TheChek News Flow

* Sub-market earnings growth to drive sector de-rating

We lower our sector earnings & PO’s again, see table 1. We are now 15% below

consensus 2017. We believe the slowdown in sector earnings growth is structural and

returns have peaked. Our forecasts imply 4% earnings CAGR in the next 3-years, below

the European market, as a result we argue for a sector de-rating from its current 30%

P/E rel. In our view the catalyst for a de-rating will be [1] increased visibility over submarket

earnings growth; and [2] a muted recovery in Chinese luxury consumption.

* Six key themes to drive luxury sector (under)performance

[1] Revenue slowdown structural, not cyclical. BofAMLe 4% rev growth for 2016

White space retail penetration into Asia drove 2/3rds of sector revenue in last 5 years.

Rev now reliant on same-store-sales for growth, difficult given limited pricing power.

[2] Retail store consolidation likely.

We see the potential for store closures in Greater China, given over capacity in Tier 2-3

cities. LVMH has started, expect others to follow suit. Limited cost savings

[3] Margin pressure to persist: retail deleverage & negative geography mix.

Ongoing rent inflation in premium real estate (6-9% pa) would result in retail

deleverage. Historic EBIT margins are now largely irrelevant as they included significant

over-earning in HK, unlikely to return.

[4] RMB devaluation poses significant risk.

Our Global Rates team has high conviction the RMB will decline by as much as 10% vs the

USD in 2016. This would reduce sector EBIT by 7%, and more significantly impact

Chinese sentiment & offshore luxury consumption. UHR, CFR & Burberry most at risk.

[5] Tourism support to fade, particularly in Europe.

Lead indicators suggest tourism would slow into Q4 & 2016. In our view, Europe is the

region with most to lose, LVMH the company.

[6] Digital & Japan the only standout’s.

Consumers increasingly shifting luxury spend online, YNAP only pure-play exposure. Japan

will likely continue to benefit from inbound tourism at the expense of HK (and margins).

* Bearish sector view reflected in U/P on LVMH, CFR & UHR

Our U/P rating on LVMH reflects its expensive P/E rel given sub-market earnings

growth, tough comps from weak EUR & tourism and bullish positioning. Swatch: weak

end demand, inventory build & smart watch threat. Richemont: exposed to weakest

categories in luxury (HK & watches) and margin pressure, vs cons expecting expansion.

* Buy YNAP & Pandora for growth, Kering self-help

Our Buy rating on YNAP reflects its pure play on digital luxury, which continues to take

share. Our high conviction emphasised by its BofAML Europe1 inclusion. Pandora:

above sector EPS growth & returns. Kering: while not immune to macro headwinds KER

has a self-help story, with a turnaround at Gucci & potential divestment of Puma. We

upgrade adidas to Neutral given ongoing strength in the category, supported by

“athleasuire”.

(HSBC) China Aircraft & Parts : Initiating coverage: Gaining take-off velocity

* Potential reforms should also improve the longer-term outlook and relative sector attractiveness

* Initiate on eight companies: Buy AviChina, JONHON, AVIC Electromechanical and AVICopter

* Significant progress but still substantial potential. China is one of the few

countries to have established a complex aerospace industry. It has reduced its

dependency on foreign designs/suppliers and is now capable of indigenously

developing more advanced 4th generation fighters (J-20 & J-31) as well as mid-sized

commercial passenger planes (C919). The technology gap with international

suppliers across both military and commercial products is rapidly closing, implying

scope for upside as improving competitiveness drives domestic and international

demand.

* Military upgrading to underpin sector growth: The PLA Air Force (PLAAF) is

undergoing rapid modernisation as it replaces aircraft types dating from the

pre-1980s (e.g. J-7 & J-8) with 3rd generation capability (e.g. J-10, J-11 & J-16) and

develops new transporters, bombers and special mission aircraft. We forecast

military aircraft procurement spend to grow at an 18% CAGR over the next five years.

In addition, we see growth upside from various commercial plane developments

especially as the indigenous programmes (e.g. C919) leverage on the strong and

growing domestic demand from the world’s second-largest aircraft market.

* SOE reforms slower than expected but still offer upside: The defence industry

should benefit from the broader SOE reforms. In particular, potential changes to the

standard “cost-plus” pricing model should boost margins, while asset injections into the

listcos and better management incentive schemes should improve industry efficiency

and profitability.

* Sector top picks are AviChina, JONHON, AVIC Electro and AVICopter: All

aircraft manufacturing in China is grouped within AVIC Group. We initiate on eight of

AVIC’s subsidiaries which have majority revenue exposure to defence spending, with

Buy ratings on AviChina (2357 HK, TP HKD8.3), China Aviation Optical-Electrical

Technology (‘JONHON’, 002179 CH, TP RMB52.6), AVIC Electromechanical

(002013 CH, TP RMB30.6) and AVIC Helicopter (‘AVICopter’, 600038 CH, TP

RMB65.9) given growth potential and relative valuations. We view valuations as fair

for AVIC Aircraft (000768 CH, TP RMB27.30), China Avionics Systems (‘AVIC

Avionics’, 600372 CH, TP RMB29.6) and AVIC Aviation Engine (‘AVIC Engine’,

600893 CH, TP RMB51.0) and initiate with Hold ratings. We initiate on Hongdu

Aviation (600316 CH) with Reduce (TP RMB8.9).

On Friday, Renault’s board is expected to change its cross-shareholdings with Nissan so they might better reflect the power balance in the two carmakers’ 16-year-old alliance. And not too soon.

When the French state raised its stake in Renault in April, it stoked Japanese concern about the partnership agreement. The alliance is a good model of how to reach scale in an industry where consolidation is difficult. The current incident shows why such alliances should not be cemented with cross-shareholdings.

The share structure is a legacy of the French carmaker’s bailout of its larger Japanese peer. In 1999, Renault invested $5bn in return for 37 per cent of its highly indebted rival. Carlos Ghosn arrived in Tokyo and turned the company round; he is now in charge of both companies. The alliance grew one project at a time. The cross-shareholding were increased as a symbolic gesture. Renault now owns 43 per cent of Nissan, which owns 15 per cent of Renault (the two companies also have an alliance with Daimler, involving smaller cross-holdings).

Alignment of interests (“skin in the game”) is the reason given for holding partner’s shares. It is a bad one. It adds legal complexity because of the web of national regulations on shareholdings, voting rights and operational control. Management needs to focus on the successes of shared projects. It is not clear how swapping shares adds to the commercial incentives already provided by investment in those projects. Cross-holdings can magnify issues associated with state control. France’s meddling in Renault has become a distraction for the alliance: the state forced Renault to adopt the Florange law (more voting rights to long-term shareholders) which has pushed Nissan to seek voting rights.

Alliances offer the benefits of scale to an industry where consolidation is blocked by family and state shareholdings. Partners swapping shares increase the risk of distracting power struggles.

The Renault-Nissan alliance offers a good model, but for the tangle of shareholdings. Renault’s board should agree to sell down its share in Nissan to protect the alliance.

We are attracted to Peugeot because we see significant upside to consensus EPS

expectations for 2017e. Our forecast of EUR2.48 indicates a doubling of operating

EPS from 2015e and is c30% ahead of consensus, driven by a reduction in net

financial expenses, lower taxes and the benefits of restructuring. From a strategy

perspective, we have also just turned positive on the autos sector with an upgrade

to overweight

* Adding Credit Agricole S.A. (ACA FP; Buy; CP EUR11.10; TP EUR14.70)

We are attracted to Credit Agricole S.A. (CASA) for two key reasons. First, the recent IPO

of Amundi has provided a clearer line of sight on the valuation of ‘core CASA’ (a 2017e

P/E of 6.9x) and second, we believe funding costs could be significantly reduced given

that CASA is already well above its TLAC targets.

* Removing Air France-KLM (AF FP; Buy; CP EUR6.39; TP EUR8.45)

We remove Air France-KLM from the portfolio because we believe that Peugeot

offers a more attractive investment opportunity.

* Removing Erste Group Bank (EBS AV; Buy; CP EUR28.76; TP EUR33.00)

We remove Erste Group Bank from the portfolio because we believe that Credit

Agricole SA offers a more attractive investment opportunity.

* Performance

Since inception on 5 January 2010, the Europe Super Ten portfolio has returned

+70.1% versus a return of +29.7% for MSCI Europe. Year-to-date, the portfolio has

returned 0.9% versus a return of -0.8% for MSCI Europe. These performance figures

are in USD terms, priced at 4 December 2015 and are calculated by Euromoney.

* Super Ten rules

Adjustments to the portfolio will be triggered by changes to analysts’ stock ratings or

strategists’ themes. Changes may also be made if better ideas become available,

e.g. through the publication of new research or through movements in share prices.

* EM-exposed stocks are now seeing relative earnings upgrades while DM consumer exposure is seeing deteriorating earnings momentum Despite the continued underperformance of EM exposed stocks, relative earnings momentum across most of our EM baskets has been improving over the last 3M. As we show in the scatter charts on Page 10, most of our EM baskets are now seeing relative earnings upgrades with improving momentum (i.e. the baskets in the top right quadrant of the right-hand chart). On the other hand, stocks where relative earnings revisions trends are deteriorating include DM consumer, domestic UK, Eurozone exposure and stronger $ beneficiaries baskets. 

* China consumer / Corporate exposure are the cheapest baskets on relative N12M PE vs history; DM consumer the most expensive The cheapest baskets in the market on 12m forward PE versus its 8Y history include China / EM consumer and corporate exposure. On relative trailing PBV vs its own history, Russia and US exposure screen as the cheapest baskets. The most expensive baskets on the other hand on 12m forward PE %tile include China investment, DM consumer and weaker EUR beneficiaries and US consumer, Eurozone and stronger $ beneficiaries on relative trailing PBV.

RBC

AIR FRANCE +1% Traffic data strong, load factor better, flight diverted.

ALTICE +5% Short-Interest near highs, positive read from ORANGE/BOUYGUES

BOUYGUES +5% Reports that ORANGE in talks to buy Media Units

DAI/VOLVO -1% ACT cuts Class '8 2016 production forecasts overnight

ENQUEST +1% Production update inline, cost cutting programme on track.

EURONEXT -1% Fined €5m by AMF for '09 HFT pilot, will appeal

ILIAD +3% Positive read from BOUYGUES/ORANGE announcement

KLEPIERRE +2% Confirmation they will replace EDF in the CAC40 on Dec 21st.

NUMERICABLE +4% Positive read from BOUYGUES/ORANGE headlines

ORANGE +3% Reports in talks to buy BOUYGUES TELECOM media unit

PUBLICIS -1% Reports that OMNICOM said to win most of P&G's N.America biz.

SWISS RE 0% Investor day inline, ROE targets as expected, dull.

JEFFERIES

Bouygues +4% Orange targeting telco unit?

Galapagos +5% +ve interim Ph II data for filgotinib in Crohn's

Orange +1% spec to buy Bouygues Tel and TF1

Publicis -3% spec have lost large part of P&G N Amer biz

Tel Italia -2% Orange may not be bidding in the end

TF1 +5% part of the Orange deal?

BoA MERRILLS

ML

ENQUEST - 15-20% cut in FY15/16 opex, YTD production in line w guidance...+5% BOUYGUES - Spec Orange to buy EN FP Telco, turned down EUR 10bn offer prev+4% KLEPIERRE - To be added to CAC 40 Index as of Dec 21st Euronext says......+3% FRENCH TELCO - ORA/EN FP tie up would be positive for all, pricing etc....+3% ORANGE - Spec co to bid for Boyugues Telco & Media unit, consolidation +ve+2% SCOR - Spec Sampo May Still Be on M&A Prowl After competitor deals........+1% ADIDAS - We UPGRADE to Neutral in year ahead piece, PO to EUR 91 from 64..+1% STEINHOFF - We INITIATE with a BUY rating, PO EUR 6.50 (ZAR 97)...........+1% HEADLAM - Trading update more or less in line with a slightly softer H2...u/c EON - Co does not need further provisions in power generation unit, BZ....u/c AIRBUS - Spec hired bankers to explore sale of Vector Aerospace Unit......u/c SWISS RE - RoE and economic net worth growth targets all in line w prev.-0.5% T.ITALIA - Spec of ORA for Bouygues Telco may dampen TI bid spec..........-1% EDF - Euronext says to be removed from CAC 40 Index on Dec 21st...........-1% VICTREX - Numbers small beat and future payout solid but no special div...-1% SMURFIT KAPPA - We DOWNGRADE to Neutral, PO down to EUR 27 from 32.50.....-1% GN STORE NORD - CFO resigns unexpectedly, 7.2% short base will support....-2% MONDI - We DOUBLE DOWNGRADE to UNDERPERFORM, PO to 1,200p from 1,686p...-2-3% PUBLICIS - Loses bulk P&G's US business to Omnicom, big contract to lose-2-3%

CREDIT SUISSE

Air France +1% Seat occupancy rate hurt by Paris attacks less than exp

Bouygues +5/6% ORA said to be in dis to buy Bouygues telco & media assets

Gameloft +5% Vivendi raises stake to 26.7%, plans to continue

GN STORE -1% CFO Anders Boyer resigns

Headlam M/P Trading update reads fine, as expected H2 has slowed

Miners -2/3 Continuation of weakness in commods from US close

Numericab +5% Spec of french mobile consolidation helpful for pricing

Oils UNCH Most of move happened in mkt, ADRs were flat

Orange +1/2% Said to be in disc to buy Bouygues' telco & media assets

Publicis -2/3% P&G shifting alomost all US business to Omnicom

Swiss Re -1% Invester day statement out, inline, capital remains unch

Tel Italia UNCH T Italia had been mentioned as possible target for ORA

Unilever +0.5% u/g to neutral on improving competitive structure

Victrex -2/3% Sales inline 263.5mln, pbt small ahead of cons at 106.4mln

Vivendi UNCH Vivendi raises stake to 26.7%, plans to continue

INVESTEC

EUR

* AIRBUS-may sell Vector unit for more than $800m (Reuters).................U/C

* AIR FRANCE-Nov occupancy -0.9%. Flight diverted o/n after threat..........U/C

* DBK-Japan seeks penalty against unit for improper handling of info........-1%

* ELUX-rivals LG & Samsung may step in to buy GE unit after blocked deal....-2%

* EON-no new impairments necessary says CFO (B-Z).........................+0.5%

* NOVARTIS-positive results from young person blood cancer drug.............+1%

* ORANGE-said in early talks to buy BOUYGUES(+5%) telco/media assets......+1.5%

* PUBLICIS-loses P&G N America contract to Omnicom..........................-3%

* UNIBAIL-sells Neuilly-sur-Seine building for €267m......................+0.5%

* VIVENDI-raises Gameloft stake 26.7%(25%),still doesn’t rule out t/over....U/C Other

* Investor Day/Capital Mkt Day: SWISS RE, THYSSEN

* Ex-Div: ADP, THALES

UK

* AMEC FW small contract win, Scot underground cable........................unch

* ANGLO AMERICAN investor day today - has been div cut spec all over press

* BRC data poor November, -0.4% lfl BUT ex food lfl +2.6% (v +2.1%)

* CAIRN +ve read across from ENQUEST ops update below........................+1%

* ENQUEST ops update Kraken on target and under budget for H1 '17............+5%

* GW PHARMA +ve test results from epilepsy drug Epidiolex AH in US...........+2%

* HEADLAM Pre Close, slowdown in H2(I/L) remains on track to meet FY.........-1%

* HELLERMANTYTON all regulatory and competition clearances achieved..........+1%

* LAMRELL Investec appointed joint broker

* TREATT TET results ahead of expectations, no change to FY16................+2%

* VICTREX FY rev +4%, gross margin -80bps, sees challenges for FY16.......-2/-3%

* VODAFONE to sell at least 10% stake in Indian unit via IPO - CNBC........+0.5%

* WOOD GRP Secures new ConocoPhillips(Aus) contract. No financials..........unch

Ahead of the speculated Renault board meeting on Dec-11th, we take a quick look at the potential scenarios unfolding in the Renault-Nissan saga. Short term, we fear that less rather than more will change in the Alliance. But we remain attracted to the fundamentals and would buy on weakness

3 potential scenarios are likely to be discussed at Renault’s board meeting on Friday It is increasingly clear that the Alliance structure needs to change before the French government’s double voting rights kick in on 1st April 2016. Any changes require board approval first, and we believe 3 scenarios will be discussed at Renault’s board meeting on Friday: 1) keeping the status quo but stakeholders limit power through binding agreements, 2) changes to the crossshareholding agreements, allowing Renault to free up EUR3.5-7.5bn of cash from its Nissan stake (equivalent to a EUR12-27 per share special dividend or even M&A?) and 3) a full blown financial merger.

Longer term only a full merger makes sense, we see 30-40% upside in that scenario After 15+ years of debate, the stars may finally be aligning for a full merger of Renault & Nissan. As the industrial partnership grows through the roll out of the CMF shared platform, the profitability of the companies will converge by 2017/18e, providing a more equal footing for a full combination. At current share prices, a nil-premium merger of Renault-Nissan would actually result in a 50:50 ownership split between Renault and Nissan in the combined NewCo. Even if more by luck than judgement, after 16 years, the stars are now finally starting to align. If not now, when?

Back to fundamentals…there is still value. While the potential outcomes are still widespread, on the balance of recent newsflow, its looking increasingly likely that less rather than more change will come out of the Renault board meeting on Friday. We would therefore exercise an element of caution this week, not all news would be good news. However, looking through this noise, our base case of EUR118 assumes no change to the structure of the Alliance. We continue to like the fundamental drivers of the Renault equity into 2016 (product cycle, mix tailwinds, sales to partners, EU exposure) and would buy on weakness

Bloomberg reported last night that Orange is in early discussions to buy Bouygues’ telecom and

media assets. Coming one week after Reuters reported that Orange had hired advisors to examine

M&A opportunities in Europe, it might well be a non-story (i.e., Orange could be simply assessing

its different options). This is especially given that Orange has been stating since the beginning of

the French M&A saga that it would not lead consolidation in the country.

* Such a deal would indeed make strategic sense…

While we see little benefits in cross-border M&A, we think there is large upside potential from incountry

consolidation. In particular, a takeover of Bouygues Telecom would remove the attacker in

the fixed-line market – a major positive for all French telcos. Such a tie-up should lead to

substantial cost and capex synergies (in particular in the context of fibre deployment) and see

Orange follow the recent trend of telco-media deals. For Bouygues, this would represent an ideal

opportunity, coming at a time when commercial momentum is strong.

* …but would face high regulatory hurdles

A combination of the two telecom businesses would raise substantial concerns in terms of market

concentration and employment in particular. Consequently, a deal would likely only go through with

large remedies. This would likely require the involvement of other players, which brings further

uncertainty. As a result, we see a low probability of such a deal materialising at this stage.

* Stock implications – potential positive for all French stocks

The market might start today pricing in a modest probability of such a deal happening, benefiting

Bouygues, Iliad, Num-SFR and Orange, in that order. We are Outperform on Iliad (TP EUR220),

Neutral on Orange (TP EUR16) and Bouygues (TP EUR32), and Underperform on Numericable-

SFR (EUR39).

Bloomberg reported last night that Orange is in early discussions to buy Bouygues’ telecom and

media assets. Coming one week after Reuters reported that Orange had hired advisors to examine

M&A opportunities in Europe, it might well be a non-story (i.e., Orange could be simply assessing

its different options). This is especially given that Orange has been stating since the beginning of

the French M&A saga that it would not lead consolidation in the country.

* Such a deal would indeed make strategic sense…

While we see little benefits in cross-border M&A, we think there is large upside potential from incountry

consolidation. In particular, a takeover of Bouygues Telecom would remove the attacker in

the fixed-line market – a major positive for all French telcos. Such a tie-up should lead to

substantial cost and capex synergies (in particular in the context of fibre deployment) and see

Orange follow the recent trend of telco-media deals. For Bouygues, this would represent an ideal

opportunity, coming at a time when commercial momentum is strong.

* …but would face high regulatory hurdles

A combination of the two telecom businesses would raise substantial concerns in terms of market

concentration and employment in particular. Consequently, a deal would likely only go through with

large remedies. This would likely require the involvement of other players, which brings further

uncertainty. As a result, we see a low probability of such a deal materialising at this stage.

* Stock implications – potential positive for all French stocks

The market might start today pricing in a modest probability of such a deal happening, benefiting

Bouygues, Iliad, Num-SFR and Orange, in that order. We are Outperform on Iliad (TP EUR220),

Neutral on Orange (TP EUR16) and Bouygues (TP EUR32), and Underperform on Numericable-

SFR (EUR39).