TAIWAN_IN_PERSPECTIVE：2013_OUTLOOK：STRONG_CYCLICAL_RECOVERY_IS_WELL_PRICED;_TACTICALLY_NEUTRAL_BUT_12M_UW-2012-12-04.ppt

Nov/00,Nov/11,Nov/02,Nov/03,Nov/04,Nov/05,Nov/06,Nov/07,Nov/08,Nov/09,Nov/12,Nov/01,Nov/96,Nov/97,Nov/98,Nov/99,Nov/10,30 30%,27,.1%,10,5,December 3,2012Asia Pacific,Taiwan in perspective,Portfolio Strategy Research,2013 Outlook:Strong cyclical recovery is well priced;Tactically neutral but 12m UWAfter two consecutive years of tepid GDP growth and negative EPS growth,we expect Taiwan to stage a visible fundamental recoveryin 2013 alongside the global cycle.However,high valuations seem to have factored in a good deal of the cyclical bounce and preventus from taking a more positive stance.We are tactically neutral on Taiwan but Underweight on 12m mainly due to our concerns overmedium-term margin sustainability.We like the earnings recovery theme in 1H and cross-strait beneficiaries in 2H.Tech is likely tofurther outperform non-tech and R&D/IP remains our core thesis in the tech universe.12m TWSE target:8,000,6.6%potential upside.,A year of growth recovery,Cyclical upturn seems well discounted,Our economists expect Taiwans GDP to grow3.5%in 13E and 4.2%in 14E after a tough 2012,during which the economy expanded only 1%.Exports recovery is likely to be the key contributorof growth,alongside the improving DM growthtrajectory throughout 2013.We forecast EPS togrow 22%and 16%in 13E and 14E,from flattish in12,but slightly below consensus of 27%and 16%.Earnings recovery may support near-term returns3m returns post earnings trough(RHS)12m fwd EPS integer(MXTW)25 25%20.3%,Taiwan trades on 14.2X forward P/E and a 22%premium to MXAPJ.History suggests that theearnings upturn is reasonably priced as earningsrealization tends to compress valuations.We aretactically neutral on Taiwan given the improvingEPS momentum but UW over 12 months due toour concerns over tech margins and lack of IP.Key themes for 20131)Global cyclicality suggests continuing techoutperformance over non tech.2)We like thegrowth recovery theme in 1H as the market is,Kinger Lau,CFA+852-2978-1224 Goldman Sachs(Asia)L.L.C.Timothy Moe,CFA+852-2978-1328 Goldman Sachs(Asia)L.L.C.Caesar Maasry+852-2978-7213 Goldman Sachs(Asia)L.L.C.Richard Tang,CFA+852-2978-0722 Goldman Sachs(Asia)L.L.C.,2015,15.0%,12.9%,15.7%,20%15%,likely to trade the delta of growthwe highlight alist of“growthy”stocks with low valuations.3),Sunil Koul,0,8.6%,10%5%0%,R our techinnovators screen contains stocks with compellingbottom-up stories such as TSMC and Largan.4)X-,+852-2978-0924 Goldman Sachs(Asia)L.L.C.,straits(GSSZTWCN):We like China exposure inmid-2013 as political/policy catalysts kick in.Source:Bloomberg,TEJ,I/B/E/S,Goldman Sachs ECS Research.Goldman Sachs 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 aconflict 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.For Reg AC certification and other important disclosures,see the Disclosure Appendix,or go to Analysts employed by non-USaffiliates are not registered/qualified as research analysts with FINRA in the U.S.This report is intended for distribution to GS institutional clients only.,The Goldman Sachs Group,Inc.,Goldman Sachs Global Economics,Commodities and Strategy Research,2,December 3,2012,Asia Pacific,2013 outlook:Strong cyclical recovery is well priced;Tactically neutral but 12m UWBottom-line:Conducive backdrop but well pricedIn our recent 2013 regional outlook piece,we lowered Taiwan to Underweight from Marketweight despite a more conduciveglobal growth environment(Exhibit 1).While this may seem contradictory to the common belief that one should own Taiwan whenthe global cycle turns,which is what we view as the core theme for 2013,we feel the markets high valuations(22%P/E premium toMXAPJ)have already discounted a good deal of the cyclical upturn in fundamentals(GS forecast:22%and 16%EPS growth in 13Eand 14E).Moreover,looking beyond near-term cyclicality,we think the medium-term growth outlook remains challenging,especially for techcomponent makers which lack sustainable bargaining power due to their low R emphasizing growth in 1H and X-straits in 2HWe envisage a better 1H performance,particularly after the uncertainty surrounding the US fiscal cliff is removed,as sentimentshould improve(barring a fiscal-cliff-provoked recession scenario,which is not our base case)and domestic macro growth is likelyto accelerate during the course of 1H alongside our expected growth trajectory in the developed world.We would focus on growth recovery beneficiaries during this period given earnings inflection points tend to bode well for equityreturns.In the six major earnings cycles over the past 15 years,earnings inflection points have tended to bode well for subsequentequity returns,yielding 6%,15%,and 24%on average in 1,3,and 6 months post the earnings troughs(Exhibits 3 and 4).Withearnings(12m forward EPS integer)now appearing to have found a bottom in September/October,this suggests the market islikely to perform well in the earlier part of the year,consistent with our Marketweight tactical view.Taiwans growth should continue to improve in 2H per our economists forecasts,but we envisage a better investing backdrop inChinese equities around mid-2013 on political and policy factors,prompting us to take a more constructive stance on cross-straitsbeneficiaries which allow investors to trade China exposure through Taiwan.Around the same time,we think investors could shifttheir focus to earnings growth sustainability for Taiwan tech going into 2014,which we have less confidence on due to our concernsrelating to IP and margins.Goldman Sachs Global Economics,Commodities and Strategy Research,3,December 3,2012,Asia Pacific,Key themes and stocks for 2013Earnings recovery:We believe this is the core theme investors should focus on regionally in 2013.As earnings growth hasbeen tepid for the past two years,we think the cyclical upturn will be a positive underpinning for the market as it tends totrade the“delta”more than the levels of growth.That said,we are mindful of how much growth is already beingdiscounted in the price and therefore highlight stocks with positive EPS growth momentum going into 2013 and valuationsthat are below 5-year historical averages(Exhibit 5).We highlight Epistar,Yuanta and FEDS in this category.Tech and non-tech rotation:Tech companies(MXTW IT)have outperformed their non-tech peers by 26%since August2011(Exhibit 6).One of the key questions for investors is whether tech companies can extend their outperformance in 2013.We note that relative returns are reasonably correlated with the global cycle and tech tends to fare better than non-techduring Expansion and Recovery(i.e.positive growth delta)phase as defined by our Global Leading Indicator(Exhibit 7).Inthis vein,the improvement we expect in global growth should support further outperformance of tech vs.non-tech,at leastin the near term.In the tech space,we will focus on R&D to pick long-term outperformers.R&D and tech innovators:R&D and the resulting intellectual property ownership remain our key top-down considerationswhen investing in tech stocks.In our report Asia Pacific:Portfolio Strategy:Why Korea will continue to outperform Taiwan,September 10,we detailed the importance of R&D and its manifestations to earnings.Consistent with our findings,techcompanies with high R&D investment(to sales)have outperformed ytd on both earnings delivery and equity returns.Wecontinue to highlight our top-down driven R&D basket(Exhibit 8),which also contains stocks with compelling bottom-upstories,including TSMC,Largan,and Delta,all rated Buy by our analysts.See Strategy Spotlight:Taiwan 3Q earningsreview:Weak overall and the R&D theme is playing out,November 5.Cross-straits:As noted earlier,we expect China to deliver better returns around mid-2013 as market-friendly and decisivepolicy announcements are more likely after the March NPC meeting when the new leadership formally assumes power.Wethink this will be a positive catalyst to Taiwan-listed stocks which have substantial end-demand exposure in China and wehighlight our cross-straits CAT(GSSZTWCN)as a liquid vehicle to capture this potential shift in market price momentum(Exhibit 9).Buy-rated names in the basket include Ruentex,Yulon Motor,TSRC,FENC and Evergreen Marine.Sector allocation to start the year:Combining our expected market path and our favored themes for 2013,we upgradeTech to Overweight primarily on its cyclical earnings rebound.We stay positive on Consumer Discretionary as we like thebottom-up story of select names in that space.We turn neutral on Financials(from Overweight)given their outperformanceand keep Materials and Industrials at Underweight as we wait for the China catalyst to manifest in mid 2013.Macro:Growth recovers on external demandOur economists expect Taiwans GDP to grow 3.5%in 2013,accelerating strongly from about 1%in 2012.Growth could furtherstrengthen to around the 4%trend level in 2014 to 2016 alongside the global path.Not surprisingly,stronger exports are expected tobe a key boost to growth for Taiwan as our economists see exports growth improving from-0.6%in 2012 to 3.7%in 2013.Domestic consumption and investment,on the other hand,are expected to exhibit less vibrant growth as unemployment seems tobe on the rise and spare capacity still weighs on capex,although the continuing accommodative monetary policy and very looseglobal liquidity conditions would be supportive of domestic demand in the earlier part of 2013 before it picks up momentum later in2013 and 2014.See Asia Economics Analyst:Our 2013-2016 forecasts:A brighter backdrop,November 29,for details.Goldman Sachs Global Economics,Commodities and Strategy Research,4,December 3,2012,Asia Pacific,Corporate earnings:Strong rebound in 2013 after two disappointing yearsAfter two years of consecutive negative growth,Taiwanese corporate earnings are expected by the consensus(I/B/E/S)to stage avisible recovery in 2013.We concur that the cyclical earnings upturn should materialize,given:Our economists forecast of exports recovery should bode well for earnings growth as corporate fundamentals are closelylinked to external demand(Exhibit 11)Earnings leading indicators appear bottoming out,suggesting the earnings downcycle should be over(Exhibit 12).SeeTaiwan in perspective:Pulse checking and screening earnings risks,October 12 for details.Consensus assumptions on sales growth and net margin look reasonable against a backdrop of improving global growth.The yoy growth appears eye-catching for tech hardware and select cyclicals but it is primarily driven by marginnormalization from depressed levels(Exhibit 13).Overall,we forecast earnings to grow 22%and 16%in 2013 and 2014,slightly below consensus expectations of 27%and 16%(Exhibit 16).Valuations:Fundamental upturn seems well discountedClearly,the delta is positive for fundamentals.However,high valuations are preventing us from taking a more bullish stance onTaiwan.At present,the market(MXTW)trades at 14.4X forward P/E(0.12 s.d.),1.8X P/B(-0.24 s.d.),representing 22%(0.4 s.d.)and10%(1.23 s.d.)valuation premiums over the regional benchmark(Exhibits 17 and 18).These numbers do not look attractive in aregional context,especially compared with Korea which is trading at 8.4X P/E(-0.6 s.d.)and P/B(-1.3 s.d.)Indeed,we have been arguing for quite some time that the high valuations seem to have factored in a fair amount of earningsrecovery in 2013,and we continue to maintain this view.We feel comfortable with our end-2013 target multiple of 13.5X as weexpect high valuations will be gradually amortized as earnings realization takes charge to drive returns,as in previous episodes(Exhibit 19).That said,we see limited risk for valuation multiples to significantly compress given that local financial conditions remain extremelyaccommodative(low nominal rates and negative real rates)and the gaps between earnings/dividend yields and bond yields andrental yields continue to stay equity-supportive(Exhibit 20).Liquidity and positioningInvestor positioning continues to look conservative in Taiwan,which has been the case for a while.Asia-and EM-focused investorsare underweight Taiwan by 632bps and 245bps respectively(Exhibit 21).Foreign investors net buying has turned marginallypositive after unloading US$9bn worth of equities in 2011(Exhibit 22).Local investors also appear cautiously positioned as they keep trimming their local equity exposure(partly due to the capital gainstax in our view)and the retail net long margin remains at historically low levels(Exhibit 23).The overall bearish investor positioning suggests to us that liquidity risk could be on the upside in the near term as cyclical earningsupturn and government pronouncements may stabilize/revive market sentiment.Goldman Sachs Global Economics,Commodities and Strategy Research,Nov/00,Nov/12,Nov/96,Nov/97,Nov/98,Nov/99,Nov/02,Nov/03,Nov/04,Nov/05,Nov/06,Nov/07,Nov/08,Nov/09,Nov/10,Nov/01,Nov/11,9,9,7,8,7,9,9,9,3,30,5,December 3,2012Exhibit 1:Asian regional markets have the potential to deliver nearly 20%return in 2013,Asia PacificExhibit 2:We are Marketweight Taiwan on 3m but Underweight on 12m dueto our concerns on medium-term margin sustainability,EPS growth forecasts,Dec 2013 index target,3-month,12-month,MarketKorea,IndexKOSPI,Index level(Nov 29)1,935,CY2013E18,CY2014E15,TargetP/E8.5,Indextarget2,300,Pricereturn(%)19,MarketKorea,AllocationOverweight,AllocationOverweight,Overweight,IndiaSingaporeChinaIndonesia,NIFTYFSSTIHSCEIJCI,5,8253,04610,4884,319,147912,14141116,13.513.010.313.5,6,6003,50012,5005,000,13151916,IndiaSingaporeChina,OverweightOverweightMarketweight,OverweightOverweightOverweight,Market weight ThailandHong KongTaiwan,SETMXHKTWSE,1,31012,2747,504,201122,131316,10.514.513.5,1,43013,4008,000,IndonesiaThailand,MarketweightMarketweight,MarketweightMarketweight,Underweight,MalaysiaAustraliaPhilippines,FBMKLCIAS51PCOMP,1,6074,4785,640,12,14.512.315.5,1,8004,8005,800,127,Hong KongTaiwan,MarketweightMarketweight,MarketweightUnderweight,Asia Pacific ex Japan(USD)Asia ex Japan(USD),MXAPJMXASJ,450528,1314,1413,11.811.4,520615,1616,MalaysiaAustralia,UnderweightUnderweight,UnderweightUnderweight,Philippines,Underweight,Underweight,Source:Local exchanges,MSCI,Bloomberg,Goldman Sachs Global ECS Research estimatesExhibit 3:We have seen six major earnings inflection points in the past 15years,after which near-term returns tend to be strong,Source:Goldman Sachs Global ECS ResearchExhibit 4:Returns after earnings trough have tended to be strong,with thebulk of earnings repair concentrated,27.1%,3m returns post earnings trough(RHS)12m fwd EPS integer(MXTW),30%,Returns post earnings trough(ex GFC),25,25%,1mth,3mth,6mth,12mth,20,20.3%,20%,Median returns(whole period),6%,15%,24%,30%,15,15.0%,12.9%,15.7%,15%,Annualized returns,96%,77%,55%,30%,Monthly returns,6%,5%,4%,2%,10,10%,8.6%,An