for ATU and IEX because in a less severe downturn we think the upside/downside equation using our current estimates and valuation remains more relevant and IEX and ATU rank better (in part because FAST has been outperforming in recent months). We also de-emphasize the very defensive attributes of ROIC, net cash positions, and non-M&A related firm-specific growth that favored GWW and FAST in the severe downturn scenario.


UBS 147

Table 90: Recession Scenario Analysis – Small/Mid Cap Industrials, Robert Barry

Sector: SMID Industrials



Actuant ATU 6.2% -1.7% -9.3% 15.5% -1.8% -18.6% $31 $20 $16Ametek AME 6.8% -4.0% -15.6% 13.8% -3.5% -25.3% $47 $34 $25Crane CR 8.8% 0.0% -8.8% 19.3% 0.5% -26.8% $58 $34 $26Fastenal FAST 18.0% 1.0% -10.1% 24.2% -7.4% -23.8% $38 $27 $22Flowserve FLS 9.7% 3.0% -2.9% 12.1% 7.5% -5.3% $121 $83 $73Grainger GWW 7.5% -0.5% -8.5% 12.6% -1.5% -15.4% $167 $120 $102Idex IEX 10.3% -1.4% -12.6% 20.5% -1.0% -22.4% $52 $36 $24Lennox LII 5.1% -1.5% -7.8% 48.9% 0.6% -14.8% $38 $27 $23Pentair PNR 7.8% -1.9% -10.3% 17.8% 6.4% -25.7% $40 $27 $20Watsco WSO 4.5% -1.1% -5.8% 21.4% -17.0% -34.3% $54 $45 $36


Top 3 Preferred StocksFlowserve FLSActuant ATUIdex IEX

Least 3 Preferred StocksPentair PNRWatsco WSOLennox LII


Top 3 Preferred StocksFlowserve FLSFastenal FASTGrainger GWW

Least 3 Preferred StocksPentair PNRWatsco WSOAmetek AME

Source: UBS


UBS 148

Intentionally Blank


UBS 149

Technology


UBS 150

Business, Education and Professional Services Ariel Sokol, 212-713-8450

Data from the past 30 years suggests that institutions benefit from increased enrollments during a period of economic contraction. However, we do not believe enrollments will uniformly rise following a modest or deep economic contraction. Rather, we believe the sector could see new start declines. We ascribe this to the following: 1) Consumers are more conservative regarding leverage. 2) Institutions are more averse to taking on the “low-quality students” who tend to have high default rates and little cash pay yet account for the bulk of countercyclical demand. 3) Those most likely to enroll during a recession did so in 2009/2010. 4) “For-profit” institutions have incurred substantial reputational damage and might lose share to “Not-for-profit” institutions.

For the above reasons, we believe that, at a minimum, a recession would not benefit enrollments in aggregate for “for-profit” operators as it has done in the past. If anything, a substantially deep economic contraction could reduce overall enrollments.

We adjust the following levers to create grey skies and black skies scenarios: 1) New starts for online degrees depend more on the affordability of the degree. 2) New starts up for career education programs. 3) Revenue per enrollment down due to price sensitive customers. 4) Sales and marketing costs down as a result of lower media cost. 5) Bad debt expense increases. Based on these scenarios, we believe DeVry could outperform its peers in the event of a downturn, as it has amassed a diversified group of institutions that have both cyclical and countercyclical drivers. Exposure to acyclical healthcare programs could offset weakness in online degrees at the company’s core DeVry University.

We believe ITT Educational Services (ESI) has the most downside risk of the companies we cover if a downturn occurs. In our opinion, a recession would greatly exacerbate ESI’s existing structural problems. Regulatory issues concerning student defaults could prevent the company from accepting additional countercyclical students, given its high cohort default rates. Also, given ESI’s high tuition, students could have difficulty financing their education if the company is unable to secure third-party private financing for student loans. The company could need to reduce tuition, provide scholarships, or some other source of financing for students concerned with high tuitions. However, lower customer acquisition costs could mitigate some of ESI’s challenges.


UBS 151

Table 91: Recession Scenario Analysis – Business, Education and Professional Services, Ariel Sokol

Business, Education and Professional Services



Apollo Group APOL -6.8% -7.4% -10.4% -28.4% -32.7% -39.1% $46 $44 $40DeVry DV 2.3% -3.0% -6.0% 3.9% -7.0% -11.0% $70 $60 $50Washington Post WPO -3.2% -5.5% -8.6% -12.7% -25.1% -36.3% $420 $360 $321ITT Educational Services ESI -9.4% -14.7% -17.3% -31.2% -44.7% -62.2% $70 $59 $40


Most Preferred StockDeVry DV

Least 3 Preferred StocksITT Educational Services ESIApollo Group APOLWashington Post WPO


Most Preferred StockDeVry DV

Least 3 Preferred StocksITT Educational Services ESIApollo Group APOLWashington Post WPO

Source: UBS


UBS 152

Computer Services & IT Consulting Arvind Ramnani, 212-713-3517

IT Services is arguably somewhat of a lagging indicator versus the economy. At the onset of an economic downturn, existing projects generally continue until their scheduled completion, and if the vendor cannot backfill these revenues by selling new work, that is when revenue/earnings growth deceleration becomes more evident. The obvious concern is that if the economic weakness becomes more broad-based and pervasive, then IT budgets will logically become much more challenging and apt to significant pull-backs.

Companies such as Cognizant and Accenture have a greater percentage of their revenues that are more mission-critical and maintenance-related. This type of work tends to be difficult to cut even during a weak economic scenario. In contrast, companies such as Sapient have greater pieces of their revenues that are discretionary and can be scaled back or cut during the downturn.


UBS 153

Table 92: Recession Scenario Analysis – Computer Services & IT Consulting, Arvind Ramnani

Computer Services & IT Consulting


Name Ticker GDP View Grey Skies Black Skies GDP View Grey Skies Black Skies GDP View Grey Skies Black SkiesAccenture plc ACN 9.0% 7.5% 6.0% 12.5% 11.0% 9.4% $64 $48 $37Amdocs Limited DOX 5.8% 3.0% 0.0% 12.5% 9.7% 6.5% $35 $28 $21Cognizant Technology Solutions Corp. CTSH 22.4% 15.0% 9.0% 21.3% 14.0% 8.1% $87 $60 $45Computer Sciences Corp. CSC 2.4% 0.0% -2.0% 0.5% -1.7% -3.7% $41 $28 $21Genpact G 20.0% 14.0% 8.0% 8.1% 16.5% 10.4% $21 $13 $9Sapient Corp. SAPE 19.2% 10.0% -2.0% 39.2% 28.0% 14.1% $15 $9 $6


Top 3 Preferred StocksCognizant Technology Solutions Corp. CTSHAccenture plc ACNAmdocs Limited DOX

Least 3 Preferred StocksSapient Corp. SAPEGenpact GComputer Sciences Corp. CSC


Top 3 Preferred StocksCognizant Technology Solutions Corp. CTSHAccenture plc ACNAmdocs Limited DOX

Least 3 Preferred StocksSapient Corp. SAPEGenpact GComputer Sciences Corp. CSC

Source: UBS


UBS 154

Data Networking & Wireline Equipment Nikos Theodosopoulos, 212-713-3286

Under a black skies scenario, we believe the 2008-2009 recession serves as a good proxy with meaningful declines to expected revenues. A grey skies scenario is slightly more difficult to forecast, requiring a material cut to current growth estimates. In total, we expect revenue growth of ~5-25% for the companies under coverage being lowered to -3% to +10% in a grey skies environment, and -10% to +5% under black skies. More specifically, Cisco’s (CSCO) revenues have the highest correlation to US/global GDP. Based on our proprietary UBS model, we estimate Cisco’s correlation at roughly 85% versus US/global GDP. Corning’s (GLW) demand drivers are more aligned to TV/LCD panels, which are becoming more aligned with GDP as the technology matures. Other companies in the communications infrastructure industry, including Juniper (JNPR), F5 Networks (FFIV), Riverbed (RVBD), and Polycom (PLCM), have less of a correlation to US/global GDP than Cisco. The lower correlations are due to a variety of factors, including their: 1) smaller sizes; 2) corporate life-cycle stages; 3) higher growth profiles; and 4) slightly varied end-market demand drivers.

The resulting impact on earnings is more difficult to forecast. Companies’ operating expense items are likely to receive heightened scrutiny with slower revenue growth. Some companies may preserve more investment in research and development, others may work to retain as many sales and marketing professionals as possible, while others may downsize significantly. Additionally, the timing of operating expense actions is difficult to forecast. Our assumptions regarding management spending plans assume consistent company-by-company behavior versus prior downturns.

Additionally, we expect the valuation multiples for larger cap companies to stay intact (and possibly expand) during a downturn, while smaller, more volatile companies will see multiple contraction. The net of this is that we believe Corning is the only company in our coverage universe that has potential upside under a grey skies scenario. Our view is Corning’s valuation on a price to book basis already discounts a recession, with only single-digit downside under a black skies environment. We have a Buy rating on Corning. Cisco, given its relatively lower valuation on more recent company-specific execution issues, also has less downside than the group, in our view. We see Cisco’s potential downside as ~8% under grey skies and ~15% with black skies. We note that although there is Cisco downside, this is meaningful outperformance versus other companies under coverage. Our sense is FFIV, RVBD, and PLCM have the highest potential downside. When considering the potential for a moderate deceleration and sharp decline in US/global GDP, we estimate potential valuation downside for FFIV, RVBD, and PLCM at 20%, 40%, and 30% for grey skies and 25%, 45%, and 45% under black skies, respectively.


UBS 155

Table 93: Recession Scenario Analysis – Data Networking & Wireline Equipment, Nikos Theodosopoulos

Data Networking & Wireline Equipment


Name Ticker GDP View Grey Skies Black Skies GDP View Grey Skies Black Skies GDP View Grey Skies Black SkiesCisco CSCO 5.2% -3.0% -10.0% 9.0% -8.4% -15.2% $17 $13 $12Corning GLW 8.5% -2.8% -10.0% 4.4% -13.1% -22.2% $24 $16 $13Juniper JNPR 14.9% 8.0% -6.0% 22.0% 16.5% -15.5% $31 $19 $14F5 Networks FFIV 19.3% 8.0% 4.0% 16.8% 4.0% 6.1% $110 $63 $58Riverbed RVBD 25.2% 10.0% 5.0% 29.1% 5.8% 8.0% $33 $14 $13Polycom PLCM 18.7% 7.0% -7.0% 34.8% 2.5% -13.9% $28 $17 $13


Top 2 Preferred StocksCorning GLWCisco CSCO

Least 3 Preferred StocksF5 Networks FFIVRiverbed RVBDPolycom PLCM


Top 2 Preferred StocksCorning GLWCisco CSCO

Least 3 Preferred StocksF5 Networks FFIVRiverbed RVBDPolycom PLCM

Source: UBS


UBS 156

IT Hardware Maynard Um, 212-713-3372

We analyzed the relationship of GDP to each of our company’s sales and EPS under coverage. We assume the impact to revenue and EPS growth estimates per point of change in global GDP growth will be similar to the revisions we saw in the 2008/09 downturn. We also looked at the difference in margin profiles versus the last downturn. We note downside in terms of multiple compression is lower this time, as the average multiple at the end of 2007 (~19.9x) declined to ~9.9x by March 9, 2009 (around the trough) versus the average multiple at the end of 2010 being ~14.4x and on August 8, 2011 being ~10.6x.

IT Hardware companies with higher annuity revenue such as IBM have very weak relationships to GDP while those exposed to more transaction-based sales, such as EMC, NetApp, and Dell, have stronger relationships. Surprisingly, despite the more transaction-based orientation of Apple’s products, there is a weak relationship between GDP and Apple’s revenue and EPS, given the demand even in the downturn. EPS correlation for transaction-based companies is relatively low except for EMC, as these companies have executed well by managing expenses during a downturn.

We see Apple as a relative safe haven, given its end-market demand trends, new product cycle, relatively low valuation (was trading near its trough multiple as of close on August 8, 2011), and strength in supply chain procurement and management. We also see Hewlett-Packard as being fairly defensive, with good risk/reward despite some issues (which we ultimately expect resolution to), and see trends of vendor consolidation to larger OEMs by customers as favorable to the company.


UBS 157

Table 94: Recession Scenario Analysis – IT Hardware, Maynard Um

IT Hardware


Name Ticker GDP View Grey Skies Black Skies GDP View Grey Skies Black Skies GDP View Grey Skies Black SkiesApple AAPL 22.5% 17.8% 13.2% 14.5% 12.2% 9.9% $510 $442 $431Dell DELL 2.2% -11.7% -25.6% 2.7% -11.2% -25.1% $19 $16 $16Hewlett Packard HPQ 4.8% 0.6% -3.7% 5.5% 0.0% -5.6% $45 $40 $37IBM IBM 4.8% 11.0% -4.6% 8.2% 6.4% 4.6% $180 $170 $166EMC EMC 6.5% 18.0% -6.2% 12.7% 3.2% -6.3% $33 $30 $26NetApp NTAP 12.5% 3.5% -5.4% 10.7% -2.7% -16.1% $67 $61 $58


Top 2 Preferred StocksApple AAPLHewlett Packard HPQ

Least Preferred StockIBM IBM


Top 2 Preferred StocksApple AAPLHewlett Packard HPQ

Least Preferred StockIBM IBM

Source: UBS


UBS 158

SemiCap Equipment / Alternative Energy Stephen Chin, 212-713-4111

Semiconductor Equipment

In the semiconductor equipment industry, our Key Global Indicator (KGI) is semiconductor capital spending, which we currently estimate at up +14% yoy in 2011 (mostly due to a strong 1H11 capex spend) and down -13% yoy for 2012. In our grey skies scenario, we assume only modest downside risk, mostly from lower capex at foundry customers, as the semiconductor equipment industry has already been in a normal down-cycle because industry semicap equipment orders have been declining qoq since 4Q10. In our black skies scenario, we estimate 2011 industry capex could be up +9% yoy and 2012 could be down -35% yoy, mostly reflecting a decline from foundry and memory customers. We note that there are still several technology migrations that semiconductor customers will likely consider using capex on (such as gate-last, vertical NAND, and quadruple patterning) that could help limit the downside in this black skies scenario compared to the 2009 downturn.

In terms of the semiconductor equipment stocks, we believe KLA-Tencor (KLAC) will again prove to be the more defensive semicap stock to own during this period of uncertainty. While KLAC has the highest percentage of orders from foundry customers (40%), we believe the current stock price already discounts potentially weaker foundry orders. On the positive side, KLAC’s high levels of backlog at $1.4B could help limit significant downside on the stock. We also note that during normal down-cycles, KLAC has historically troughed at around 2.0x book value (the stock is currently trading at 2.0x). In a black skies scenario, we believe KLAC’s quarterly sales could trough higher than the $300M/quarter level that we saw in 2009 as the company has more success in new segments. We also estimate KLAC’s cash break-even at about $300M/quarter, so the company should be at least cash flow neutral even on trough sales. This should allow it to maintain its dividend payment (yield is 3.9%), which is another differentiator for this company in a downturn.

Alternative Energy

Our alternative energy space is currently composed of two sub-industries: solar and LED. For solar, solar module prices are our KGI. In a grey skies scenario, we forecast that solar module prices will decline by 12% from our 2012 base case, and that total solar demand will drop by 5%, resulting in 15% oversupply. In a black skies scenario, we see a 20% decline from our 2012 base case, resulting in a 14% decline in total demand and an industry oversupply of 25%. In these scenarios, we believe First Solar is best positioned, given its cost and market share leadership. Specifically, we expect First Solar to grow earnings at a faster pace than its peers in 2012, as 40% of its 2012 module shipments will go toward its utility scale pipeline business, which commands a 75% ASP premium.

For LED, our key industry assumptions are that LED TV penetration rates and growth rates of LED general lighting are the two largest drivers of LED sales. We estimate LED TVs account for about 35% of the demand for LED chips (by area) while general lighting uses about 25% of the LED chips (by area). In our grey skies scenario, our estimates do not change much from our base case. We note that LED growth rates have slowed for about one year already, starting in 3Q10, mostly due to lower sales of LED backlighting applications (TVs). The LED industry has also recently seen weaker demand for general lighting LED applications in 2Q11, which is why our grey skies scenario does not differ too much from our base case scenario. In a black skies scenario, we estimate LED TV penetration rates will be only 40% in 2012, versus 65% in our baseline scenario. In a black skies scenario for lighting, although we note capacity underutilization may lead to oversupply of LED and lower ASP, increased demand will likely offset this, to some degree, as LED lighting becomes more cost competitive with incandescent and compact fluorescent bulbs. LED maker Aixtron noted recently that a tipping point in LED adoption likely occurs when LED bulbs reach ~10x the incandescent bulb price, and that prices are already close to this level in Japan (12.5x) and Taiwan (13.9x). However, in terms of the LED stocks, there have been some early signs of industry stabilization and, as such, we believe Cree’s stock could have 30-40% potential downside in a black skies scenario from lower LED general lighting demand and higher competition.


UBS 159

Table 95: Recession Scenario Analysis – SemiCap Equipment / Alternative Energy, Stephen Chin

SemiCap Equipment / Alternative Energy


Name Ticker GDP View Grey Skies Black Skies GDP View Grey Skies Black Skies GDP View Grey Skies Black SkiesSemicap EquipmentApplied Materials AMAT -6.5% -14.9% -28.1% -7.2% -57.8% -93.0% $15 $14 $9Lam Research LRCX -5.0% -14.1% -27.9% -13.7% -50.4% -153.2% $55 $52 $33KLA-Tencor KLAC -5.8% -13.7% -27.5% -12.1% -46.3% -110.4% $50 $47 $30Novellus NVLS -17.5% -15.4% -29.7% -23.7% -57.9% -186.0% $34 $32 $20Teradyne TER -3.5% -16.2% -30.1% 4.0% -67.3% -148.4% $16 $15 $9

Alternative Energy - Solar First Solar FSLR 48.5% 43.1% 36.4% 23.7% 4.0% -22.8% $150 $120 $85

Alernative Energy - LEDCree CREE 30.5% 24.2% 21.5% 58.0% 34.5% 7.8% $32 $27 $20



Semicap EquipmentKLA Tencor KLACLam Research LRCX

Alternative Energy - SolarFirst Solar FSLR

Alternative Energy - LEDN/A


Semicap EquipmentNovellus NVLSTeradyne TER

Alternative Energy - SolarN/A

Alternative Energy - LEDCree CREE



Semicap EquipmentLAM Research LRCXKLA Tencor KLAC

Alternative Energy - SolarFirst Solar FSLR

Alternative Energy - LEDN/A


Semicap EquipmentNovellus NVLSTeradyne TERApplied Materials AMAT

Alternative Energy - SolarN/A

Alternative Energy - LEDCree CREE

Source: UBS


UBS 160

Semiconductors Uche Orji, 212-713-4015

In the last downturn, we had a more muted decline in semiconductor revenues relative to S&P500 earnings, as semi companies were able to limit pricing declines by slashing wafer starts and cutting capacity. We expect similar behavior to occur in the event of another major downturn. As a result, we believe global semiconductor revenues will decline less dramatically than the UBS Strategy Group expects S&P500 earnings to drop in the event of a slowdown in GDP growth. Specifically, we project that 2012 global semiconductor revenues will decline by 15% in a grey skies scenario and 30% in a black skies scenario.

We use this projected change in our semiconductor Key Global Indicator (KGI) to analyze potential changes to our companies’ revenue forecasts and consider company-specific items in modeling leverage to project EPS. We believe Microchip Technology (MCHP) is best positioned to weather the storm in a recessionary environment. MCHP has a broad-based microcontroller business with revenue trends likely to perform largely in line with the semiconductor industry. However, we expect earnings to remain relatively resilient, given: 1) low leverage on COGS due to its relatively low fixed cost base; 2) operating expenses that can be modulated with the economic conditions (the entire company incurred a 10% pay cut and no bonuses that helped avoid layoffs during the 2008 downturn). Even as the dividend payout ratio could somewhat exceed 100% in a black skies scenario, the company has $1.5bn of cash & equivalents that should support maintaining the current $0.347/share quarterly dividend level (currently 4.4% yield).

In the event of a recession, we are especially concerned about companies that have made large acquisitions recently, putting a strain on corporate resources and balance sheets during a challenging time. Specifically, Texas Instruments (TXN) recently acquired National Semiconductor for $6.5B in cash. TXN has taken on debt of $3.5B and used the cash on its balance sheet to fund the acquisition. After the close of the deal, the company will be cash neutral. Furthermore, integration of National raises the risk for the overall business; therefore, investors are not likely to perceive TXN as a safe haven (unlike in past downturns, when TXN was viewed by investors as a safe haven, given a cash rich balance sheet and steady cash flow analog business).

ON Semiconductor (ONNN) recently acquired Sanyo’s semiconductor business. With its leveraged balance sheet with negative cash position further compounded by a larger fixed cost foot print and relatively high capital intensity, ONNN is likely to face challenges in a recessionary environment. The timeframe for synergies from the Sanyo acquisition is likely to be pushed out and magnitude may not be in line with expectations. We believe that with declining revenue, ONNN is not likely to invest much in consolidating Sanyo’s manufacturing facilities and may be forced to abandon a sizable part of Sanyo’s business.


UBS 161

Table 96: Recession Scenario Analysis – Semiconductors, Uche Orji

Semiconductors


Name Ticker GDP View Gray Skies Black Skies GDP View Gray Skies Black Skies GDP View Gray Skies Black SkiesAdvanced Micro Devices AMD 5.8% -9.6% -17.8% 29.0% -18.7% -44.0% $7 $6 $5Altera ALTR 8.5% -7.3% -15.7% 3.6% -16.9% -25.2% $52 $42 $39Analog Devices ADI -0.9% -13.0% -22.0% -5.8% -24.9% -39.2% $43 $29 $25Atmel ATML 11.1% -5.1% -13.7% 20.6% -6.5% -18.8% $18 $15 $14Broadcom BRCM 9.9% -5.0% -16.0% 19.9% -15.3% -55.7% $45 $28 $13Cypress Semiconductor CY 20.7% -2.0% -10.1% 35.7% -7.8% -17.1% $26 $20 $19Intel INTC 8.3% -7.5% -15.9% 8.1% -20.7% -30.9% $29 $22 $20Linear Technology LLTC -9.1% -13.0% -18.0% -35.2% -27.2% -35.2% $31 $24 $20LSI LSI 7.5% -14% -22.0% 19.7% -28.1% -95.7% $7 $5 $3Marvell MRVL 13.8% -9.0% -20.0% 24.2% -24.7% -58.1% $18 $11 $6Maxim Integrated Products MXIM 4.8% -11.0% -20.0% 5.6% -8.7% -27.1% $27 $23 $19Microchip Technology MCHP 6.6% -8.9% -17.1% 9.9% -10.4% -19.2% $34 $29 $27Micron Technology MU 9.4% -10.0% -20.0% 144.7% -32.3% -347.3% $14 $7 $4NVIDIA NVDA 4.0% -11.1% -19.2% 5.3% -24.7% -38.9% $17 $13 $11ON Semiconductor ONNN 5.8% -14.0% -33.0% 12.8% -50.7% -111.8% $9 $6 $4Qualcomm QCOM 26.0% +0.0% -10.0% 20.5% -33.8% -52.3% $70 $37 $29SanDisk SNDK 16.0% -2.0% -16.0% 15.1% -27.3% -73.8% $62 $36 $12Skyworks Solutions SWKS 23.9% -5.0% -10.0% 28.3% -8.0% -20.7% $40 $16 $12Texas Instruments TXN 1.9% -14.0% -22.0% 5.0% -22.1% -37.3% $32 $23 $18Xilinx XLNX 5.3% -10.0% -18.2% 16.2% -16.1% -28.1% $36 $30 $27


Top 3 Preferred StocksIntel INTCQualcomm QCOMMicrochip Technology MCHP

Least 3 Preferred StocksON Semiconductor ONNNNVIDIA NVDATexas Instruments TXN


Top 3 Preferred StocksIntel INTCMicrochip Technology MCHPLinear Technology LLTC

Least 3 Preferred StocksON Semiconductor ONNNNVIDIA NVDAAdvanced Micro Devices AMD

Source: UBS


UBS 162

Software Brent Thill, 415-352-4694

In the event of another downturn, we assume a similar IT spending pattern that occurred in the last recession will repeat. Our black skies scenario assumes a downturn similar to the 08/09 recession. Grey skies assume a difficult environment, but slightly better than a black skies scenario. Also, it is worth noting that specific software segments such as security should hold up better. In general, perpetual license revenue models are more at risk, while recurring revenue streams such as subscriptions or maintenance are relatively better protected.

Our top three preferences under a black skies scenario are Oracle, Check Point Software, and Intuit. The companies have heavier mixes of recurring revenues and higher priority spend categories (eg, security), and they held up well in the last recession. Our three least preferred names under black skies are Autodesk, Adobe, and Citrix Systems. These companies have a lower mix of recurring revenues, coupled with valuation concerns.


UBS 163

Table 97: Recession Scenario Analysis – Software, Brent Thill

Software


Name Ticker GDP View Grey Skies Black Skies GDP View Grey Skies Black Skies GDP View Grey Skies Black SkiesAdobe Systems ADBE 14.1% 4.3% -18.5% 12.4% -2.7% -33.5% $40 $31 $22Autodesk ADSK 13.0% -8.0% -18.3% 29.2% -7.2% -32.4% $52 $34 $24Check Point Software CHKP 12.5% 10.0% 8.7% 13.5% 11.1% 9.7% $68 $59 $51Citrix Systems CTXS 15.1% 11.0% 8.0% 15.2% 8.0% 3.4% $79 $66 $59Informatica INFA 17.0% 13.5% 9.9% 22.7% 19.0% 15.2% $67 $55 $45Intuit INTU 8.3% 6.9% 5.8% 8.6% 6.1% 4.7% $57 $51 $47Microsoft MSFT 9.4% 7.7% 5.7% 10.5% 6.5% 4.7% $33 $29 $25Microstrategy MSTR 13.4% 10.3% 4.8% 127.0% 120.8% 109.8% $190 $152 $125Nuance NUAN 14.0% 11.3% 7.9% 12.8% 9.1% 2.0% $24 $20 $17Oracle ORCL 8.0% 5.5% 4.0% 8.2% 5.4% 3.6% $40 $34 $30Qlik Technologies QLIK 20.2% 18.3% 16.0% 50.3% 48.0% 45.1% $37 $30 $26Red Hat RHT 15.7% 12.0% 9.4% 19.5% 12.6% 8.9% $54 $41 $33Salesforce.com CRM 23.8% 20.2% 18.8% 40.7% 31.5% 27.4% $184 $142 $121Symantec SYMC 5.9% 4.5% 3.5% 12.0% 10.1% 8.9% $22 $20 $16Vmware VMW 20.0% 15.0% 12.0% 19.0% 11.0% 7.0% $125 $104 $90


Top 3 Preferred StocksCheck Point CHKPOracle ORCLIntuit INTU

Least 3 Preferred StocksCitrix CTXSQlik Technologies QLIKAutodesk ADSK


Top 3 Preferred StocksOracle ORCLCheck Point CHKPIntuit INTU

Least 3 Preferred StocksAutodesk ADSKAdobe ADBECitrix CTXS

Source: UBS


UBS 164

Technology Supply Chain & Wireless Equipment Amitabh Passi, 415-352-5537

We expect the revenue decline for our companies in the event of a downturn to be comparable to what we saw in the 2008/09 timeframe. In completing our revenue and earnings sensitivity analysis for our coverage universe for two different recession scenarios, we conducted a regression test comparing sub-sector revenue growth with GDP growth. As a result of this test and our sector-specific margin analysis, we have made the following core assumptions:

Connector Companies: 1% GDP downside risk leads to 6.1% revenue downside risk for the connector companies (TE Connectivity, Amphenol, and Molex) and incremental/decremental operating margin of 25%.

EMS Companies: 1% GDP downside risk leads to 5.4% revenue downside risk for the EMS companies (Flextronics and Jabil Circuit), and incremental/decremental operating margin of 8%.

Distributors Companies: 1% GDP downside risk leads to 7% revenue downside risk for the distributors (Arrow and Avnet), and incremental/decremental operating margin of 8%

Wireless Handset Companies: 1% GDP downside risk leads to 8.5% unit downside risk for wireless handsets, with average selling prices declining another 5% (grey skies) and 10% (black skies) relative to our base case.

For each company, we applied the anticipated impact to revenues and margins to our base case scenario, which differs in some cases for companies in the same sector, given each company’s unique growth trajectory, to determine the downside risk to earnings and revenues. In estimating our valuations, for a black skies scenario, we did not quite revert to the multiples seen during the 08-09 recession, when some of our companies saw extremely depressed multiples on balance sheet concerns. Many of those companies have meaningfully de-levered and we have, therefore, assumed margins in those cases will likely not compress to the 08-09 levels.

Under a black skies scenario, our two preferred names would be Amphenol (APH) and Motorola Mobility (MMI). While APH has some cyclical exposure as well, it has proven to be a relatively more defensive name in our coverage universe. During the 01-02 and 08-09 downturns, while revenues declined ~25% and ~15%, respectively, from peak to trough, operating margins remained relatively resilient, troughing at 15.7% in 01-02 and 16.8% in 08-09 (down 300bps peak to trough). In addition, the company has 13.4m shares remaining in its share buy-back plan (through January 2014) and we would expect management to be aggressive in buying shares should the environment turn for the worse. Management has consistently shown execution prowess and an ability to flex its business model to cope with deteriorating conditions.

We also prefer MMI, which we value on a sum-of-the-parts basis, given limited visibility into earnings power. With little value being implied for the mobile device business already, $7-8/share for the Home business, $8/share in deferred tax assets, $11/share in cash, and a robust patent portfolio, we continue to believe there should be limited downside risk to the shares. MMI also has a robust patent portfolio (more than 21k wireless patents, owned and pending), and with increasing attention being placed in the marketplace on wireless patents, we believe shares will hold up relatively well in a black skies scenario.

Tyco Electronics (TEL) rounds out our top three investment picks, given its broad-based end market exposure, strong secular trends in global FTTx spending, incremental synergies anticipated from the ADC Telecommunications (ADCT) acquisition, strong free cash flow profile, attractive dividend, and valuation. While the company does have exposure to the more cyclical automotive and industrial sectors, posing risk in any economic contraction, we note automotive sales trends remain below scrappage levels in the US, which coupled with better emerging markets trends, should limit downside risk. We also note since the 2008-2009 recession, TEL has optimized its manufacturing footprint by reducing the number of plants by 40-plus and delevered its balance sheet, putting it in a better position to cope with any downturn. At less than 10x NTM PE and a FCF yield of 10-percent plus, we remain constructive on the shares.


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Table 98: Recession Scenario Analysis – Technology Supply Chain & Wireless Equipment, Amitabh Passi

Technology Supply Chain & Wireless Equipment


Name Ticker GDP View Grey Skies Black Skies GDP View Grey Skies Black Skies GDP View Grey Skies Black SkiesTE Connectivity TEL 5.4% -5.3% -16.4% 11.4% -10.5% -33.9% $45 $30 $18Amphenol APH 7.0% -3.9% -15.1% 8.7% -6.3% -22.0% $55 $37 $26Molex MOLX 4.9% -5.8% -16.9% 7.6% -14.8% -38.7% $24 $16 $9Flextronics FLEX -1.1% -10.0% -19.1% 8.0% -22.4% -55.8% $10 $5 $2Jabil JBL 9.0% -0.8% -10.9% 13.4% -7.9% -30.6% $23 $17 $9Arrow ARW -0.3% -12.0% -24.1% -1.3% -25.3% -51.1% $48 $30 $14Avnet AVT -0.7% -12.4% -24.5% -6.9% -33.7% -62.8% $44 $22 $9Motorola Mobility MMI 15.7% 6.8% -2.2% 163.8% 138.5% 112.5% $31 $29 $27Research In Motion RIMM 5.2% -5.8% -17.6% -2.0% -13.9% -27.4% $30 $24 $19


Top 3 Preferred StocksMotorola Mobility MMIAmphenol Corp APHTE Connectivity Ltd. TEL

Least 3 Preferred StocksFlextronics International Ltd. FLEXMolex Incorporated MOLXResearch In Motion Ltd. RIMM


Top 3 Preferred StocksMotorola Mobility MMIAmphenol Corp APHTE Connectivity Ltd. TEL

Least 3 Preferred StocksFlextronics International Ltd. FLEXMolex Incorporated MOLXResearch In Motion Ltd. RIMM

Source: UBS


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Analyst Certification

Each research analyst primarily responsible for the content of this research report, in whole or in part, certifies that with respect to each security or issuer that the analyst covered in this report: (1) all of the views expressed accurately reflect his or her personal views about those securities or issuers and were prepared in an independent manner, including with respect to UBS, and (2) no part of his or her compensation was, is, or will be, directly or indirectly, related to the specific recommendations or views expressed by that research analyst in the research report.


UBS 167

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This report has been prepared by UBS Securities LLC, an affiliate of UBS AG. UBS AG, its subsidiaries, branches and affiliates are referred to herein as UBS.

For information on the ways in which UBS manages conflicts and maintains independence of its research product; historical performance information; and certain additional disclosures concerning UBS research recommendations, please visit www.ubs.com/disclosures. The figures contained in performance charts refer to the past; past performance is not a reliable indicator of future results. Additional information will be made available upon request. UBS Securities Co. Limited is licensed to conduct securities investment consultancy businesses by the China Securities Regulatory Commission.

UBS Investment Research: Global Equity Rating Allocations

UBS 12-Month Rating Rating Category Coverage1 IB Services2

Buy Buy 54% 39%Neutral Hold/Neutral 39% 35%Sell Sell 7% 14%

UBS Short-Term Rating Rating Category Coverage3 IB Services4

Buy Buy less than 1% 33%Sell Sell less than 1% 25%

1:Percentage of companies under coverage globally within the 12-month rating category. 2:Percentage of companies within the 12-month rating category for which investment banking (IB) services were provided within the past 12 months. 3:Percentage of companies under coverage globally within the Short-Term rating category. 4:Percentage of companies within the Short-Term rating category for which investment banking (IB) services were provided within the past 12 months. Source: UBS. Rating allocations are as of 30 June 2011. UBS Investment Research: Global Equity Rating Definitions

UBS 12-Month Rating Definition

Buy FSR is > 6% above the MRA. Neutral FSR is between -6% and 6% of the MRA. Sell FSR is > 6% below the MRA.

UBS Short-Term Rating Definition

Buy Buy: Stock price expected to rise within three months from the time the rating was assigned because of a specific catalyst or event.

Sell Sell: Stock price expected to fall within three months from the time the rating was assigned because of a specific catalyst or event.


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KEY DEFINITIONS

Forecast Stock Return (FSR) is defined as expected percentage price appreciation plus gross dividend yield over the next 12 months. Market Return Assumption (MRA) is defined as the one-year local market interest rate plus 5% (a proxy for, and not a forecast of, the equity risk premium). Under Review (UR) Stocks may be flagged as UR by the analyst, indicating that the stock's price target and/or rating are subject to possible change in the near term, usually in response to an event that may affect the investment case or valuation. Short-Term Ratings reflect the expected near-term (up to three months) performance of the stock and do not reflect any change in the fundamental view or investment case. Equity Price Targets have an investment horizon of 12 months.

EXCEPTIONS AND SPECIAL CASES

UK and European Investment Fund ratings and definitions are: Buy: Positive on factors such as structure, management, performance record, discount; Neutral: Neutral on factors such as structure, management, performance record, discount; Sell: Negative on factors such as structure, management, performance record, discount. Core Banding Exceptions (CBE): Exceptions to the standard +/-6% bands may be granted by the Investment Review Committee (IRC). Factors considered by the IRC include the stock's volatility and the credit spread of the respective company's debt. As a result, stocks deemed to be very high or low risk may be subject to higher or lower bands as they relate to the rating. When such exceptions apply, they will be identified in the Company Disclosures table in the relevant research piece.

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UBS Securities LLC: Jonathan Golub, CFA; Chip Miller, CFA; Manish Bangard, CFA; Daniel Murphy; Vishal Patel; Thomas M. Doerflinger, Ph.D.; Natalie Garner, CFA; Maury N. Harris; David A. Bleustein; Ana Recinos.


UBS 169

Company Disclosures

Company Name Reuters 12-mo rating Short-term rating Price Price date

Abbott Laboratories4, 6a, 6c, 7, 8a, 16 ABT.N Buy N/A US$49.91 15 Aug 2011 Accenture plc4, 6a, 6b, 6c, 7, 16 ACN.N Buy N/A US$55.42 15 Aug 2011 Activision Blizzard Inc.4, 6a, 6b, 6c, 7,

16 ATVI.O Buy N/A US$11.00 15 Aug 2011

Actuant Corporation4, 6a, 6c, 7, 16 ATU.N Buy N/A US$20.59 15 Aug 2011 Adobe Systems Inc.4, 6c, 7, 13, 16 ADBE.O Buy N/A US$24.65 15 Aug 2011 Advanced Micro Devices13, 16, 20 AMD.N Neutral (CBE) N/A US$6.43 15 Aug 2011 AECOM Technology Corp.1, 5, 16 ACM.N Buy N/A US$19.94 15 Aug 2011 Aetna Inc.1, 2, 4, 5, 6a, 6b, 6c, 7, 16, 22 AET.N Neutral N/A US$38.35 15 Aug 2011 Alexion Pharmaceuticals, Inc.16 ALXN.O Neutral N/A US$53.13 15 Aug 2011 Allergan16 AGN.N Buy N/A US$74.75 15 Aug 2011 Allscripts Healthcare Solutions Inc.2, 4, 5, 6a, 16

MDRX.O Buy N/A US$15.71 15 Aug 2011

Alpha Natural Resources4, 5, 6a, 13, 16 ANR.N Buy N/A US$34.08 15 Aug 2011 Altria Group16, 18h, 22 MO.N Buy N/A US$25.70 15 Aug 2011 Amazon.com Inc16, 18ap AMZN.O Neutral N/A US$202.95 15 Aug 2011 Amdocs Limited5, 16 DOX.N Buy N/A US$27.83 15 Aug 2011 Ameren Corp.4, 5, 6a, 16 AEE.N Neutral N/A US$28.35 15 Aug 2011 American Campus Communities16 ACC.N Buy N/A US$37.23 15 Aug 2011 American Electric Power, Inc.4, 5,

6a, 6b, 6c, 7, 16, 22 AEP.N Neutral N/A US$37.49 15 Aug 2011

American Tower Corporation16 AMT.N Buy N/A US$51.48 15 Aug 2011 Ameriprise Financial, Inc.4, 5, 6a, 6b,

6c, 7, 16 AMP.N Buy N/A US$45.30 15 Aug 2011

Ametek, Inc.16 AME.N Neutral N/A US$38.85 15 Aug 2011 Amgen Inc.2, 4, 5, 6a, 6c, 7, 16, 22 AMGN.O Neutral N/A US$51.60 15 Aug 2011 Amphenol Corp16 APH.N Neutral N/A US$47.22 15 Aug 2011 Anadarko Petroleum Corp.4, 5, 6a, 6c,

7, 13, 16 APC.N Buy N/A US$74.32 15 Aug 2011

Aon Corporation2, 4, 6a, 6b, 6c, 7, 16 AON.N Buy N/A US$46.37 15 Aug 2011 Apollo Group Inc.5, 13, 16 APOL.O Neutral N/A US$45.85 15 Aug 2011 Apple Inc.6c, 7, 16, 18a AAPL.O Buy N/A US$383.41 15 Aug 2011 Applied Materials Inc.5, 16 AMAT.O Neutral N/A US$11.87 15 Aug 2011 Arch Coal, Inc.4, 6a, 16 ACI.N Buy N/A US$21.32 15 Aug 2011 Ares Capital Corporation2, 4, 6a, 6b, 7,

13, 16 ARCC.O Buy N/A US$14.82 15 Aug 2011

Autodesk Inc.8a, 8b, 16 ADSK.O Buy N/A US$30.09 15 Aug 2011 AutoNation Inc.16 AN.N Sell N/A US$35.80 15 Aug 2011 Auxilium Pharmaceuticals Inc16 AUXL.O Buy N/A US$15.17 15 Aug 2011 Avon Products16 AVP.N Buy N/A US$21.78 15 Aug 2011 Axis Capital Holdings Ltd.16 AXS.N Buy N/A US$29.60 15 Aug 2011 Babcock & Wilcox Co16 BWC.N Neutral N/A US$22.78 15 Aug 2011 Baker Hughes Inc.2, 4, 5, 6a, 6b, 6c, 7, 13,

16 BHI.N Buy N/A US$64.57 15 Aug 2011

Bank of America Corp.2, 4, 5, 6a, 6b, 6c,

7, 16, 22 BAC.N Neutral N/A US$7.76 15 Aug 2011

Baxter International Inc.4, 5, 6a, 6c, 7,

16, 22 BAX.N Buy N/A US$54.16 15 Aug 2011

Bed Bath & Beyond Inc.16 BBBY.O Neutral N/A US$54.60 15 Aug 2011 Best Buy Co. Inc.2, 4, 5, 6a, 6c, 7, 13, 16 BBY.N Neutral N/A US$24.53 15 Aug 2011 BorgWarner Inc.13, 16, 18i BWA.N Buy N/A US$71.32 15 Aug 2011 Boston Scientific Corp.4, 5, 6a, 6c, 7,

16, 22 BSX.N Neutral N/A US$6.53 15 Aug 2011

Brinker International16 EAT.N Buy N/A US$24.47 15 Aug 2011 Bristol-Myers Squibb2, 4, 6a, 6c, 7, 16 BMY.N Neutral N/A US$28.17 15 Aug 2011


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Brown-Forman Corp.16 BFb.N Neutral N/A US$68.58 15 Aug 2011 C.H. Robinson Worldwide16, 18j CHRW.O Buy N/A US$68.49 15 Aug 2011 Cadence Pharmaceuticals Inc16 CADX.O Neutral N/A US$7.15 15 Aug 2011 Calpine Corporation2, 4, 6a, 13, 16 CPN.N Buy N/A US$14.64 15 Aug 2011 Camden Property Trust1, 4, 5, 6a, 6b, 7,

16 CPT.N Buy N/A US$67.05 15 Aug 2011

Campbell Soup Co.2, 4, 5, 6a, 6b, 6c, 7,

16, 22 CPB.N Neutral N/A US$31.06 15 Aug 2011

Cardinal Health, Inc.2, 4, 6a, 6c, 7, 16,

18b, 22 CAH.N Buy N/A US$41.60 15 Aug 2011

Carnival Corp.6c, 7, 14, 16, 22 CCL.N Buy N/A US$31.56 15 Aug 2011 Caterpillar Inc.6b, 7, 13, 16, 18k, 22 CAT.N Neutral N/A US$91.37 15 Aug 2011 CBOE Holdings Inc.4, 6a, 16 CBOE.O Neutral N/A US$24.19 15 Aug 2011 CBS Corp.4, 6a, 13, 16, 22 CBS.N Buy N/A US$25.00 15 Aug 2011 Celanese Corporation6a, 16 CE.N Neutral N/A US$45.36 15 Aug 2011 Celgene Corporation6c, 7, 16 CELG.O Buy N/A US$55.74 15 Aug 2011 Cerner Corp.16 CERN.O Neutral N/A US$59.54 15 Aug 2011 Charles Schwab Corp3b, 4, 5, 6a, 6b, 6c,

7, 16, 18l SCHW.N Buy N/A US$12.48 15 Aug 2011

Check Point Software Technologies Ltd16

CHKP.O Buy N/A US$56.73 15 Aug 2011

Chesapeake Energy Corp.4, 6a, 16 CHK.N Neutral N/A US$32.29 15 Aug 2011 Chevron Corp.6b, 7, 16 CVX.N Buy N/A US$99.10 15 Aug 2011 Church & Dwight16 CHD.N Neutral N/A US$41.89 15 Aug 2011 Cisco Systems Inc.2, 4, 6a, 6b, 6c, 7, 8a,

13, 16, 18m CSCO.O Neutral N/A US$16.03 15 Aug 2011

Citrix Systems Inc.16, 18n CTXS.O Neutral N/A US$62.02 15 Aug 2011 Cliffs Natural Resources, Inc.16 CLF.N Buy N/A US$77.08 15 Aug 2011 Clorox16 CLX.N Neutral N/A US$69.95 15 Aug 2011 CME Group Inc.4, 5, 6a, 6c, 7, 16 CME.O Buy N/A US$260.58 15 Aug 2011 Coca-Cola Co.2, 4, 5, 6a, 6b, 6c, 7, 13, 16 KO.N Buy N/A US$68.20 15 Aug 2011 Cognizant Technology Solutions Corp.4, 6a, 6c, 7, 13, 16

CTSH.O Buy N/A US$63.93 15 Aug 2011

Comcast Corporation4, 5, 6a, 6b, 6c, 7,

16 CMCSA.O Buy N/A US$21.27 15 Aug 2011

Community Health Systems, Inc.4,

6a, 16 CYH.N Buy N/A US$21.14 15 Aug 2011

Computer Sciences Corp.4, 6a, 6c, 7,

16, 22 CSC.N Neutral N/A US$30.07 15 Aug 2011

ConocoPhillips6a, 6b, 6c, 7, 16, 22 COP.N Neutral N/A US$67.48 15 Aug 2011 CONSOL Energy, Inc.4, 5, 6a, 16 CNX.N Buy N/A US$42.37 15 Aug 2011 Consolidated Edison4, 5, 6a, 6b, 7, 16 ED.N Neutral N/A US$54.79 15 Aug 2011 Constellation Brands Inc.16 STZ.N Buy N/A US$19.25 15 Aug 2011 Constellation Energy Group2, 4, 5,

6a, 6b, 6c, 7, 16, 19, 22 CEG.N Neutral (CBE) N/A US$37.23 15 Aug 2011

Cooper Industries Inc.2, 4, 6a, 6c, 7, 16 CBE.N Buy N/A US$49.53 15 Aug 2011 Corning Inc.16, 20 GLW.N Buy (CBE) N/A US$15.56 15 Aug 2011 Coventry Health Care2, 4, 5, 6a, 6b, 6c, 7,

16 CVH.N Neutral N/A US$31.32 15 Aug 2011

Cree Inc.13, 16 CREE.O Neutral N/A US$37.11 15 Aug 2011 CSX Corp.2, 4, 5, 6a, 16, 22 CSX.N Buy N/A US$22.98 15 Aug 2011 D.R. Horton Inc.4, 5, 6a, 6b, 7, 16, 20 DHI.N Neutral (CBE) N/A US$9.93 15 Aug 2011 Danaher Corporation2, 4, 5, 6a, 16 DHR.N Buy N/A US$44.72 15 Aug 2011 Darden Restaurants Inc.16 DRI.N Buy N/A US$48.96 15 Aug 2011 Davita Inc.16 DVA.N Buy N/A US$74.66 15 Aug 2011 DCT Industrial Trust Inc16 DCT.N Neutral N/A US$4.57 15 Aug 2011 Deere & Co.16, 22 DE.N Buy N/A US$76.50 15 Aug 2011


UBS 171


Delta Air Lines Inc.2, 4, 5, 6a, 13, 16, 20 DAL.N Buy (CBE) N/A US$7.32 15 Aug 2011 DeVry Inc4, 5, 6a, 16 DV.N Buy N/A US$44.27 15 Aug 2011 Digital Realty Trust4, 6a, 16 DLR.N Sell N/A US$58.80 15 Aug 2011 Discovery Communications Inc16 DISCA.O Neutral N/A US$39.50 15 Aug 2011 Dow Chemical5, 6a, 6b, 6c, 7, 13, 16, 22 DOW.N Buy N/A US$30.08 15 Aug 2011 Dr Pepper Snapple Group Inc.2, 4,

6a, 6b, 6c, 7, 16 DPS.N Neutral N/A US$37.05 15 Aug 2011

DuPont Fabros Technology5, 6a, 16 DFT.N Neutral N/A US$22.77 15 Aug 2011 Dynegy, Inc.13, 16, 19 DYN.N Neutral (CBE) N/A US$4.34 15 Aug 2011 Eaton Corporation2, 4, 5, 6a, 6c, 7, 16, 18o ETN.N Neutral N/A US$42.68 15 Aug 2011 eBay16, 20 EBAY.O Buy (CBE) N/A US$30.89 15 Aug 2011 El Paso Corp.4, 5, 6a, 6b, 7, 13, 16 EP.N Buy N/A US$19.03 15 Aug 2011 Emerson Electric Co.4, 6a, 6c, 7, 16, 18p EMR.N Neutral N/A US$46.91 15 Aug 2011 Endo Pharmaceuticals Holdings6a,

16 ENDP.O Buy N/A US$33.09 15 Aug 2011

EOG Resources2, 4, 6a, 16, 22 EOG.N Neutral N/A US$96.29 15 Aug 2011 Expedia Inc.16, 20 EXPE.O Neutral (CBE) N/A US$29.63 15 Aug 2011 Express Scripts Inc.16 ESRX.O Buy N/A US$48.24 15 Aug 2011 ExxonMobil Corp.3a, 4, 5, 6b, 7, 16, 18q XOM.N Neutral N/A US$74.29 15 Aug 2011 F5 Networks, Inc.16, 20 FFIV.O Neutral (CBE) N/A US$83.65 15 Aug 2011 Fastenal Co.16 FAST.O Buy N/A US$32.77 15 Aug 2011 FedEx Corp.16 FDX.N Buy N/A US$81.85 15 Aug 2011 First Solar Inc13, 16 FSLR.O Buy N/A US$106.10 15 Aug 2011 Flextronics International Ltd.4, 5, 6a,

6b, 6c, 7, 16 FLEX.O Buy N/A US$5.71 15 Aug 2011

Flowserve Corp.16 FLS.N Neutral N/A US$92.18 15 Aug 2011 Fluor Corporation4, 6a, 6b, 6c, 7, 13, 16 FLR.N Buy N/A US$60.42 15 Aug 2011 Foot Locker Inc.16 FL.N Neutral N/A US$19.30 15 Aug 2011 Ford Motor Co.4, 6a, 6b, 6c, 7, 13, 14, 16,

18c F.N Buy N/A US$11.35 15 Aug 2011

Foster Wheeler Ltd.5, 13, 16 FWLT.O Buy N/A US$24.12 15 Aug 2011 Gannett Co.16 GCI.N Neutral N/A US$10.74 15 Aug 2011 General Electric Co.4, 5, 6a, 6b, 6c, 7, 16,

18r, 22 GE.N Buy N/A US$16.39 15 Aug 2011

General Motors Company4, 5, 6a, 6b,

6c, 7, 16 GM.N Buy N/A US$26.42 15 Aug 2011

Genon Energy Inc.16, 20 GEN.N Neutral (CBE) N/A US$3.23 15 Aug 2011 Genpact4, 5, 6a, 16 G.N Buy N/A US$16.04 15 Aug 2011 Georgia Gulf Corp.16 GGC.N Buy N/A US$19.29 15 Aug 2011 Gilead Sciences16 GILD.O Buy N/A US$37.27 15 Aug 2011 Goldman Sachs Group Inc.2, 4, 6a,

6b, 6c, 7, 13, 16, 18s, 22 GS.N Buy N/A US$119.13 15 Aug 2011

Goodrich Corp.2, 4, 5, 6a, 6b, 6c, 7, 16, 22 GR.N Buy N/A US$88.28 15 Aug 2011 Google Inc.2, 4, 5, 6a, 6b, 6c, 7, 16, 18d GOOG.O Buy N/A US$557.23 15 Aug 2011 H.J. Heinz Company4, 5, 6a, 6c, 7, 16 HNZ.N Buy N/A US$51.83 15 Aug 2011 Hansen Natural Corporation5, 6b, 7,

13, 16 HANS.O Buy N/A US$81.05 15 Aug 2011

Harley-Davidson Inc.6c, 7, 16 HOG.N Neutral Buy US$38.20 15 Aug 2011 Hasbro Inc.16 HAS.O Neutral N/A US$37.88 15 Aug 2011 HCA Inc16 HCA.N Buy N/A US$22.58 15 Aug 2011 HealthSpring Inc.4, 6a, 16 HS.N Buy N/A US$36.22 15 Aug 2011 Hess Corp.4, 6a, 13, 16 HES.N Buy N/A US$60.21 15 Aug 2011 Hewlett-Packard Co.2, 4, 5, 6a, 6b, 6c, 7,

16, 22 HPQ.N Buy N/A US$32.43 15 Aug 2011

Home Depot Inc.16 HD.N Buy N/A US$31.47 15 Aug 2011


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Host Hotels & Resorts Inc.2, 4, 5, 6a,

16 HST.N Neutral N/A US$12.54 15 Aug 2011

Humana Inc.6b, 7, 16 HUM.N Buy N/A US$74.04 15 Aug 2011 Huntsman Corp.16 HUN.N Buy N/A US$14.30 15 Aug 2011 IAC/InterActive Corp16, 18aq IACI.O Neutral N/A US$38.37 15 Aug 2011 IBM Corp.2, 4, 5, 6a, 6b, 6c, 7, 16, 18e, 22 IBM.N Neutral N/A US$172.99 15 Aug 2011 IDEX Corp.16 IEX.N Buy N/A US$37.30 15 Aug 2011 Illinois Tool Works4, 5, 6a, 16 ITW.N Buy N/A US$45.29 15 Aug 2011 Illumina Inc.16 ILMN.O Buy N/A US$54.10 15 Aug 2011 Impax Laboratories Inc.16 IPXL.OQ Neutral N/A US$19.11 15 Aug 2011 Incyte Pharmaceuticals16, 20 INCY.O Buy (CBE) N/A US$15.70 15 Aug 2011 Ingersoll-Rand Co.16, 18aq, 22 IR.N Neutral N/A US$31.40 15 Aug 2011 Intel Corp.4, 5, 6b, 6c, 7, 8a, 13, 16, 18u INTC.O Buy N/A US$20.89 15 Aug 2011 IntercontinentalExchange, Inc.13, 16 ICE.N Buy N/A US$116.43 15 Aug 2011 Interpublic Group of Companies, Inc.1, 4, 5, 6a, 6c, 7, 13, 16, 22

IPG.N Buy N/A US$8.90 15 Aug 2011

Intuit Inc.16 INTU.O Buy N/A US$43.13 15 Aug 2011 ITT Educational Services13, 16 ESI.N Sell N/A US$74.05 15 Aug 2011 JB Hunt Transport4, 5, 6a, 16, 18v JBHT.O Buy N/A US$40.69 15 Aug 2011 Johnson & Johnson16, 18w JNJ.N Buy N/A US$64.59 15 Aug 2011 Johnson Controls Inc.13, 16 JCI.N Neutral N/A US$32.89 15 Aug 2011 Joy Global Inc.3c, 4, 6a, 13, 16, 20 JOYG.O Buy (CBE) N/A US$81.98 15 Aug 2011 JPMorgan Chase & Co.4, 5, 6a, 6b, 6c,

7, 16, 18x JPM.N Buy N/A US$36.88 15 Aug 2011

Kansas City Southern2, 4, 6a, 16 KSU.N Neutral N/A US$56.02 15 Aug 2011 KBR, Inc.4, 6a, 6c, 7, 16 KBR.N Buy N/A US$30.69 15 Aug 2011 Kennametal Inc.16 KMT.N Neutral N/A US$35.61 15 Aug 2011 Kimberly-Clark2, 4, 6a, 6b, 6c, 7, 16 KMB.N Buy N/A US$66.10 15 Aug 2011 KLA-Tencor Corp.16 KLAC.O Buy N/A US$36.97 15 Aug 2011 Kraft Foods Inc.4, 5, 6a, 6b, 6c, 7, 16, 18y,

22 KFT.N Buy N/A US$34.68 15 Aug 2011

Kraton Performance Polymers, Inc.2, 4, 6a, 16

KRA.N Buy N/A US$25.99 15 Aug 2011

LAM Research Corp.16 LRCX.O Buy N/A US$39.83 15 Aug 2011 Lear Corporation4, 6a, 6c, 7, 16 LEA.N Buy N/A US$46.15 15 Aug 2011 Lennar2, 4, 6a, 6b, 7, 16, 20, 22 LEN.N Neutral (CBE) N/A US$14.92 15 Aug 2011 Lennox International Inc.4, 6a, 16 LII.N Neutral N/A US$32.09 15 Aug 2011 Level 3 Communications16, 20 LVLT.O Neutral (CBE) N/A US$1.99 15 Aug 2011 Life Technologies Corp.16 LIFE.O Buy N/A US$38.84 15 Aug 2011 LifePoint Hospitals, Inc.16 LPNT.O Buy N/A US$34.08 15 Aug 2011 Lincare Holdings, Inc.16 LNCR.O Buy N/A US$22.13 15 Aug 2011 Linear Technology Corp.16 LLTC.O Neutral N/A US$27.77 15 Aug 2011 Lockheed Martin Corp.4, 5, 6a, 6b, 6c, 7,

16, 22 LMT.N Neutral N/A US$70.26 15 Aug 2011

Lorillard13, 16 LO.N Buy N/A US$105.82 15 Aug 2011 LPL Investment Hldg Inc2, 4, 6a, 16 LPLA.O Neutral N/A US$27.12 15 Aug 2011 LyondellBasell Industries6b, 7, 16 LYB.N Buy N/A US$33.94 15 Aug 2011 Marriott International, Inc.16, 18z, 22 MAR.N Buy N/A US$28.82 15 Aug 2011 Marsh & McLennan Companies, Inc.2, 4, 5, 6a, 6b, 6c, 7, 16, 22

MMC.N Buy N/A US$28.45 15 Aug 2011

Masco Corp.16 MAS.N Sell N/A US$8.83 15 Aug 2011 Mattel Inc.16 MAT.O Buy N/A US$24.81 15 Aug 2011 McDermott International5, 16 MDR.N Buy N/A US$15.16 15 Aug 2011 McDonalds Corp.6b, 7, 13, 16, 22 MCD.N Buy N/A US$86.82 15 Aug 2011 McKesson Corporation16, 22 MCK.N Buy N/A US$78.92 15 Aug 2011 MeadWestvaco4, 6a, 6c, 7, 16, 22 MWV.N Buy N/A US$27.86 15 Aug 2011


UBS 173


Medicis Pharmaceutical Corp.16 MRX.N Neutral N/A US$37.60 15 Aug 2011 Medtronic, Inc.4, 5, 6a, 6b, 6c, 7, 16 MDT.N Buy N/A US$32.03 15 Aug 2011 MetLife2, 4, 5, 6a, 6b, 6c, 7, 13, 16 MET.N Buy N/A US$34.42 15 Aug 2011 Mettler-Toledo International Inc.4,

5, 6a, 6b, 6c, 7, 16 MTD.N Buy N/A US$155.49 15 Aug 2011

Microchip Technology, Inc.5, 16 MCHP.O Neutral N/A US$32.34 15 Aug 2011 Mohawk Industries, Inc.16 MHK.N Buy N/A US$47.10 15 Aug 2011 Molex Incorporated16 MOLX.O Neutral N/A US$21.30 15 Aug 2011 Molson Coors Brewing4, 5, 6a, 16 TAP.N Buy N/A US$44.29 15 Aug 2011 Momenta Pharmaceuticals Inc2, 4,

6a, 16 MNTA.O Neutral N/A US$17.37 15 Aug 2011

Morgan Stanley6b, 6c, 7, 16, 18aa, 22 MS.N Neutral N/A US$17.92 15 Aug 2011 Mosaic Co2, 4, 5, 16 MOS.N Buy N/A US$66.44 15 Aug 2011 Motorola Mobility Holding Inc13, 16,

19 MMI.N Neutral (CBE) N/A US$38.13 15 Aug 2011

Nabors Industries2, 4, 5, 6a, 6b, 6c, 7, 16 NBR.N Restricted N/A US$19.98 15 Aug 2011 NASDAQ OMX Group, Inc.4, 6a, 6b,

6c, 7, 16 NDAQ.O Neutral N/A US$23.62 15 Aug 2011

Nike Inc.16, 18ab NKE.N Buy N/A US$85.13 15 Aug 2011 NiSource Inc.4, 6a, 6b, 7, 16, 18ac NI.N Neutral N/A US$20.41 15 Aug 2011 Noble Energy, Inc.2, 4, 6a, 6c, 7, 16 NBL.N Buy N/A US$89.85 15 Aug 2011 Northrop Grumman Corp.16, 22 NOC.N Neutral N/A US$53.05 15 Aug 2011 Novellus Systems Inc.16 NVLS.O Neutral N/A US$29.63 15 Aug 2011 NRG Energy Inc.13, 16 NRG.N Neutral N/A US$22.87 15 Aug 2011 Nucor Corp.16 NUE.N Neutral N/A US$34.79 15 Aug 2011 NVIDIA Corporation16 NVDA.O Neutral N/A US$13.37 15 Aug 2011 Occidental Petroleum Corp.2, 4, 5, 6a,

16, 18ad OXY.N Buy N/A US$89.31 15 Aug 2011

Olin Corp.16 OLN.N Neutral N/A US$20.07 15 Aug 2011 ON Semiconductor Corp5, 6c, 7, 16 ONNN.O Neutral N/A US$7.81 15 Aug 2011 Oracle Corporation16, 18ae ORCL.O Buy N/A US$27.64 15 Aug 2011 O'Reilly Automotive, Inc.16 ORLY.O Buy N/A US$60.74 15 Aug 2011 Par Pharmaceutical Companies Inc.16

PRX.N Buy N/A US$30.03 15 Aug 2011

Patterson Cos Inc16 PDCO.O Neutral N/A US$29.58 15 Aug 2011 Patterson-UTI Energy, Inc.16 PTEN.O Neutral N/A US$27.55 15 Aug 2011 Pentair Inc4, 5, 6a, 16 PNR.N Neutral N/A US$33.66 15 Aug 2011 PepsiCo Inc.2, 4, 5, 6a, 6b, 6c, 7, 16, 18af PEP.N Buy N/A US$63.57 15 Aug 2011 PerkinElmer, Inc.4, 5, 16 PKI.N Buy N/A US$22.79 15 Aug 2011 Perrigo16 PRGO.O Buy N/A US$88.38 15 Aug 2011 PetSmart, Inc.16 PETM.O Buy N/A US$41.86 15 Aug 2011 Pfizer Inc.6b, 7, 16, 22 PFE.N Buy N/A US$18.34 15 Aug 2011 PG&E Corporation2, 4, 6a, 16 PCG.N Neutral N/A US$40.76 15 Aug 2011 Pharmasset Inc.16 VRUS.O Buy N/A US$129.00 15 Aug 2011 Pinnacle West Capital Co.3d, 4, 6a, 16 PNW.N Neutral N/A US$42.26 15 Aug 2011 Plum Creek16 PCL.N Neutral N/A US$36.72 15 Aug 2011 Polo Ralph Lauren4, 6a, 16 RL.N Buy N/A US$140.69 15 Aug 2011 Polycom, Inc.16 PLCM.O Neutral N/A US$26.21 15 Aug 2011 Potlatch16 PCH.O Sell N/A US$34.09 15 Aug 2011 PPL Corporation2, 4, 5, 6a, 6c, 7, 16 PPL.N Neutral N/A US$26.65 15 Aug 2011 Priceline.com Inc16, 20 PCLN.O Neutral (CBE) N/A US$514.35 15 Aug 2011 Principal Financial Group5, 6b, 7, 16 PFG.N Neutral N/A US$24.10 15 Aug 2011 Procter & Gamble2, 4, 5, 6a, 6b, 6c, 7, 8a,

16, 18ag PG.N Buy N/A US$61.88 15 Aug 2011

Progress Energy Inc.6a, 16, 22 PGN.N Neutral N/A US$46.88 15 Aug 2011


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Public Service Enterprise Group4,

6a, 6b, 7, 16 PEG.N Buy N/A US$32.37 15 Aug 2011

Pulte Homes4, 6a, 6b, 7, 16, 20, 22 PHM.N Neutral (CBE) N/A US$4.84 15 Aug 2011 QEP Resources Inc.16 QEP.N Buy N/A US$36.98 15 Aug 2011 Qlik Technologies16 QLIK.O Neutral N/A US$29.78 15 Aug 2011 Qualcomm Inc.16, 18f QCOM.O Buy N/A US$51.26 15 Aug 2011 Quality Systems, Inc.16 QSII.O Neutral N/A US$82.27 15 Aug 2011 Quest Diagnostics16, 22 DGX.N Neutral N/A US$48.95 15 Aug 2011 Questar Corp4, 5, 6a, 16 STR.N Neutral N/A US$18.90 15 Aug 2011 Ralcorp Holdings Inc.6b, 7, 16 RAH.N Buy N/A US$83.32 15 Aug 2011 Range Resources Corp.2, 4, 6a, 16 RRC.N Neutral N/A US$62.52 15 Aug 2011 Raytheon Co.2, 4, 6a, 6c, 7, 16, 22 RTN.N Neutral N/A US$41.24 15 Aug 2011 Reinsurance Group of America Inc.4, 5, 6a, 6b, 7, 16

RGA.N Buy N/A US$51.49 15 Aug 2011

RenaissanceRe Holdings Ltd.6b, 6c,

7, 16 RNR.N Buy N/A US$63.90 15 Aug 2011

Research in Motion Limited13, 16, 20 RIMM.O Neutral (CBE) N/A US$27.11 15 Aug 2011 Reynolds American16 RAI.N Buy N/A US$35.15 15 Aug 2011 Riverbed Technology6c, 7, 16, 20 RVBD.O Neutral (CBE) N/A US$26.13 15 Aug 2011 Rockwell Automation Inc.4, 6a, 6b, 6c,

7, 16, 18ah ROK.N Neutral N/A US$64.53 15 Aug 2011

Rockwell Collins Inc.4, 5, 6a, 6b, 6c, 7,

8a, 16, 18ai COL.N Buy N/A US$47.68 15 Aug 2011

Royal Caribbean16 RCL.N Neutral N/A US$26.59 15 Aug 2011 SandRidge Energy Inc2, 4, 6a, 16 SD.N Neutral N/A US$8.10 15 Aug 2011 Sapient Corp.16, 20 SAPE.O Neutral (CBE) N/A US$11.19 15 Aug 2011 Schlumberger Ltd.16, 18aj SLB.N Buy N/A US$80.07 15 Aug 2011 Scripps Networks Interactive Inc3e, 16

SNI.N Neutral N/A US$43.00 15 Aug 2011

Seattle Genetics, Inc.16, 20 SGEN.O Neutral (CBE) N/A US$15.37 15 Aug 2011 Sigma-Aldrich Corp.2, 4, 5, 6a, 16 SIAL.O Buy N/A US$64.55 15 Aug 2011 Simon Property Group4, 5, 6a, 16 SPG.N Buy N/A US$116.03 15 Aug 2011 Southern Company2, 4, 6a, 16 SO.N Neutral N/A US$40.41 15 Aug 2011 Southwest Airlines4, 6a, 6c, 7, 16, 22 LUV.N Neutral N/A US$8.50 15 Aug 2011 Southwestern Energy Company4,

6a, 16 SWN.N Neutral N/A US$39.88 15 Aug 2011

Spectra Energy Corp.6a, 16 SE.N Buy N/A US$25.32 15 Aug 2011 Spirit AeroSystems Holdings16 SPR.N Buy N/A US$15.96 15 Aug 2011 Sprint Nextel Corporation16, 20, 22 S.N Neutral (CBE) N/A US$3.48 15 Aug 2011 Starbucks Corp.6a, 6b, 6c, 7, 13, 16, 18ak SBUX.O Buy N/A US$38.42 15 Aug 2011 Starwood Hotels & Resorts Worldwide, Inc13, 16, 22

HOT.N Buy N/A US$45.83 15 Aug 2011

Steel Dynamics Inc.16 STLD.O Neutral N/A US$13.04 15 Aug 2011 Tanger Factory Outlet Centers16 SKT.N Buy N/A US$26.97 15 Aug 2011 TD Ameritrade Holding Corp6b, 7, 16 AMTD.O Neutral N/A US$14.86 15 Aug 2011 TE Connectivity Ltd.2, 4, 5, 6a, 6b, 6c, 7,

8a, 16, 18an TEL.N Buy N/A US$31.51 15 Aug 2011

TECO Energy Inc.6a, 16 TE.N Buy N/A US$17.56 15 Aug 2011 Tenet Healthcare Corp.16, 20 THC.N Buy (CBE) N/A US$5.07 15 Aug 2011 Teradyne Inc.5, 16 TER.N Neutral N/A US$12.47 15 Aug 2011 Texas Instruments Inc.8a, 16 TXN.N Neutral N/A US$27.49 15 Aug 2011 The Hershey Company2, 4, 6a, 6b, 6c, 7,

16, 18t HSY.N Neutral N/A US$56.73 15 Aug 2011

Thermo Fisher Scientific Inc.16, 18al TMO.N Buy N/A US$54.91 15 Aug 2011 Toll Brothers16, 20 TOL.N Buy (CBE) N/A US$16.83 15 Aug 2011 Transocean Ltd.2, 4, 5, 6a, 6c, 7, 13, 16,

18am, 22 RIG.N Buy N/A US$57.26 15 Aug 2011


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Under Armour, Inc.13, 16 UA.N Neutral N/A US$65.96 15 Aug 2011 United Continental Holdings Inc5,

13, 16, 18ar, 20 UAL.N Buy (CBE) N/A US$18.26 15 Aug 2011

United Parcel Service2, 4, 5, 6a, 6b, 6c,

7, 16, 18g UPS.N Buy N/A US$65.88 15 Aug 2011

United States Steel Corp13, 16 X.N Buy N/A US$31.89 15 Aug 2011 United Technologies Corp.4, 8a, 16,

18ao UTX.N Buy N/A US$73.54 15 Aug 2011

UnitedHealth Group2, 4, 5, 6a, 6b, 6c, 7,

16 UNH.N Buy N/A US$45.94 15 Aug 2011

Universal Health Services16, 22 UHS.N Buy N/A US$40.00 15 Aug 2011 URS Corporation4, 6a, 16 URS.N Neutral N/A US$34.32 15 Aug 2011 V.F. Corp.16 VFC.N Buy N/A US$113.35 15 Aug 2011 Valero Energy Corporation4, 6a, 16,

22 VLO.N Buy N/A US$21.53 15 Aug 2011

Validus Holdings, LTD.4, 6a, 16 VR.N Buy N/A US$25.85 15 Aug 2011 Verizon Communications2, 4, 6a, 6c, 7,

16 VZ.N Neutral N/A US$35.05 15 Aug 2011

Vertex Pharmaceuticals Inc.16 VRTX.O Neutral N/A US$46.31 15 Aug 2011 Viacom Inc.2, 4, 6a, 6c, 7, 16 VIAb.N Buy N/A US$45.81 15 Aug 2011 Visteon Corp.16 VC.N Buy N/A US$52.27 15 Aug 2011 W.W. Grainger Inc16 GWW.N Neutral N/A US$138.57 15 Aug 2011 Walt Disney Co.4, 6a, 6c, 7, 16, 22 DIS.N Neutral N/A US$33.65 15 Aug 2011 Walter Energy Inc16 WLT.N Buy N/A US$84.98 15 Aug 2011 Washington Post16 WPO.N Neutral N/A US$361.11 15 Aug 2011 Waters Corp.4, 5, 6a, 6b, 6c, 7, 16 WAT.N Neutral N/A US$81.11 15 Aug 2011 Watsco Inc16 WSO.N Neutral N/A US$56.94 15 Aug 2011 Watson Pharmaceuticals Inc.16 WPI.N Buy N/A US$65.10 15 Aug 2011 Weatherford International Ltd.2, 4, 5,

6a, 16 WFT.N Buy N/A US$17.68 15 Aug 2011

Wendy's-Arby's Group Inc.4, 5, 6a, 16 WEN.N Buy N/A US$5.06 15 Aug 2011 Westar Energy, Inc.4, 5, 6a, 16 WR.N Neutral N/A US$25.36 15 Aug 2011 Westlake Chemical Corp16 WLK.N Neutral N/A US$43.42 15 Aug 2011 Weyerhaeuser16, 22 WY.N Neutral N/A US$17.22 15 Aug 2011 Williams Cos Inc.13, 16, 22 WMB.N Buy N/A US$28.67 15 Aug 2011 Williams-Sonoma, Inc.16 WSM.N Neutral N/A US$31.65 15 Aug 2011 Willis Group Holdings Limited16 WSH.N Neutral N/A US$37.42 15 Aug 2011 Windstream Corporation16 WIN.O Neutral N/A US$12.10 15 Aug 2011 Wisconsin Energy Corp.4, 6a, 16 WEC.N Buy N/A US$30.62 15 Aug 2011 Yahoo Inc.4, 5, 6a, 13, 16, 20 YHOO.O Neutral (CBE) N/A US$13.47 15 Aug 2011 Zimmer Holdings, Inc.16 ZMH.N Buy N/A US$53.38 15 Aug 2011

Source: UBS. All prices as of local market close. Ratings in this table are the most current published ratings prior to this report. They may be more recent than the stock pricing date 1. UBS Securities LLC is acting as manager/co-manager, underwriter, placement or sales agent in regard to an offering of

securities of this company/entity or one of its affiliates.

2. UBS AG, its affiliates or subsidiaries has acted as manager/co-manager in the underwriting or placement of securities of this company/entity or one of its affiliates within the past 12 months.

3a. UBS Ltd is acting as financial advisor to Royal Dutch Shell plc and ExxonMobil Corporation on the sale of certain underground gas storage facilities in Germany to GDF Suez

3b. UBS Securities LLC is acting as Advisor to Charles Schwab on the $1bn acquisition of OptionsXpress Holding Inc.

3c. UBS Securities LLC is acting as advisor to Joy Global Inc on the announced acquisition of a stake in International Mining Machinery.

3d. UBS Securities LLC is acting as advisor to Pinnacle West Capital on its announced agreement to acquire a 48% undivided ownership interest in Units 4 and 5 at the Four Corners Power Plant from Southern California Edison


UBS 176

3e. UBS Securities LLC is acting as advisor to Virgin Media Inc on its announced agreement to sell its stake in UKTv to Scripps Networks Interactive.

4. Within the past 12 months, UBS AG, its affiliates or subsidiaries has received compensation for investment banking services from this company/entity.

5. UBS AG, its affiliates or subsidiaries expect to receive or intend to seek compensation for investment banking services from this company/entity within the next three months.

6a. This company/entity is, or within the past 12 months has been, a client of UBS Securities LLC, and investment banking services are being, or have been, provided.

6b. This company/entity is, or within the past 12 months has been, a client of UBS Securities LLC, and non-investment banking securities-related services are being, or have been, provided.

6c. This company/entity is, or within the past 12 months has been, a client of UBS Securities LLC, and non-securities services are being, or have been, provided.

7. Within the past 12 months, UBS Securities LLC has received compensation for products and services other than investment banking services from this company/entity.

8a. The equity analyst covering this company, a member of his or her team, or one of their household members has a long common stock position in this company.

8b. The equity analyst covering this company, a member of his or her team, or one of their household members has a long options position in this company.

13. UBS AG, its affiliates or subsidiaries beneficially owned 1% or more of a class of this company`s common equity securities as of last month`s end (or the prior month`s end if this report is dated less than 10 days after the most recent month`s end).

14. UBS Limited acts as broker to this company.

16. UBS Securities LLC makes a market in the securities and/or ADRs of this company.

18a. A U.S. based global equity strategist, a member of his team, or one of their household members has a long common stock position in Apple, Inc.

18b. A U.S. based global equity strategist, a member of his team, or one of their household members has a long common stock position in Cardinal Health, Inc.

18c. A U.S. based global equity strategist, a member of his team, or one of their household members has a long common stock position in Ford Motor, Co.

18d. A U.S. based global equity strategist, a member of his team, or one of their household members has a long common stock position in Google, Inc.

18e. A U.S. based global equity strategist, a member of his team, or one of their household members has a long common stock position in International Business Machines.

18f. A U.S. based global equity strategist, a member of his team, or one of their household members has a long common stock position in Qualcomm Inc.

18g. A U.S. based global equity strategist, a member of his team, or one of their household members has a long common stock position in United Parcel Service Inc.

18h. The U.S. equity strategist, a member of his team, or one of their household members has a long common stock position in Altria Group.

18i. The U.S. equity strategist, a member of his team, or one of their household members has a long common stock position in BorgWarner Inc.

18j. The U.S. equity strategist, a member of his team, or one of their household members has a long common stock position in C.H. Robinson Worldwide.

18k. The U.S. equity strategist, a member of his team, or one of their household members has a long common stock position in Caterpillar Inc.

18l. The U.S. equity strategist, a member of his team, or one of their household members has a long common stock position in Charles Schwab Corp.

18m. The U.S. equity strategist, a member of his team, or one of their household members has a long common stock position in Cisco Systems Inc.

18n. The U.S. equity strategist, a member of his team, or one of their household members has a long common stock position in Citrix Systems Inc.

18o. The U.S. equity strategist, a member of his team, or one of their household members has a long common stock position in Eaton Corp.


UBS 177

18p. The U.S. equity strategist, a member of his team, or one of their household members has a long common stock position in Emerson Electric Co.

18q. The U.S. equity strategist, a member of his team, or one of their household members has a long common stock position in Exxon Mobil Corp.

18r. The U.S. equity strategist, a member of his team, or one of their household members has a long common stock position in General Electric.

18s. The U.S. equity strategist, a member of his team, or one of their household members has a long common stock position in Goldman Sachs.

18t. The U.S. equity strategist, a member of his team, or one of their household members has a long common stock position in Hershey Co.

18u. The U.S. equity strategist, a member of his team, or one of their household members has a long common stock position in Intel Corp.

18v. The U.S. equity strategist, a member of his team, or one of their household members has a long common stock position in JB Hunt Transport.

18w. The U.S. equity strategist, a member of his team, or one of their household members has a long common stock position in Johnson & Johnson.

18x. The U.S. equity strategist, a member of his team, or one of their household members has a long common stock position in JPMorgan Chase & Co.

18y. The U.S. equity strategist, a member of his team, or one of their household members has a long common stock position in Kraft Foods Inc.

18z. The U.S. equity strategist, a member of his team, or one of their household members has a long common stock position in Marriott International, Inc.

18aa. The U.S. equity strategist, a member of his team, or one of their household members has a long common stock position in Morgan Stanley.

18ab. The U.S. equity strategist, a member of his team, or one of their household members has a long common stock position in Nike Inc.

18ac. The U.S. equity strategist, a member of his team, or one of their household members has a long common stock position in NiSource, Inc.

18ad. The U.S. equity strategist, a member of his team, or one of their household members has a long common stock position in Occidental Petroleum Corp.

18ae. The U.S. equity strategist, a member of his team, or one of their household members has a long common stock position in Oracle Corporation.

18af. The U.S. equity strategist, a member of his team, or one of their household members has a long common stock position in PepsiCo Inc.

18ag. The U.S. equity strategist, a member of his team, or one of their household members has a long common stock position in Procter & Gamble Co.

18ah. The U.S. equity strategist, a member of his team, or one of their household members has a long common stock position in Rockwell Automation Inc.

18ai. The U.S. equity strategist, a member of his team, or one of their household members has a long common stock position in Rockwell Collins Inc.

18aj. The U.S. equity strategist, a member of his team, or one of their household members has a long common stock position in Schlumberger.

18ak. The U.S. equity strategist, a member of his team, or one of their household members has a long common stock position in Starbucks Corp.

18al. The U.S. equity strategist, a member of his team, or one of their household members has a long common stock position in Thermo Electron Corp.

18am. The U.S. equity strategist, a member of his team, or one of their household members has a long common stock position in Transocean Inc.

18an. The U.S. equity strategist, a member of his team, or one of their household members has a long common stock position in Tyco Electronics Ltd.

18ao. The U.S. equity strategist, a member of his team, or one of their household members has a long common stock position in United Technologies Corp.


UBS 178

18ap. The U.S. equity strategist, a member of his team, or one of their household members has a short common stock position in Amazon, Inc.

18aq. UBS AG, its affiliates or subsidiaries held other significant financial interests in this company/entity as of last month`s end (or the prior month`s end if this report is dated less than 10 working days after the most recent month`s end).

18ar. UBS Securities LLC is acting as an advisor to Continental Airlines on its announced agreement to merge with UAL Corp.

19. Because this company is an announced takeout candidate, UBS believes the security presents lower-than-normal risk. We have widened its rating band to +6%/-10% compared with +6%/-6%, respectively, under the normal rating system.

20. Because UBS believes this security presents significantly higher-than-normal risk, its rating is deemed Buy if the FSR exceeds the MRA by 10% (compared with 6% under the normal rating system).

22. UBS AG, its affiliates or subsidiaries held other significant financial interests in this company/entity as of last month`s end (or the prior month`s end if this report is dated less than 10 working days after the most recent month`s end).

Unless otherwise indicated, please refer to the Valuation and Risk sections within the body of this report.

For a complete set of disclosure statements associated with the companies discussed in this report, including information on valuation and risk, please contact UBS Securities LLC, 1285 Avenue of Americas, New York, NY 10019, USA, Attention: Publishing Administration.


UBS 179

Global Disclaimer

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financial pacific - what if a grey or black skies lie ahead (third party)

Business

grey skies recession

recession base case

severe black skies recession

moderate recession

black skies scenario

cfa probability of recession

base case scenario

normal grey skies