Local Equity

ANALYSIS : EQUITY RESEARCH – Special Report Stock Universe I June 28, 2017

2H17 Investment Strategies: What’s Left for the Stock Market when almost Everything Seems Expensive?

Near the end of the first half, the stock market accumulated an upside of 7.4%, partially reducing 2H17 Top Picks – Equity the gap maintained by other Latin American indices on . Such increase largely captures Target the positive but moderate recovery sense that the Colcap forecast updates made during 1Q17 Company Recommendation Upsie Weight Price and 2Q17 had brought. By the beginning of the second half the models are refreshed again, Grupo Éxito Buy 21,700 40.9% 100% seeking to incorporate new information and changes in the conditions of the economy, the market Source: Grupo Bancolombia and the perception of agents. With an upward revision of ~2%, up to 1,502 points, the local stock market index offers a 3.5% upside over the next six months, extending the dynamics observed

since the beginning of 2016. Evolution Colcap vs. Top Picks 1H17 Despite the positive omens this forecast may bring, the absence of clear value catalysts highlights 125 the difficulties that the Colcap will have to face in order to cover the almost 52 points left to reach fair value. The main challenges facing the local equity market’s in 2H17 are: i) a less dynamic 115 economic recovery, ii) the downward bias in the oil market, iii) the delay in the execution of 4G 105 projects, and iv) the dependence on foreign flows. 95 By contrast the favorable conditions that could facilitate the capture of valuations, although may 85 already be partially discounted by prices, are: i) further reductions in interest rates and their effects 75 on economic activity and in the possible repricing of the market multiples, ii) an additional 65 improvement in the perception of country risk that brings with it additional buying flows (due to a Jan-15 May-15 Sep-15 Jan-16 May-16 Sep-16 Jan-17 May-17 deterioration of the appetite for developed markets in favor of emerging ones), and iii) the Top Picks COLCAP

execution of investment strategies towards indexation by institutional agents that favor the Source: Grupo Bancolombia, Bloomberg. creation of iColcap units. This risk balance, biased downward, is reflected in the result of the methods of 2H17 Top Picks, where only Grupo Exito stands out as the name with enough conditions to present a superior Performance recommended portfolio vs. COLCAP

performance against the rest of the market. Although there are other groups of stocks worthy of Top Picks Colcap Alpha (bps) mention, such as , Celsia and , at the top of the list, only Grupo Exito meets 1H15 -13.6% -8.5% -515 the minimum requirements of the methodology, details we analyze in this report. 2H15 -4.4% -13.7% 927 1H16 20.1% 15.8% 427 Grupo Exito: Dancing to the Rhythm of Samba 2H16 3.1% -2.5% 560 1H17 11.4% 13.1% -167 After applying our asset selection methodology we have chosen Grupo Exito as the only Top Pick Historical 15.17% 3.51% 1,166 for 2H17. Our main reason continues to be the company’s exposure to the Brazilian market and Source: Grupo Bancolombia. the potential recovery we expect it to have in the short and medium term. Since the 30th of November, when we published our previous Top Picks report, Grupo Exito’s stock has valued

7.7%. Despite this, we still believe that the asset is undervalued and the reasons may not differ much from those presented in the previous report. Analysts/Specialists Name: Jairo Julian Agudelo Restrepo It is important to emphasize that our methodology does not only take into account fundamental Phone: (574) 6047048 aspects but also those regarding market and risks in order to achieve an objective selection in E-mail: [email protected]

line with our economic vision of 2017. Name: Juan Nicolas Pardo Ayala Phone: (574) 4029516 E-mail: [email protected]

Name: Juan Pablo Espinosa Arango Phone: (571) 7463991 ext. 37313 E-mail: [email protected]

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Colombian Equity | Colombian Universe Update

June 28, 2017

Greater Convergence in Forecasting Models

The quarterly update of the Colcap forecast for the end of 2017 shows a positive result, going from an expected level of 1,472 to 1,502 points. Beyond a 2% upward revision in the final estimate, the analysis of the components of the projection methodology reveals a unique behavioral pattern of the main levers of market value. On one hand we have corporate variables, those that are traditionally studied under bottom-up approaches and that denote the strength or financial weakness of the listed companies. The upside contribution of these variables in the new forecast is minimal. As shown below, the variations in target prices of the fundamental Table 1 – Fundamental Model – Target Prices methodology and the growth in earnings per share of the relative value methodology have a lower incidence. Stock Var% 3Q 2Q Bancolombia PF -0.6% 29,488 29,659 On the other hand, economic and market variables related to the appetite of agents for risky G. Sura -0.9% 41,592 41,991 assets, commonly associated with top-down analysis approaches, are having a greater impact 0.0% 1,420 1,420 on some of the forecast components. The sentiment methodology reveals this greater preference Nutresa 0.0% 27,920 27,920 G. Argos 0.0% 22,950 22,950 for risk, while opening the door to the debate about the repricing opportunity in the multiple at Bancolombia -1.8% 29,433 29,975 which the Colcap is valued. Cemargos -10.0% 11,650 12,940 G. Aval PF -1.0% 1,248 1,261 Fundamental Model G. Sura PF 1.6% 42,133 41,461 ISA 26.5% 13,050 10,320 For 2H17, the fundamental model increases only 1.1%, from 1,514 to 1,531 points. This is due to EEB 15.0% 2,070 1,800 the fact that 16 names, corresponding to 56% of the index, maintained relative stability in their G. Argos PF 0.0% 22,950 22,950 Corficol 15.2% 40,900 35,500 contributions to the Colcap due to small variations in their target prices (~2%). Of this group, Éxito 0.0% 21,700 21,700 Canacol stands out, whose valuation decreased 22.6% compared to 2Q17, but due to its low BanBOgotá 0.0% 64,000 64,000 weighting in the index the net effect is very small. Among those names that had the greatest PF -0.8% 33,225 33,490 negative impact in the estimate, issuers from the financial sector stand out. Whether due to Cemargos PF -10.0% 11,650 12,940 reductions in target prices or a weaker weighting in the index, Bancolombia and ’s CLH -5.2% 13,550 14,300 Celsia 2.4% 5,220 5,100 shares contributed much less than they did in previous quarters. Finally, Cementos Argos, whose G. Aval n,a, n,a, 1,150 core value was revised downwards by ~10%, also joined the group of smaller contributions. Avianca PF 0.0% 4,440 4,440 Canacol -22.6% 10,340 13,360 On the other hand, the great contributors were Isa, EEB and . In spite of their Conconcreto 0.0% 1,800 1,800 moderate weights within the index, the strong revision of target prices (~26%, 15% and 15%, ETB 0.0% 745 745 respectively) took them to lead the new estimate of the fundamental exercise. BVC 0.0% 23.7 23.7 COLCAP Fundamental 1,531 1,514 As of the closing date of this report, the fundamental methodology reveals a valuation potential of 5.5%, up to 1,531 points. It’s worth emphasizing that such a scenario is challenging, since low- Bloomberg Analysts Consensus weighted shares and even those with moderate liquidity should value more than 15% over the Bancolombia Equity Research next six months for this scenario to materialize, which is highly challenging. n.a. : Not available Source: Grupo Bancolombia. In short, except for isolated cases of material upward revisions, the fundamental methodology suggests that the fair value of the companies that make up the market index maintains relative stability.

Relative Value Model The result of this methodology shows a target level of 1,491 points, presenting the smallest variation compared to the 2Q17 revision, which stood at 1,487. The theory behind this valuation Table 2 – Relative Value Model method assumes that the level of the index at the end of 2017 will be determined by i) the earnings per share (EPSs - 2018E) and ii) the expected Price to Earnings (FWD P/E). From a corporate Var% 3Q 2Q perspective it’s reasonable to anticipate that there will be no major changes in the forecasts of the short- and medium-term EPSs. On the contrary, the precision of the model will depend on the EPS 2018E (COP/share) -0.7% 127.6 128.5 fact that, between 2017 and 2018, local companies report a ~26% increase in net profits to 127.6 P/E Forward 1.0% 11.7x 11.6x index units, a situation that, although challenging, is plausible from a bottom-up perspective of COLCAP Relative 1,240 1,491 1,487 issuers. Source: Grupo Bancolombia

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Now, from a top-down perspective, is it possible to justify a repricing of the multiple used? Would Figure 1 – P/E Forward it be reasonable to price the stock market under a P/E ratio greater than 11.6x, corresponding to the multiple used in the last review of the valuation exercise? In short, no. However, there are 25 indications that would justify considering it. The specialized literature establishes that the P/E is 23 determined by i) the return on equity (RoE), ii) the long-term growth rate (g) and iii) the investor’s 21 level of risk (Ke). For the Colombian case, a variation of the first two components that justify an 19 upward revision of the multiple is not anticipated. However, a change in outlook on emerging 17 markets and their risk level open the discussion over the fair value of equity (Ke). See Equiation 15

1. 13 Figures 1 and 2 indicate that increases in the perception of risk lead to a deterioration in prices 11 and in the P/E level. Thus, a 28% reduction in the EMBI+ Colombia between 2016 and 2017 9 justify considering a revision of the Ke of the Colombian market. It’s estimated that a reduction of 7 jun.-09 jun.-10 jun.-11 jun.-12 jun.-13 jun.-14 jun.-15 jun.-16 jun.-17 50-bp of Ke could bring the expected P/E from 11.6x to 12.6x. However, a multiple of these Source: Grupo Bancolombia. characteristics would rest more than two standard deviations above its average of the last 12

months, which would imply a rapid and unusual rebound of the multiple. The historical analysis

of the behavior of the multiple shows that, on average, it only stands 2.7% above a standard

deviation, making a 12.6x unlikely. Equation 1 – Determinants of P/E On the other hand, i) weaknesses in the country’s fiscal front, ii) the speed with which the macro

recovery (U-shaped) is anticipated, and iii) the still clear dependence on oil and its

lateral/downward bias are other reasons leading to the conclusion that a repricing of the local P/E

will be limited. For the remainder of 2017 the valuation then uses 11.7x, equivalent to the daily Source: Grupo Bancolombia. moving average of the last year, plus a standard deviation. However, it’s worth thinking of an intermediate value, close to 12x, beginning to be relevant in the 2018E assessments of the Colcap, once there’s more evidence that on the macro front the worst has happened. Figure 2 – Reverse CDS vs. COLCAP

Sentiment Model 2000 1.4%

1900 Finally, the feeling model, although the most conservative estimate of the three approaches, 1.2% 1800 showed the greatest variation, at 4.8%, against the forecast of the previous quarter. This result is 1700 consistent with the better perceived risk dynamics described in the previous section, which was 1.0% 1600

reflected in an average value of 1,484 points for the Colcap at the end of 2017 and with the global 1500 0.8%

dynamics of the markets where the preference for stocks in developed markets such as the US 1400 0.6% and Japan has declined in favor of Latin American and Asian emerging markets. 1300

1200 The main reasons the participating agents have that could justify higher levels of index are: i) the 0.4% 1100 evident inflows to emerging markets, as observed in May, when the daily trading average doubled 1000 0.2% compared to previous months, and ii) improvements in the Colombian macroeconomic scenario Jun-13 Dec-13 Jun-14 Dec-14 Jun-15 Dec-15 Jun-16 Dec-16 Jun-17 COLCAP 1/CDS with the control of inflation and the reduction of rates by the Central Bank. Meanwhile, the main sources of risk identified are i) problems of corporate governance afflicting the market, and ii) Source: Grupo Bancolombia.

persistence of lower oil prices that crack public finances.

Figure 3 – Sentiment Model

1,500 1,484

1,450 1,416

1,400 1,370 1,350 1,324 1,316 1,306 1,296 1,300

1,250 1Q16 2Q16 3Q16 4Q16 1Q17 2Q17 3Q17 Source: Grupo Bancolombia.

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Colombian Equity | Colombian Universe Update

June 28, 2017

Towards a U-Shaped Recovery

Traditionally in Colombia episodes of economic moderation have concluded with rapid and pronounced recoveries. In other words, the country has become accustomed to experiencing V- shaped economic cycles.

However, according to our new projections, this time conditions will be different. In fact, we expect the country to experience a U-shaped economic cycle in which last year’s and current growth rates will be similar, and the much-desired return of growth close to productive potential will take longer.

It’s important to bear in mind that our vision incorporates information that is already known year Figure 4 – Quarterly GDP (YoY) to date, which has surprised downwards and places a bearish bias on our GDP forecast scenario for all 2017 (2%). Thus, with the figures available of production activity in Colombia in 1Q17 Previous Forecast Revised Forecast 3.41% (1.1%), we expect that as the months pass the growth outlook becomes more constructive. 3.24% 2.96% 2.63% 2.66% 2.40% 2.58% 2.48% This view is supported by three factors. First, the year started at a much lower rate than expected. 2.30% 1.93% Despite good signals from exports, most domestic market activities have slowed as a reflection 1.75% 1.30% of poor performance in private consumption and investment. This shows that in the short term the 1.59% 1.11% tax reform had a negative effect on household purchasing power, and that the low consumer and 1.14% business confidence has led to an adjustment in spending.

Second, we continue to predict that as the second half goes by, productive activity will gradually 1Q15 2Q15 3Q15 4Q15 1Q16 2Q16 3Q16 4Q16 1Q17 2Q17 3Q17 4Q17 gain traction. The main catalysts of this change of direction will be moderation of inflation, cuts in Source: Grupo Bancolombia. interest rates made by the Central Bank, recovery in confidence, and a positive base effect.

Third, despite the numerous sources of risk in the world today, the global environment will be more constructive than in previous years. Although at lower rates than forecast three months ago, the terms of trade will increase and the growth of the country’s trading partners will be energized.

Going forward, we estimate that the acceleration cycle that will become most visible in 2018 will extend over the next two years. Such performance will be linked to the increasing pace of implementation of infrastructure projects and the effects of a less restrictive monetary policy.

Figure 5 – Inflation (YoY) All of the above shows that the strong shocks that struck Colombia in recent years generated

both temporary and permanent effects and that the country is still in the process of shaping the Previous Forecast Revised Forecast 9% 8.97% macroeconomic conditions that will prevail in the post-boom period. 8% 7% 5.75% In this sense, the proactive management of risks and adaptation to more challenging growth 6% 5% 4.70% dynamics will be decisive to navigate successfully in this unprecedented U-shaped cycle that we 4.30% 4% 4.20% will be experiencing this and the following years. 3.90% 3% 3.74% 2% 1%

Challenges for the Second Half

Jun-13 Jun-14 Jun-15 Jun-16 Jun-17

Mar-13 Mar-14 Mar-15 Mar-16 Mar-17

Sep-16 Sep-13 Dec-13 Sep-14 Dec-14 Sep-15 Dec-15 Dec-16 Sep-17 Dec-17 Dec-12 Although we are aware that in previous top pick reports the word that has prevailed is “selectivity”, Source: Grupo Bancolombia, Dane. it’s quite difficult in an economic context as described above, where it is evident that the recovery of the Colombian economy is going to take place in a more gradual way than the one initially expected, to move away from this premise.

The above gets more relevant when analyzing the two sectors that are the main drivers of the

economy, and particularly in the Colombian market. Oil, which until a couple of years was not only

the support of the Colombian economy and national government finances but also the sector with

more weight in the COLCAP index, and infrastructure projects through the 4G program, which

since the fall in oil prices have not only offer great support to the economy but represent the most

tangible promise of a recovery in the growth of Colombia.

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Colombian Equity | Colombian Universe Update

June 28, 2017

Oil: Downward Bias Prevails

Figure 6 – Oil revenues (% of GDP) Oil has been at the center of both clients’ and investment managers’ minds for the better part of almost three years. What once represented one of the main drivers of growth and profitability for 3.9 3.33 the Colombian economy, quickly turned into a source of concern and an era of re-adjustment 3.4 dawned on both government and companies as they learned to live with the new reality. Volatility 2.9 2.64 2.6 persists, however some stability has been achieved. 2.4 1.9 1.56 As we move towards the second half of 2017 uncertainties remain high as ever as we find politics, 1.4 1.1 0.62 0.61 0.62 both domestic and foreign, at the center stage of the debate. Downside risks include: i) high 0.9 0.46 0.54 0.58 0.33 0.17 inventories in the US, ii) uncertainties around OPEC production cuts, iii) tension in Arab states, 0.4 0.02 and iv) Trump politics. On the bright side, there’s the peace agreement. -0.1 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 2024

Tax revenue Dividends Total revenue Production in the US, and rising inventories, has been one of the main concerns of the oil market over the last three years. As soon as oil prices recovered, rig count started to increase, effectively Source: Ministerio de Hacienda y Crédito Público, Grupo Bancolombia. capping OPEC’s efforts to bring stability to the market. On their May 26th report, the Energy Information Administration (EIA) revealed crude inventories settled at 509.9 million barrels, 6.4 Figure 7 – US inventories

million below the previous week report, following the downward trend seen over the last eight 600 weeks. However, inventories remain near record highs. According to a study from our 550 macroeconomic team, who performed a regression between US inventories and WTI crude price, 500 with the current level of inventories oil should be around USD40. In order to achieve price 450

corrections towards USD60, inventories would have to fall to 421.2 million, which, assuming a 5 400 mmbed million reduction per week, would take around 4-5 months. Given the average year-to-date 350 change in inventories, this seems to be an unlikely scenario. 300 250 200 Despite this, the OPEC, which produces a third of global oil, wishes to put a USD50 floor below Jun-07 Jun-09 Jun-11 Jun-13 Jun-15 Jun-17 crude oil prices with the hope to drive it closer to USD60. In theory squeezing the supply, along Weekly final oil inventories USA ex-strategic reserve Average with cuts in Russian production, should mean a rise in prices, however, this is yet to happen. Despite cuts, some OPEC-countries, such as Libya and Nigeria, which are not part of the Source: U.S. Energy Information Administration (EIA), Grupo Bancolombia. agreement, have recently begun rising production, somewhat challenging OPEC’s efforts to cut production output and balance supply and demand. Regardless, Colombia could benefit greatly from this and stimulate the slowing economy. As a non-OPEC country no controls on production Figure 8 – OPEC prod. vs. US, Libya & Nigeria mean that the Colombian oil industry could step up exports whilst benefitting from the increased prices, although Oxford Economics Analysts have predicted that no significant change will be 34,000 12,500 seen until at least 2018. In the wake of these cuts the US has turned to alternate suppliers, 33,000 12,000 demonstrating that demand from the US, Colombia’s number one oil destination, is still high. 32,000 31,000 11,500

30,000 Kbpd

The latest challenge to OPEC commitment on production cuts comes from the latest 29,000 11,000 developments in the Middle East. Tensions in the Arab states have risen to boiling point and 28,000

political instability threatens oil export prices. With Yemen, UAE, Egypt and perhaps most 27,000 10,500 worryingly Saudi Arabia cutting flight and diplomatic links with Qatar, the current outlook appears 26,000 25,000 10,000 to be bleak. Saudi Arabia also closed its borders and there has been a move to close surrounding Oct-13 Apr-14 Oct-14 Apr-15 Oct-15 Apr-16 Oct-16 Apr-17

air space to Qatari flights. In short, the tensions arose from Qatar’s alleged support of fundamental OPEC USA + Nigeria + Libya (RHS) Muslim groups both financially or otherwise. However, oil prices were not affected significantly; Source: Joint Organization Data Initiative (JODI), Grupo Bancolombia. traders seemed to predict the tension and we saw only a small drop in price. That being said, the

lack of cohesion within the region is troubling as this particular confrontation was unexpected and

appears to be an early warning to Qatar if it continues its alleged support. An escalation and

increased negative attention to the area could drive oil prices down by putting into question the

agreement to cut production.

On the other hand, many of Trump’s decisions have risen political shockwaves around the world,

and his actions can impact the Colombian oil industry both positively and negatively. First,

protectionist policies do not bode well for Colombian oil exports to the US, since a border closure

would force Colombia to compete in a broader market that is already saturated with oil. However,

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since the US has not the capacity to be self-sufficient in terms of energy yet, and that Trump Figure 9 – OPEC prod. vs. Qatar’s share administration officials have indicated that there would be few changes in the current state of the 35,000 2.5% relationship with Colombia, we believe it's quite unlikely that this will happen. Secondly, just over 32,000 a year after the Paris Agreement was opened to signatures, Trump has announced his intention 2.3% to withdraw the , on the grounds that it is damaging to US businesses and gives 29,000

non-compliant countries, such as Russia and China, a competitive edge. 26,000 2.0% Kbpd

23,000 The Paris Agreement is the largest single effort globally to reduce the effects of climate change. 1.8% 20,000 In leaving the agreement Trump is putting industry first and, whilst globally this is devastating, it 17,000 1.5% may not be so for Colombia. Trump’s economic and industrial focus will require energy and, more Apr-14 Oct-14 Apr-15 Oct-15 Apr-16 Oct-16 Apr-17

importantly, oil. In short, Trump’s America will have greater demands for oil and Colombia should OPEC Ex. Saudi Arabia Saudi Arabia % Qatar OPEC endeavor to quench its thirst. However, higher production from the US would also translate into Source: Joint Organization Data Initiative (JODI), Grupo Bancolombia. further downward pressure on oil prices.

Locally, the current political situation in Colombia offers a promising prospect in the near future.

The cessation of the main armed conflict will allow the safe and profitable exploration of new rural Figure 10 – Oil demand vs. US PMI areas with the potential to find new oil reserves and encourage foreign investment. This should translate into increased oil production in Colombia. However, social unrest continues, and now 21 61 59 with the increase in the mechanism of popular consultations against oil activity many projects 21 57 20 have been put on hold. In addition, the constant attacks on the Caño Limón-Coveñas oil pipeline, 55

which on average experiences a weekly attack, prevent the Colombian oil industry from reaching 20 53 mmboed 51 its potential. It’s clear that the main challenge the Colombian oil industry’s facing is to increase 19 reserves and for this it requires exploration efforts, but it can’t neglect the risks above the ground. 49 19 47

18 45 Overall, downside risks clearly outweigh potential upside on the short term. Despite a more Jan-12 Jan-13 Jan-14 Jan-15 Jan-16 Jan-17 positive domestic outlook on the back of the peace agreement and less attacks to the EEUU Oil Demand PMI EEUU (RHS) infrastructure, the ELN remains outside from any agreement, still posing a potential threat. Global Source: Investing, EIA, Grupo Bancolombia. politics and the OPEC agreement, also appear to be threatened by Trump politics, tensions in the Middle East and production from non-OPEC countries, while inventories in the US remain high. Although the OPEC agreement allowed for a substantial price increase and subsequent stability in the USD45-USD55 range, the current commitment to cut production by 1.8 million barrels a Figure 11 – ECO’s infrastructure repair day until March 2018, doesn’t seem to be enough to provide the balance the market requires. expenditure (COP bn)

With this scenario in mind, we believe the market will continue to show significant volatility, 180 157 struggling to keep the USD50 floor the OPEC wishes to establish. 160 140 Fourth-Generation Concessions: Positive Dynamics but not yet Materialized 120 98 100 85 The fourth-generation road concessions program is one of the most significant investments made 80

in Colombia recently, having no precedent. Its priority arises from the high logistics costs in the 60 44 country and the lag in road infrastructure compared to other countries in the region. 40 24.3 25 21 21 17 22 20 8.7 9 Total investment nears COP52tn over the next eight years, allocating COP38tn for public initiative 0 2014 1Q15 2Q15 3Q15 4Q15 2015 1Q16 2Q16 3Q16 4Q16 2016 1Q17 projects comprised in three waves, COP12tn for private initiative projects, and the remaining COP2tn for strategic projects. Source: Ecopetrol, Grupo Bancolombia.

So far, eight projects have made financial closure, i.e., have complete resources, defined uses and defined, reaching COP12.6tn. It’s expected that by the second half seven to eight projects would have financial closure, both those of the second wave of public initiative and private initiative.

The strategic projects refer to those works that need to be continued, since they were interrupted for different reasons, among them are: i) Tunel de La Linea, which expired and is receiving proposals from builders, ii) Ruta del Sol Tramo II, which had early termination and progresses in the new bidding process, and iii) Navelena (Navegabilidad del Rio Magdalena), which expired and is in the process of opening a new tender.

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It’s important to bear in mind that recent cases of corruption in the infrastructure sector, such as the alleged bribery by the Brazilian company Odebrecht, may to some extent permeate the confidence of participating institutions and companies in the 4G concessions program.

However, we believe that the 4G concessions were conceived and structured under new guidelines aiming at the transparency and control of works; the creation of the National Infrastructure Agency (ANI) and the National Development Finance (FDN) allowed the inclusion of builders and international banks, coupled with funding through the capital market.

The largest impact on the growth of the Colombian economy from the infrastructure sector will definitely not be at the end of 2017. Projects with financial closure are carrying out initial work such as land clearance and other preparatory works, while others are in the pre-construction stage (one year before construction) which includes permits, licenses and acquisition of properties. For these reasons, the significant revenues of 4G will not yet be reflected, and construction materials such as cement, ready-mix, iron and others, would begin to be distributed by 4Q17. A peak in the dynamics of construction is projected towards 2018 and 2019.

The cement companies under cover (Cementos Argos and Latam Holdings) have announced their participation as suppliers of cement and ready-mix in multiple functional units of awarded concessions. At the close of 1Q17, Cementos Argos reported the awarding of 40 functional units in cement distribution, equivalent to 82% of the concessions of the first wave, 61% of the second wave, and 50% of privately owned PPPs. CLH, at the end of 2016, announced its participation in 4G projects as a supplier of 17 functional units; its goal is to meet between 40% and 50% of the cement demand in the pipeline of infrastructure projects (public and private 4G + Vias de la Equidad) which can demand more than 3 million tons.

In conclusion, road infrastructure projects are progressively developing; public contract awardings

have concluded with the latest project of the third wave (Pamplona-Cucuta) and are increasing

appetite from plural structures is being seen on concessions of private initiative, about 13 projects

have been awarded so far. However, 2017 will not be driven by the above reasons, demand for

cement and ready-mix will begin with distribution to concessions in the last months of the year

and representative peaks in the next two years.

A Flow-Dependent Market There is no doubt that a 7.4% return half-yearly is more than satisfactory in a context of macroeconomic weakness and lack of catalysts. However, the post-closing analysis of the evolution of the Colombian equities market gives important indications about the reasons behind Figure 12 – Colcap YTD this advance. This does not seek to discredit the value trapped by listed companies, which since the beginning of the year suggested signs of undervaluation. On the contrary, this analysis seeks 1,495

to identify the driver that took to Colcap to its highest level in 30 months and to anticipate an 1,460 eventual extension of this movement. 1,425

As shown in graph 12, the behavior of the index during the first four months was relatively stable 1,390

and lateral, ranging between 1,318 and 1,378 points, i.e., between -2.7% and +1.7% with respect 1,355 to its mean value. At the end of this period the Colcap was only 1.5% up YTD and the average 1,320 daily volume of the last 12 months was COP134,000mn. The turning point occurred in May, when the MSCI rebalancing for emerging markets was carried out, an index that incorporated 1,285 Bancolombia’s share into the group of eight other local names that were already part of this index. 1,250 Dec-16 Jan-17 Feb-17 Mar-17 Apr-17 May-17 Jun-17 Not surprisingly, this change had a significant impact on the market, as it had in May and Source: Bloomberg, Grupo Bancolombia. November 2015 and 2016, when Colombian names had also undergone changes in their shares

within the index. As a result, the Colcap valued 5% in May 2017, led by ISA (+20.9%), Bancolombia (+12.7%), Bancolombia PF (+12.3%), CLH (+8.4%) and Davivienda (+6.5%), and

another nine stocks with positive performance in the month. This market valuation was accompanied by an unusual increase in trading volumes, with a daily mean of COP237,801mn,

or 69.7% above the average of the previous year.

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These events confirm the incidence of investment flows in the Colombian market price

configuration. In May 44% of the total flows of the stock went through pension funds and Figure 13 – Colcap monthly variation foreigners, whose net purchase volumes were COP401,000mn and COP197,000mn, respectively. Regarding the former it’s foreseeable that their market share will remain on the 10% buying side, but to a lesser extent than those recorded in May, a situation that would guarantee 8% 6% 5.0% sustainability at the current levels of the index. On the part of foreigners it is foreseeable that the 4%

dynamics will be lowers, given i) the beginning of the summer season in the northern hemisphere, 2% ii) the absence of new rebalances in the short term, and iii) the lower upside potential in the names 0% with most liquidity on the market. Finally, individuals, who contributed 23% of stock market flows -2% -2.3% -4% in May, with net sales for COP337,000mn, are not expected to change positions. Their sales flows -3.7% -6% will continue to be absorbed by other agents and therefore will not be a positive catalyst for the -5.8% -8% -6.4%

Colcap. -10% -8.5% May-15 Sep-15 Jan-16 May-16 Sep-16 Jan-17 May-17 In short, while corporate fundamentals will always be part of the analysis of agents, the periodicity, Source: BVC, Grupo Bancolombia. recurrence and magnitude of international index rebalances are making the stock market become a flow-dependent entity. A reconfiguration of these will not be anticipated for the second half of the year: traditional buyers will continue to fuel demand, while sellers will do the same. In light of the current macro scenario and current price levels, the foregoing anticipates support for stocks but discards valuations as pronounced as those seen in May.

COLCAP: Continuation of Upward Trend but amidst Turbulence

Top Picks Evolution

Since launching our 1H17 Top Picks, on November 30, 2016, through June 27, 2017, those

recommended assets performed lower to the COLCAP. While our picks accumulated a valuation

of 11.4%, the Colombia main stock market index recorded 13.1%. However, we believe it’s worth

assessing our 1H17 top picks in three time windows. First, until January 23, both the COLCAP

and the Top Picks recorded a positive behavior, very similar to each other. Subsequently, our

recommendation surpassed the COLCAP for a period of almost four months, until May 16. From

that moment, the Top Picks and the COLCAP presented similar movements, but the market

gained a difference of 130bps.

We highlight the positive result of equities in Colombia in the first half of 2017, which was also captured through our Top Picks. It’s important to keep in mind that our recommendation for the first half, which was invested in Grupo Exito (35%), Grupo Argos (30%), Cementos Argos (25%)

and Ecopetrol (10%), experienced two adjustments during the first half: i) on February 21 we excluded Ecopetrol, due to the disappointing hydrocarbon reserves update report for 2016, and ii) on May 12 we took out Cementos Argos’ stock against a challenging scenario for the company

in the Colombian market mainly. After these decisions, we re-weighed the remaining two assets, changing their share proportionally to what was initially indicated, with the remaining Top Picks being Grupo Exito (54%) and Grupo Argos (46%).

Top Picks: What’s Left for the Stock Market when almost Everything Seems Expensive? Table 3 - Variables & weighting Variables Weight We continued with our usual methodology for a rigorous selection of the assets to be recommended, using the model that considers six elements: macro variables, liquidity, risk, Macro 15.0% fundamental, momentum in financial results, and the feeling of the Economic Research team and Liquidity 12.5% and Equity Strategy teams. Indebtness 20.0% EPS growth 12.5% On this occasion the result of the exercise was quite particular, since only one asset exceeded Fundamental 20.0% the minimum threshold to be part of our Top Picks. Thus, Grupo Exito’s stock maintains its position Sentiment 20.0% and is designated as our only Top Pick for 2H17. Source: Grupo Bancolombia. Below we briefly describe the ranges and adjustments made in the selection criteria:

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Macro variable: We included two additional variables that we consider to be sensitive to the economic situation in which the companies of the stock exchange are: delays in the execution of

4G projects and international exposure of operations. Thus, the group of macro variables for the rating is complemented by: exchange rate, oil price, GDP growth, Central Bank’ repo rate, and inflation.

In this sense, the macro variables were measured based on a greater devaluation than the one

estimated by our macroeconomic team and its impact on the company, oil falling below USD40, lower GDP growth than that estimated by our economic research team (2%) for 2017, a faster decline in the repo rate of the Central Bank during the second half of 2017, a less rapid correction

of inflation, a greater delay in the execution of the 4G projects and finally if the international exposure each company has benefits it or not.

Table 4 – Macro variables – ranking

Interest 4G International Dollar Oil GDP CPI Ranking Rate Progress Exposure Grupo Argos 4.0 3.0 2.0 4.0 4.0 2.5 3.8 3.3

ISA 3.0 3.0 3.0 3.5 3.0 3.0 4.5 3.3 Cemargos 4.0 3.0 2.0 4.0 3.0 1.5 4.5 3.1 Celsia 2.5 4.0 2.0 3.5 3.0 3.0 4.0 3.1 Exito 3.5 3.0 2.0 4.0 2.5 3.0 3.8 3.1 Canacol 3.0 2.8 3.0 3.0 2.8 3.0 3.0 2.9 ETB 3.0 3.0 2.0 3.5 3.0 3.0 3.0 2.9 Conconcreto 3.0 3.0 2.0 4.0 3.5 1.5 3.0 2.9

EEB 2.0 3.0 2.0 3.5 2.5 3.0 4.0 2.9 Nutresa 2.0 3.0 2.0 3.8 2.5 3.0 3.4 2.8 Ecopetrol 4.0 1.0 3.0 3.5 2.5 2.5 3.0 2.8 Terpel 3.0 2.5 2.0 3.0 3.2 2.5 3.0 2.7 El Cóndor 3.0 3.0 2.0 3.0 3.5 1.0 3.0 2.6 Avianca 1.0 4.0 2.0 3.0 2.5 3.0 3.0 2.6 Cemex Latam Holdings 1.0 3.0 2.5 3.5 3.0 1.0 3.8 2.5

Weighting 14% 14% 14% 14% 14% 14% 14% Source: Grupo Bancolombia

Liquidity: We maintained the methodology of considering in this component the average daily volume of the asset in the last 360 days (70% weighting) and rotation, number of shares traded in a 180-day period based on the floating (30% weighting).

Profit growth in 2017: This criterion seeks to collect the companies’ earnings power for 2017, which becomes a relevant fundamental variable that should support good performance.

It’s important to note that in oil and energy companies this variation can be very high, taking into account that after the sharp drop in oil prices and the severe El Niño phenomenon, mainly in the

second half of 2015, they’re the ones that could offer positive surprises in terms of financial results, mainly from net income.

Risk: Let’s remember that since the previous report, we improved the process of deepening this element. Instead of measuring the risk by the degree of leverage of each company, through the indicator net debt/EBITDA or net debt/EBITDAR, depending on the sector of exposure of the

asset, we decided to strengthen our practice by replicating Moody’s risk rating methodology with the goal of not only basing our rating on an indicator but also on qualitative variables that measure factors such as the diversification of the operation, market share, size of the company, among

others. After having the score of both factors we proceeded to give a 50% weighting to the net debt/EBITDA indicator and 50% to the rating provided by the Moody’s methodology.

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Table 5 – Risk indicator summary Figure 14 – Debt ratio

Net Debt / 3,50 2,9 2,9 Moody's Rating Rating Ranking 3,00 2,8 2,8 EBITDA 2,7 2,4 2,3 2,50 2,2 1,9 Exito A2 4.5 0.82 5 4.8 2,00 1,5 ETB A2 4.5 0.67 5 4.8 1,50 1,0 1,0 0,8 0,9 Ecopetrol Baa3 4 1.93 4 4.0 1,00 0,6 0,6 0,7 0,50 Nutresa A3 4.5 2.54 3 3.8 0,00

Cemex Latam Holdings A3 4.5 2.39 3 3.8

1Q15 1Q13 2Q13 3Q13 4Q13 1Q14 2Q14 3Q14 4Q14 2Q15 3Q15 4Q15 1Q16 2Q16 3Q16 4Q16 1Q17

EEB A3 4.5 2.60 3 3.8 Deuda neta / EBITDA Terpel A3 4.5 2.51 3 3.8 Source: Grupo Bancolombia. Grupo Argos Baa1 4 2.99 3 3.5 Cemargos Baa1 4 3.60 2 3.0 El Cóndor Ba2 3 2.88 3 3.0 Canacol B1 2 2.63 3 2.5 Celsia Ba2 3 3.60 2 2.5 ISA Baa2 4 4.00 1 2.5 Conconcreto Ba1 3 3.83 2 2.5 Figure 15 – EBITDA vs. Net debt Ba3 3 5.47 1 Avianca 2.0 EBITDA Source: Grupo Bancolombia 120.000 Deuda neta consolidada

Fundamental: The fundamental variable takes into account the valuation potential of each asset 100.000 for 2017. 80.000

60.000 Analyst/Specialist sentiment: Our teams of Equity Research and Equity Strategy have a wide knowledge not only from the fundamental point of view, but also from the point of view of the 40.000 market, expectations and risks the current economic conjuncture can have on the financial results 20.000 of the companies. Based on this, the sentimnt was analyzed as an average of the different 0 measurements made by each of the members of both teams. In this regard, we highlight the 1Q13 3Q13 1Q14 3Q14 1Q15 3Q15 1Q16 3Q16 1Q17 preference of our analysts for the stocks of Celsia, Grupo Argos and Grupo Exito. Source: Grupo Bancolombia.

Finally, after developing the methodology and applying the different weights, we find that only the stock of Grupo Exito exceeded the minimum threshold (3.5) to be part of our Top Picks. However, we make special mention to assets such as Avianca, Celsia and Grupo Argos that were at the top of the final ranking.

Table 6 – Top Pick selection from covered companies

Fundament Macro Liquidity Indebtedness EPS growth Feeling Ranking al upside Exito 3.1 5.0 4.8 5.0 5.0 4.1 4.49 Avianca 2.6 4.0 2.0 4.0 5.0 2.6 3.32 Celsia 3.1 2.0 2.5 5.0 3.0 4.3 3.30 Grupo Argos 3.3 2.8 3.5 2.0 3.0 4.3 3.25 Ecopetrol 2.8 4.6 4.0 5.0 2.0 2.1 3.24 ETB 2.9 1.8 4.8 1.0 5.0 2.1 3.16 Nutresa 2.8 2.8 3.8 3.0 2.0 3.8 3.05 Canacol 2.9 1.6 2.5 2.0 4.0 3.9 2.96 ISA 3.3 3.2 2.5 4.0 1.0 3.8 2.84 Conconcreto 2.9 1.4 2.5 2.0 5.0 1.8 2.72 Cemex Latam Holdings 2.5 3.6 3.8 1.0 3.0 1.9 2.69 El Cóndor 2.6 1.0 3.0 2.0 5.0 1.5 2.67 Cemargos 3.1 3.2 3.0 2.0 2.0 2.6 2.65 EEB 2.9 1.6 3.8 2.0 2.0 2.9 2.60 Terpel 2.7 1.4 3.8 1.0 2.0 2.4 2.34 Weighting 15% 13% 20% 13% 20% 20% Source: Grupo Bancolombia

It’s also important to understand what strengths and weaknesses we find in our recommendation, which we explain below.

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Grupo Exito: Exposure to Compensates for Latent Risks

Once again Grupo Exito is part of our Top Picks this semester, the particularity is that this time is Figure 16 – Selic rate Brazil

the only one. Although since November 30, when we published our previous Top Picks report, 16 the share of Grupo Exito has valued 7.7%, we still believe that the asset is undervalued and the 15 reasons may not differ much from those presented in the previous report. 14 13

12 Our main reason continues to be the company’s exposure to the Brazilian market and the potential 11

recovery we expect it to have in the short and medium term. 2016 was a year full of political and 10 economic uncertainty that ended up affecting GPA (Grupo Pão de Açúcar) results, however, it 9 also marked a turn point for the economy of the neighboring country. While we expect that in the 8 short term Brazil will continue to show growth figures below the regional average, the negative 7 6 trend should change. Even in recent months the country has begun to show signs of recovery Q4 15 Q1 16 Q2 16 Q3 16 Q4 16 Q1 17 Q2 17 E Q3 17 E Q4 17 E Q1 18 E that support our thesis, such as the beginning of an expansive monetary policy, with the Selic rate Source: Grupo Bancolombia, Bloomberg. decreasing 200bps since 2016, the significant decrease of inflation to 4.6% and the lower reduction in GDP which reached -0.35% in 1Q17. All this has led the IMF to revise its growth expectations for this country, expecting it to grow 0.16% and 1.75% in 2017 and 2018. Although recent corruption scandals about the new government have set off the alarms again, we don’t expect these to slow down the economic recovery and that in turn this favors the financial results Figure 17 – Brazilian inflation 2017 of GPA, therefore Grupo Exito consolidated. It should be noted that the results of GPA in 1Q17 11 have already started to show this recovery. 10

9 On the other hand, although the sale of GPA’s stake in Via Varejo (non-food) has not yet 8 materialized, we believe it will be favorable from a fundamental point of view. As our valuation of 7 Via Varejo has a TP of BRL9.1 per share, the market price is at BRL10.2 and the average TP of 6 analysts is BRL11.9, this increases the chances that the deal will take place at a price higher than 5

the one used in our valuation. However, we would like to emphasize that after the sale GPA would 4

have a sub-optimal capital structure, thanks to its low levels of leverage, which makes it of great 3 importance to know the way in which the company will manage this cash position. Q4 15 Q1 16 Q2 16 Q3 16 Q4 16 Q1 17 Q2 17 E Q3 17 E Q4 17 E Q1 18 E Source: Grupo Bancolombia, Bloomberg. Although Uruguay and Argentina account for only 9.2% and 1.5% of EBITDA, respectively, we

expect both countries to continue to contribute positively to the Grupo’s results during 2017. Healthy sales growth coupled with a good control of spending and lower inflation scenarios would allow maintaining operating margins, while a low level of indebtedness would translate into

positive contributions to Exito, both in cash and profit.

Finally, in Colombia, whilst the economic slowdown has negative effects on Exito’s traditional business and will continue to do in the future, the company has managed moderate the impact Figure 18 – Brazilian GDP throught its diversification and the growth of alternate businesses such as insurance, travel and real state. 4

Although our bet on Grupo Exito focuses on the recovery of Brazil, we will continue to monitor the 2 behavior of the Colombian economy and the strength of emerging direct competitors within the 0 large discounts store market. Any deterioration in these variables represents the greatest risk to our recommendation. -2

-4 -6 Q1 12 Q4 12 Q3 13 Q2 14 Q1 15 Q4 15 Q3 16 Q2 17 E Q1 18 E

Source: Grupo Bancolombia, Bloomberg.

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Special Mentions

Finally, we would like to make a special mention to a number companies despite the facts they didn’t surpass the 3.5 threshold in our assessment, to be a part of our Top Picks, do have important attributes that are worth noting like Avianca, Celsia and Grupo Argos. Avianca, ranks second with an overall score of 3.32 but when using the fundamental upside as an indicator both Conconcreto and Avianca stands at the top. This high undervaluation takes us to highlight it as a company that must be on the radar. However, we must emphasize that Avianca has two black spots that undoubtedly affected its rating. Firstly, a high indebtedness, which makes it the company with the highest level of leverage among the companies under cover; and secondly, a lateral-negative perception as a result of the lawsuit not yet defined filed by Kingsland (Kriete family) against Synergy (German Efromovich) and . However, we emphasize that the turbulence generated by this news has mostly calmed down and, the stock could show some rebound, granted nothing extraordinary occurs.

In Celsia, the upside potential has decreased considerably due to the accumulated advance (12.2% YTD). This is as a result of the recovery of profitability margins after being affected during the El Niño phenomenon, we emphasize that it is the name with the highest earnings power between 2017 and 2018. In addition, Celsia has the Porvenir II project (352 MW hydroelectric plant), which has not yet been incorporated into our valuation model. Although, according to our calculations, the company does not currently have the capacity to finance the project, different sources of financing are being assessed as well as a project finance that will allow the construction to begin. We emphasize that any news on this front can boost the asset. Finally, in Grupo Argos, we highlight the diversification of the investment portfolio as well as the strategic redirection that the company has given to its assets. Such is the case of , a company that has decided to clean up the basis of its portfolio to focus on high value projects. Although we believe that the cement business in Colombia is not going through the best moment, becoming one of its main short-term challenges, other income lines, such as Cemargos’ exposure in the US, and other business segments such as energy, concessions, real state and ports, compensate for this circumstance. As long the management continues to provide evidence of the correct execution of its business plan and the generation of value, this name may converge towards its target value.

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Equity Sales Equity Research

Rupert Stebbings Jairo Agudelo Restrepo Equity Markets Vice President Head of equity research [email protected] [email protected] +574 6045138 +574 6047048

Diego Buitrago Aguilar Fixed Income Energy Analyst

[email protected] Manuel Rey Ayala +571 7463984 ext 37307 MD - International Institutional Investors

[email protected] German Zúñiga Saavedra +571 353 5205 Cement & Infrastructure Analyst

[email protected] Economic Research +574 6047045

Juan Pablo Espinosa Federico Perez Garcia Head of Economic Research Consumption & Industry Analyst [email protected] [email protected] +571 7463991 ext. 37313 +574 6048172

Arturo González Peña Andrea Atuesta Meza Central Bank and Financial System Analyst Financial Sector Analyst [email protected] [email protected] +571 7463980 ext 37385 +571 4886000 ext 37387

Rodrigo José Torres Vargas Maria Antonia Yarce Villa Central Bank and Financial System Analyst Oil & Gas Analyst [email protected] [email protected] +571 7463988 +574 6049821 ext 39631

Henry Alexander Otero Giraldo Daniel Esteban Meneses Piedrahita International and Markets Analyst Intern [email protected] +574 6046496 +571 7463980 ext 37310 [email protected]

Julián Felipe Huertas Espitia Erika Ivanna Baquero Jimenez Analyst Intern [email protected] +571 7463980 ext 37376 +571 7463988 ext. 37303 [email protected]

Juan Camilo Hernández Orjuela

Intern Research Assistant [email protected] +571 7463988 ext. 37310 Claudia Restrepo Research Editor Sergio Daniel Pedraza Quiñones [email protected] Intern +574 404 3809 [email protected]

+571 7463988 Ext. 37316

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TERMS OF USE

This report has been prepared by Analysis Bancolombia a research and analysis department at Grupo Bancolombia. It shall not to be distributed, copied, sold, or altered in any way without the express permission of Grupo Bancolombia, nor be used for any purpose other than to serve as background material which does not constitute an offer, advice, recommendation, or suggestion by Grupo Bancolombia for making investment decisions or conducting any transactions or business. The use of the information provided is solely the responsibility of the recipient.

Before making an investment decision, you should assess multiple factors such as the risks of each instrument, your risk profile, your liquidity needs, among others. This report is only one of many elements that you should consider in making your investment decisions. In order to extend the content of this information, we ask you to contact your business manager. We recommend you not to make any investment decision until fully understanding all factors involved in such decisions. Fixed income and equity securities, interest rates, and other information found here are purely informational and are not an offer or firm demand to perform transactions. Also, according to the applicable regulations, our opinions or recommendations do not constitute a commitment or guarantee of return for the investor.

The information and opinions in this research report constitute a judgment as of the date indicated and are subject to change without notice. The information may therefore not be accurate or current. Future projections, estimates, and forecasts are subject to several risks and uncertainties that prevent us from ensuring that they will prove correct or accurate, or that the information, interpretations, and knowledge on which they are based will be valid. In that sense, actual results may substantially differ from the forward-looking statements contained here. You should be aware of the fact that investments in securities or other financial instruments involve risks. Past results do not guarantee future performance.

The entities that are part of Grupo Bancolombia may have acquired and maintain at the time of preparation, delivery or publication of this report, for their own position or that of their clients, the securities or financial assets to which the reports refers. Grupo Bancolombia has risk policies to avoid a concentration in their own positions and those of their clients, which contributes to avoid conflicts of interest.

As regards to conflicts of interest, we declare that (i) Valores Bancolombia S.A. Comisionista de Bolsa and/or Banca de Inversión Bancolombia S.A. Corporación Financiera have participated in structuring or underwriting/placing equity securities for Bancolombia S.A., (ii) Grupo Bancolombia is the beneficial owner of 10% or more of the shares issued by Valores Simesa S.A., and Proteccion S.A., (iii) Bancolombia is one of the biggest shareholders of Fondo Inmobiliario Colombia – FIC, and (iv) Valores Bancolombia S.A. Comisionista de Bolsa is a wholly owned subsidiary of Bancolombia S.A. Nevertheless, it has been prepared by our Analysis Bancolombia department team based on strict internal policies that require from us objectivity and neutrality, as well as independence from our areas of brokerage and investment banking.

The information contained in this report is not based, does not include nor has been structured based on privileged or confidential information. Any opinions or projections contained herein are solely attributable to the author and have been prepared independently and autonomously in the light of the information available at the time.

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