13 January 2017 Asia Pacific/ Equity Research Strategy

2017 Japan Outlook Research Analysts STRATEGY Head of Japan Equity Research Jonathan Tischler 81 3 4550 7445 Gearing up for another year of surprises [email protected] Product Manager Daisuke Takato Figure 1: Factor Gearing – Company Examples 813 4550 9671 Factor Favorable Unfavorable [email protected] 1) Yen Depreciation Fuji Heavy Go Tanaka Sysmex Taisho 81 3 4550 7266 Shinko Electric Nidec etc... etc... [email protected] 2) Higher Interest Rates & Inflation MUFG Suruga Shimano Fudosan Japan Real Estate Inv Corp etc... etc... 3) High Operating Leverage & Stronger Suzuki Economic Growth Sumitomo Osaka Cement Construction Companies Nippon Shinyaku Sawai etc... etc... 4) Improved Corporate Governance & SMC Shareholder Returns etc... etc... 5) Self Help & Structural Change NEC Takeda Mitsubishi Tanabe Aisin Seiki Unipres etc... etc... 6) Secular Themes Canon Keihin etc... etc... 7) Valuation Toto Mitsui Chemical Mitsubishi Gas Chemical etc... etc...

Source: Credit Suisse

■ Bullish on Japan: We are optimistic on Japan’s outlook, as highlighted in our 23 November report, where Chief Global Equity Strategist Andrew Garthwaite upgraded Japan to Overweight. Japan is a quintuple play on global growth given its gearing to: i) high operational leverage, ii) cyclicality, iii) higher US interest rates, iv) expected additional monetary stimulus, and v) higher inflation. Accordingly, Japanese corporates should gain an earnings boost from the yen’s weakness and high operational leverage, while rising inflation expectations should fuel a further shift to equities. Additionally, valuations remain attractive, Garthwaite writes, with P/Es being discounted versus other developed markets. ■ Gearing to the cycle: Keeping with the focus on both gearing and the potential for surprises, in this year’s outlook report we have asked our analysts to identify which of their coverage companies are most (and least) favorably exposed to the following seven factors: 1) Yen Depreciation, 2) Higher Interest Rates & Inflation, 3) High Operating Leverage & Stronger Economic Growth, 4) Improved Corporate Governance & Shareholder Returns, 5) Structural Change, 6) Secular Themes, and 7) Valuation.

DISCLOSURE APPENDIX AT THE BACK OF THIS REPORT CONTAINS IMPORTANT DISCLOSURES, ANALYST CERTIFICATIONS, LEGAL ENTITY DISCLOSURE AND THE STATUS OF NON-US ANALYSTS. US Disclosure: Credit Suisse 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. 13 January 2017

Table of contents

Executive Summary 3

Focus List / Top Ideas 4

Macro Landscape for 2017 6

Cyclicals 10 Autos / Masahiro Akita ...... 10 Auto Parts / Masahiro Akita & Koji Takahashi...... 11 Machinery / Shinji Kuroda ...... 12 Electronic Components / Akinori Kanemoto...... 14 Industrial Electronics / Hideyuki Maekawa...... 16 Consumer Electronics / Mika Nishimura ...... 18 Internet & Games / Keiichi Yoneshima ...... 20 Chemicals / Masami Sawato...... 23 Metals / Shinya Yamada ...... 26

Defensives 28 Pharmaceuticals & Biotechnology / Fumiyoshi Sakai & Yen Ting Chen...... 28 Consumer Staples / Masashi Mori ...... 31 Real Estate, Housing, Construction, REITs / Masahiro Mochizuki & Yasuko Fukuda ...... 32

Financials 34 Banks / Takashi Miura...... 34 Brokers, & Nonbank Financials / Takehito Yamanaka ...... 36

Key stocks by factor 38 1) Yen Weakness...... 38 2) Interest Rates & Inflation...... 39 3) Operating Leverage & Economic Growth ...... 40 4) Corporate Governance & Shareholder Returns...... 41 5) Self Help & Structural Change ...... 42 6) Secular Themes...... 43 7) Valuation ...... 44

HOLT 45

2017 Japan Outlook2 13 January 2017

Executive Summary The year 2016 certainly offered its fair share of surprises. The world watched in awe and confusion as the UK voted to leave the European Union and Donald Trump was elected US president. At home, the Bank of Japan lowered the policy rate into negative territory, only to reverse course eight months later and focus instead on yield-curve control. In the end, the markets did a U-turn, with both TOPIX and the yen ending the year roughly back where they started, and the index underperforming world markets in both yen and dollar terms.

Figure 2: Relative Performance, the Yen, and Yield Spreads

Note: MSCI performance and USDJPY are indexed to 100. Source: Credit Suisse, the BLOOMBERG PROFESSIONAL™ service, MSCI

The macro landscape as we start 2017 is supportive. Japan is seeing the highest number of upward consensus earnings revisions in the world (Figure 5), largely driven by the yen’s recent decline and ROE’s have also ticked modestly higher (Figure 6). Cyclicals are leading the earnings recovery, which also should in turn help “normalize” the valuation gap between cyclicals and defensives – cyclicals are trading at 15x P/E compared to 17x at defensives, though the gap has historically been about 4x (Figures 8 and 9). An increase in US yields (Figure 10), should be positive for Japanese stocks as historically been the case, and could encourage foreign investors back into Japan (Figure 11). Uncertainties remain – CS global strategist Garthwaite points out the absence of economic reform and deceleration in US growth momentum as key risks, which could lead to a “slip back into deflation” and expose the underlying weakness of the economy. Thus, in an attempt to provide investors with a way to navigate what could be another year of surprises, we have asked our analysts to identify which of their coverage companies are most (and least) favorably exposed to the following seven factors: 1) Yen Depreciation, 2) Higher Interest Rates & Inflation, 3) High Operating Leverage & Stronger Economic Growth, 4) Improved Corporate Governance & Shareholder Returns, 5) Structural Change, 6) Secular Themes, and 7) Valuation. We find that the analysts are, unsurprisingly, most focused on the yen, with companies such as Fuji Heavy, Toshiba, Shinko Electric, MUFG, Dai-ichi Life, among the largest beneficiaries. Higher interest rates and inflation could be a net wash out as it impacts both input and output costs, and because many Japanese companies are cash-rich and hold little debt. Structural change and shareholder returns – a key tenet of Abenomics – will continue to be a theme in 2017, and here we highlight companies such as SMFG, Sekisui Chemical, and Kawasaki Heavy among companies with potential for positive change, while our analysts believe firms like Tokuyama and Sharp still carry significant baggage that they may not be able to unpack this year. In secular themes, we highlight long-term stories such as automotive self-drive, 5G technology and oncology.

2017 Japan Outlook3 13 January 2017

Focus List / Top Ideas In this report, our analysts mention more than 150 companies with exposures to the seven factors, but here we distill it down to the stocks that are on the Japan Focus List (i.e., our highest-conviction OUTPERFORM names). A sector-by-sector table with detailed company comments follows from page 10, as well as a factor-by-factor table from page 38. With few exceptions, most companies on the Japan Focus List are favorably geared to the factors outlined in this report. While tempting to chase companies favorably exposed to yen weakness, five of the names are geared to high operating leverage & stronger economic growth, five to self-help and six to secular themes. Admittedly, few screen as decidedly cheap.

2017 Japan Outlook4 13 January 2017

Figure 3: How our Focus List holds up to the seven factors Sector Company / Analyst Factor Autos Suzuki Motor (7269) - Yen Depreciation (Unfavorable) Masahiro Akita -High Operating Leverage & Stronger Economic Growth (Favorable) -Improved Corporate Governance & Shareholder Returns (Unfavorable) Auto Parts Aisin Seiki (7259) - Self Help & Structural Change (Favorable) Masahiro Akita Machinery Daikin Industries (6367) - Improved Corporate Governance & Shareholder Returns (Favorable) Shinji Kuroda Electronic Components Nissha Printing (7915) - Yen Depreciation (Favorable) Akinori Kanemoto -High Operating Leverage & Stronger Economic Growth (Favorable) -Secular Themes (Favorable)

Industrial Electronics Toshiba (6502) - Yen Depreciation (Favorable) Hideyuki Maekawa -Higher Interest Rates & Inflation (Unfavorable) -Improved Corporate Governance & Shareholder Returns (Unfavorable) Consumer Electronics (6758) - Yen Depreciation (Unfavorable) Mika Nishimura -Higher Interest Rates & Inflation (Favorable) Internet Recruit Holdings (6098) - Secular Themes (Favorable) Keiichi Yoneshima Chemicals (4183) - Self Help & Structural Change (Favorable) Masami Sawato -Secular Themes (Favorable) Chemicals (3402) - Secular Themes (Favorable) Masami Sawato Metals Hitachi Metals (5486) - Self Help & Structural Change (Favorable) Shinya Yamada Pharmaceuticals & (4507) - Secular Themes (Favorable) Biotechnology Fumiyoshi Sakai Pharmaceuticals & Nippon Shinyaku (4516) - High Operating Leverage & Stronger Economic Growth (Favorable) Biotechnology Yen Ting Chen Consumer Staples KOSE (4922) - High Operating Leverage & Stronger Economic Growth (Favorable) Masashi Mori Consumer Staples Morinaga & Co (2201) - Self Help & Structural Change (Favorable) Masashi Mori Real Estate, Housing, Sekisui House (1928) - Valuation (Favorable) Construction, REITs Masahiro Mochizuki Real Estate, Housing, Sumitomo Osaka - High Operating Leverage & Stronger Economic Growth (Favorable) Construction, REITs Cement (5232) Masahiro Mochizuki

Real Estate, Housing, Taisei Corp (1801) - Valuation (Favorable) Construction, REITs Masahiro Mochizuki Banks Shinsei Bank (8303) - Valuation (Favorable) Takashi Miura Banks Sumitomo Mitsui - Improved Corporate Governance & Shareholder Returns (Favorable) Financial Group (8316) -Self Help & Structural Change (Favorable) Takashi Miura

Brokers, Insurance & Credit Saison (8253) - Yen Depreciation (Unfavorable) Nonbank Financials Takehito Yamanaka -Secular Themes (Favorable)

Source: Credit Suisse

2017 Japan Outlook5 13 January 2017

Macro Landscape for 2017 Figure 4: Earnings Environment Again Supportive: Revision Trends Turn Positive From 2013 to 2015 the Japanese market led global markets on the strength of earnings revisions, largely on account of yen weakness. This reversed in March 2016 as the yen strengthened above ¥110 to the USD. Once again, we have seen a sharp reversal of the yen since November, of Japanese companies with an earnings revision, 62% received an earnings upgrade in December, up from 49% in November and the low of 34% in July at the height of recent yen strength. Favorable revisions were led by the auto, banks, insurance, semiconductor & semiconductor equipment, and retail sectors. The expectation is that favorable momentum should continue and provide support for the market. 130 EPS forecasts & FX rate 125 2018 EPS 120 2019 EPS 115

110 2017 EPS 105 USDJPY 100 2016 EPS 95 90 2015 EPS 85 80 2013 2014 2015 2016 2017

Broad Market Revisions Ratio Japan Global 70% 60% 50% 40% 30% 20% 0 1 2 3 4 5 6 0 1 2 3 4 5 6 0 1 2 3 4 5 6 0 1 2 3 4 5 6 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 ------l l l l l l l t t t t t t t r r r r r r r n n n n n n n c c c c c c c u u u u u u u p p p p p p p a a a a a a a J J J J J J J J J J J J J J O O O O O O O A A A A A A A

Revisions Up/(Up + Down) Ratio Jan-16 Feb-16 Mar-16 Apr-16 May-16 Jun-16 Jul-16 Aug-16 Sep-16 Oct-16 Nov-16 Dec-16 Automobiles & Transportation Equipment 29% 23% 16% 19% 6% 27% 14% 15% 22% 21% 40% 82% Banks 17% 15% 5% 14% 20% 33% 48% 31% 56% 50% 69% 59% Commercial & Wholesale Trade 33% 42% 24% 30% 20% 62% 50% 35% 44% 40% 50% 46% Construction & Materials 52% 62% 50% 59% 51% 48% 44% 52% 62% 55% 64% 74% Electric Appliances & Precision Instruments 36% 32% 25% 23% 16% 31% 18% 28% 37% 41% 41% 71% Electric Power & Gas 40% 50% 64% 25% 31% 21% 33% 73% 62% 50% 25% 44% Energy Resources 25% 25% 29% 50% 50% 50% 14% 25% 0% 33% 20% 67% Financials (Ex Banks) 73% 38% 41% 40% 12% 27% 27% 33% 36% 43% 43% 48% Foods 68% 68% 40% 47% 61% 69% 64% 73% 62% 67% 63% 62% IT & Services, Others 57% 42% 37% 42% 34% 55% 39% 51% 53% 50% 53% 38% Machinery 28% 20% 21% 24% 45% 27% 26% 25% 26% 36% 45% 76% Pharmaceutical 53% 42% 41% 56% 48% 57% 35% 65% 58% 69% 48% 56% Raw Materials & Chemicals 59% 52% 41% 27% 32% 33% 30% 44% 53% 44% 47% 65% Real Estate 71% 58% 69% 71% 71% 75% 64% 53% 57% 50% 60% 61% REIT 50% 63% 88% 56% 69% 62% 69% 47% 83% 56% 67% 75% Retail Trade 52% 36% 52% 44% 36% 33% 40% 29% 48% 54% 53% 52% Steel & Nonferrous Metals 33% 22% 9% 16% 26% 21% 25% 40% 50% 18% 29% 71% Transportation & Logistics 50% 46% 52% 56% 52% 38% 44% 34% 41% 45% 46% 38%

Source: HOLT®, the BLOOMBERG PROFESSIONAL™ service Note: 5 sectors in each month with the most upward revisions are highlighted in green, 5 sectors with the most downward revisions are highlighted in red. Revisions ratio defined as # of companies with positive revisions divided by positive revisions + negative revisions. HOLT® is not part of Credit Suisse Research

2017 Japan Outlook6 13 January 2017

Figure 5: Japan Positive Revisions Now Outstrip Figure 6: Leading to a Modest Uptick in Expected Global: Global Comparison of Revisions Trends ROE The chart below shows that Japan boasts the highest This transition back to favorable revisions in Japan has led number of consensus EPS revisions at just above 65% of to a recent modest uptick in the expected return on equity companies (as plotted on the y-axis), while ranking in the of TOPIX which stands at about 7.5% for the current middle in terms of the absolute magnitude of revisions over running year, modestly up from the September low of the last three months (x-axis). 7.4%. Still, this is well below the 9.5% high at end-2013, and S&P 500’s average of about 15%, giving it ample room About half of global companies are now seeing an upward for improvement. revision in consensus forecasts, which is a sharp contrast from March 2011 when downward revisions outstripped Although difficult to quantify the impact, increased capital upward revisions by a ratio of about three-to-two. Global management activities have helped to mitigate what would revisions are also now at a five-year high. With Japan a have been a more meaningful reduction in ROE since the leveraged play on global growth, it provides an additional peak of 2013. tailwind to yen weakness.

70% s

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v 60% e R North S 55% P

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h Europe Ex t i

w 45% UK EM Ex

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C 40%

f o 35% % 30% -0.20% 0.00% 0.20% 0.40% CFROI (EPS) Revisions, last 13 weeks

Source: HOLT®; Note: HOLT® is not part of Credit Suisse Research. Source: the BLOOMBERG PROFESSIONAL™ service

Figure 7: But CFROI Still Flattish HOLT’s CFROI® measure, which provides a less sanguine view of the market, has demonstrated less volatility than return on equity and currently stands at about 3% for Japan, a level that is still well below both cost of capital and global markets which are expected to produce a 6% CFROI. Japan’s CFROI has chronically been held back by EBITDA margins that average about 11%, short of the 15% average globally. The “glass is half full argument” suggests that there is considerable scope for improvement in Japan’s CFROI that has so far yet to be realized. For example, the goldilocks scenario that was in place in 2007 (global growth plus yen weakness) saw CFROI hit 4.7%. Additional building blocks would be improvements in asset efficiency driven by business restructuring as well as the benefit of increased capital management activity.

Source: HOLT® Note: Excludes financials and regulated utilities. HOLT® is not part of Credit Suisse Research.

2017 Japan Outlook7 13 January 2017

Figure 8: Catch Up Time? Cyclicals vs. Defensives Figure 9: Defensives Valuation Premium Has Earnings Index Eroded: Cyclicals vs. Defensives P/E Earnings forecasts for cyclicals started to correct in early Defensives have traded at an almost four multiple point 2016 as the yen strengthened. For the valuation premium to cyclicals over the last five years. relationship between cyclicals and defensives to normalize This spread has now narrowed to two points and to 5-year average levels (and assuming that defensives are defensives now trade at the lowest premium to cyclicals fairly valued), earnings for cyclicals would have to advance since May 2013. Moreover, in absolute terms cyclicals by 13%. This seems plausible given in part that company trade at the most expensive valuation since June 2010. guidance is currently set at ¥100–105 to the USD. We expect that the situation should at least partially Such a move in cyclical earnings would see the P/E spread normalize as earnings estimates are revised higher. between defensives and cyclicals widen to 3.9x, in line with the average over the last five years. 160 25x 140 20x 120 15x 100 80 10x 60 5x 40 0x 20 -5x 0 -20 -10x

Cyclicals Earnings Defensives Earnings Spread Cyclicals P/E Defensives P/E

1-Year Forward Average by Defensives Cyclicals P/E Average Estimates by Defensives Cyclicals Year P/E P/E Spread Calendar Year Earnings YoY Earnings YoY 2007 19.2x 15.7x -3.5x 2007 100 10% 100 18% 2008 16.8x 11.6x -5.2x 2008 86 -14% 93 -7% 2009 16.1x 13.0x -3.1x 2009 76 -12% 17 -81% 2010 76 0% 58 235% 2010 15.8x 15.0x -0.8x 2011 73 -4% 69 20% 2011 13.3x 12.2x -1.1x 2012 75 3% 67 -3% 2012 12.9x 11.2x -1.7x 2013 91 21% 78 17% 2013 16.4x 13.2x -3.2x 2014 102 12% 93 20% 2014 17.4x 12.4x -4.9x 2015 119 16% 105 12% 2015 19.2x 13.3x -5.9x 2016 135 13% 92 -12% 2016 16.4x 12.7x -3.7x Current 140 4% 93 1% Current 17.0x 14.8x -2.2x 5-Year Average 16.4x 12.6x -3.9x 10-Year Average 16.3x 13.0x -3.3x

Note: Rebased to a 2007 average of 100. Source: Credit Suisse, the BLOOMBERG PROFESSIONAL™ service Source: Credit Suisse, the BLOOMBERG PROFESSIONAL™ service

2017 Japan Outlook8 13 January 2017

Figure 10: US Real Yields Key: MSCI Japan Relative Figure 11: Foreign Participation Recovering: to MSCI World (local currency) vis a vis US 10-Year Foreigner Net Purchases vs. Relative Market TIPS Yields Performance Relative performance of the Japanese market in local Foreigner purchases of Japanese equities hit a weekly currency versus global markets still appears to be highly high of nearly $16 billion in April 2013 and on a 12-month correlated to real yields in the US where yields on TIPS basis approached $250 billion. Inflows largely remained have picked up from about 0% in June to just under 0.4% positive through mid-2015 and ultimately moved to an now. outflow of $250 billion in the 12-months ended March 2016. This move was coincident with about 16% outperformance Buying by foreigners on a 12-month moving-average basis of MSCI Japan (local) versus world over this period. finally turned positive in the week of the US election and has continued to remain positive since. If the historical relationship outlined in the chart below holds, a further 50 basis-point increase in real US yields Based on past peaks, there would appear to be modest would suggest about 10% outperformance of the Japanese continued opportunity for foreign participation to continue. market (local currency terms) versus global markets.

Source: the BLOOMBERG PROFESSIONAL™ service, MSCI Source: the BLOOMBERG PROFESSIONAL™ service, MSCI

2017 Japan Outlook9 13 January 2017

Cyclicals Autos / Masahiro Akita

Factor Favorable Unfavorable 1) Yen Depreciation Fuji Heavy (7270, Outperform) Suzuki Motor (7269, Outperform) Highest USD/JPY sensitivity in the automaker sector. Lowest USD/JPY sensitivity in the automaker sector. Every 1% change in USD/JPY affects OP by around Every 1% change in USD/JPY changes OP by only 2.5%. around 0.2%.

2) Higher Interest Rates & Fuji Heavy (7270, Outperform) Motor (7201, Neutral) Inflation Impact on auto financing business Impact on auto financing business FHI does not have its own financing business, and While all of the Japanese Big 3 have financing given its US customer demographics, we expect businesses, Nissan’s US financing business’ retail net higher interest rates to have relatively little impact on credit ratio recently rose to around 1%. its sales in its core US market.

3) High Operating Suzuki Motor (7269, Outperform) Toyota Motor (7203, Neutral) Leverage & Stronger Unit sales growth Unit sales growth Economic Growth Suzuki has promising medium/long-term growth With global demand growth set to slow over medium- prospects given its exposure to India, where we term, Toyota, the world’s biggest automaker, will likely forecast double-digit demand growth. see its unit sales growth remain at a low level.

4) Improved Corporate Motors (7202, Outperform) Suzuki Motor (7269, Outperform) Governance & Isuzu will likely maintain a large cash position by virtue Suzuki’s dividend yield is among the lowest in the Shareholder Returns of its stable free cash flow. We see ample potential for sector. near-term share buyback. In FY3/16, Isuzu announced a buyback when reporting 3Q earnings.

5) Self Help & Nissan Motor (7201, Neutral) Motor (7267, Neutral) Structural Change Alliances Alliances Likely to realize synergies from alliance with Mitsubishi Largely without alliances amid ongoing consolidation Motors. among Japanese automakers.

6) Secular Themes Toyota Motor (7203, Neutral) Isuzu Motors (7202, Outperform) Development of next-generation technologies Development of next-generation technologies Backed by ample funds, diverse alliances and a strong Isuzu has limited corporate resources to meet the truck supply chain, Toyota is developing a broad range of and passenger car markets’ technology needs. It may next-gen Electrification / Automation / Informatization eventually have to depend even more than it already technologies. does on alliance partners for development of next-gen technology.

7) Valuation Nissan Motor (7201, Neutral) (7211, Underperform) Valued at lowest P/E in sector and at sub-1x P/B also. Valued at highest P/E in sector. P/B also high relative to ROE.

2017 Japan Outlook 10 13 January 2017

Auto Parts / Masahiro Akita & Koji Takahashi

Factor Favorable Unfavorable 1) Yen Depreciation Tokai Rika (6995, Neutral) DaikyoNishikawa (4246, Outperform) Highest USD/JPY sensitivity in auto parts sector. Every Near bottom of auto parts sector in USD/JPY 1% change in USD/JPY changes OP by 1.8%. sensitivity. Exchange rate movements have very little impact on consolidated OP, as over 80% of it is domestic.

2) Higher Interest Rates & Okamoto (5122, Outperform) (5108, Neutral) Inflation Pricing power vs input cost increases Sumitomo Rubber (5110, Neutral) Both auto parts and condom sales are growing, mainly Pricing power vs input cost increases in the high-end price range, driving improvement in With raw material prices in a mild uptrend, tire makers sales mix. The ultra-thin condom market being an continue to raise prices. FY12/17 will likely be the most oligopoly, Okamoto has very little need to adjust prices adverse year for the spread between tire sales prices in response to raw material price changes. and raw material prices.

3) High Operating NGK Insulators (5333, Outperform) GS Yuasa (6674, Neutral) Leverage & Stronger Unit sales growth & margins Unit sales growth & margins Economic Growth With global demand set to slow over the medium-term, Lithium-ion batteries are a growth market with many NGK Insulators should benefit from growth in the competitors, making it difficult to expand market share. share of vehicles equipped with its ceramic emission With an OPM of −4%, GS Yuasa’s automotive Li-ion control products in the wake of tightening emission business has yet to achieve profitability. standards. Its ceramics segment has a high OPM of over 26%.

4) Improved Corporate Bridgestone (5108, Neutral) Koito Manufacturing (7276, Underperform) Governance & Highest dividend payout ratio and dividend yield in Lowest dividend payout ratio and dividend yield in Shareholder Returns sector. sector. Share buyback probability also low.

5) Self Help & Aisin Seiki (7259, Outperform) Unipres (5949, Neutral) Structural Change Ichikoh Industries (7244, Outperform) Consolidation and restructuring Consolidation and restructuring Pressed parts account for 85% of total sales while Aisin Seiki could play a central role in intra-group main customer Nissan Motor consistently accounts for consolidation given the duplication of product lines over 85%. Unipres’s business structure is unlikely to among Toyota Group companies. Other group change much over the medium-term. companies, mainly AT suppliers, will likely be consolidated into Aisin Seiki. Ichikoh Industries should benefit from synergies from its recently expanded alliance with Valeo.

6) Secular Themes Denso (6902, Neutral) Keihin (7251, Neutral) Development of next-generation technologies Development of next-generation technologies Denso is stepping up development of next-generation Honda Group accounts for over 90% of total sales. technologies in its information & safety systems and High-added-value products (e.g., electronic controls, ADAS businesses. hybrid vehicle parts) are largely dependent on Honda designs. Keihin may partner with companies outside the Honda Group to strengthen the competitiveness of its next-generation products to be sold to customers unaffiliated with Honda.

7) Valuation DaikyoNishikawa (4246, Outperform) Koito Manufacturing (7276, Underperform) Valued at lowest P/E in sector. P/B also low relative to Valued at highest P/E in sector (excluding exceptions ROE, which is the highest among the sector stocks we such as takeover target Calsonic Kansei). P/B also cover. relatively high.

2017 Japan Outlook 11 13 January 2017

Machinery / Shinji Kuroda

Factor Favorable Unfavorable 1) Yen Depreciation Kawasaki Heavy (7012, Neutral) Yen-denominated exports comprise a large part of Has the highest FX sensitivity in our coverage, with Nabtesco (6268, Neutral) sales in the factory OP increasing roughly ¥2bn for every ¥1/USD automation (FA) subsector and Fanuc (6954, depreciation (= 6% of full-year company OP Underperform) sales in the machine tools subsector; guidance). therefore they are relatively less likely to benefit from a weakening yen. 30% of Makita (6586, Neutral) costs are denominated in Chinese renminbi, and it is one of the few stocks that actually benefits from a stronger yen.

2) Higher Interest Rates & The rise in oil prices is positive for the plant-related Inflation sector. In particular, (6841, Outperform) should benefit from oil majors restarting their capex to improve efficiency. The rise in coal and iron ore prices is positive for mining machinery and equipment-related names like Komatsu (6301, Neutral) and Hitachi Construction Machinery (6305, Underperform).

3) High Operating Yaskawa Electric (6506, Neutral) and SMC (6273, Machinery sector overall Leverage & Stronger Neutral) should benefit from increases in iPhone 8- Most machinery stocks are cyclical in nature, so a Economic Growth related capex. In addition, highly cyclical names like macro slowdown is negative. NTN (6472, Outperform) and NSK (6471, Outperform) should also attract more attention, as expectations for an improvement in PMI and increased demand for their highly profitable industrial machinery bearings pick up.

4) Improved Corporate Daikin (6367, Outperform) and Komatsu (6301, SMC (6273, Neutral) Governance & Neutral) continue to be outstanding at ESG and The stock dropped after a sell recommendation by an Shareholder Returns improving corporate governance. activist short-seller, and we are unsure why the company did not respond by, for example, announcing a share buyback. Investors could question the effectiveness of its outside directors. IHI (7013, Underperform) Risk of equity financing remains.

5) Self Help & Kawasaki Heavy (7012, Neutral) IHI (7013, Underperform) Structural Change We believe a restructuring of its shipbuilding business Structural reforms are likely to be far smaller than could be announced as early as May. hoped for.

2017 Japan Outlook 12 13 January 2017

6) Secular Themes The factory automation (FA) growth scenario ("silver The rise of electric vehicles beyond 2025 is a cycle") of an aging and shrinking labor force driving fundamental risk to machinery manufacturers. demand for automation and streamlining investments However, in the next two to three years it could also remains unchanged. In 2017, we also want to focus on be an earnings driver for NSK (6471, Outperform) the "golden cycle" of higher resource prices triggering and NTN (6472, Outperform), which have a cycle of machinery equipment demand between successfully obtained orders from US electric vehicle developed economies and emerging economies. makers. In machinery tool orders, we look for a reacceleration of demand towards the strengthening of auto emissions standards in 2020. Automated driving of construction machinery and farming equipment is also a long-term theme.

7) Valuation Amada (6115, Neutral) Keyence (6861, Neutral) Only company in the 26 companies we cover with a Holds nearly ¥1trn yen in cash and the potential for dividend yield of over 3%. We forecast a P/B of 1.1x shareholder returns is large. However, valuations are and P/E of 17.2x for FY3/17. expensive, even after adjusting for its cash holdings.

2017 Japan Outlook 13 13 January 2017

Electronic Components / Akinori Kanemoto

Factor Favorable Unfavorable 1) Yen Depreciation Shinko Electric Industries (6967, Neutral) Nidec (6594, Outperform) Highest forex sensitivity in sector by far. Every ¥1/$ of Among the least forex-sensitive companies in sector yen depreciation tacks on about ¥1bn to OP. Main (but growth prospects compensate for low forex product sales are mostly invoiced in USD with costs sensitivity). incurred mostly in JPY. (6971, Neutral), Wacom (6727, Nissha Printing (7915, Outperform) Underperform) Second-highest forex sensitivity in sector. Every ¥1/$ Among the least forex-sensitive companies in sector. of yen depreciation adds about ¥450mn to OP. Device business manufactures products domestically, and touch sensors and force sensors for tablets and OLED smartphones have high FX sensitivity.

2) Higher Interest Rates & Not applicable Inflation Many companies in sector are net cash positive.

3) High Operating Rohm (6963, Outperform) Not applicable Leverage & Stronger Rohm’s 75–80% marginal profitability is highest in Most companies in the electronic components sector Economic Growth sector by far. Sales growth should translate directly to maintain a marginal profit ratio of at least 40%. bottom-line growth, particularly in its automotive business. Nissha Printing (7915, Outperform) Device business maintains marginal profitability of over 40%. Expanding sales of touch/force sensors for OLED smartphones should further increase operating leverage.

4) Improved Corporate Not applicable Ibiden (4062, Neutral) Governance & Shareholder returns have been steadily improving but Stopped disclosing details of its actual results, making Shareholder Returns no single company stands out. Overall, improved it difficult to forecast earnings. Governance has room to earnings by virtue of weaker yen should lead to more be improved. dividend increases in FY3/18 than FY3/17.

5) Self Help & Nidec (6594, Outperform) Wacom (6727, Underperform) Structural Change Investing in plant automation. Labor cost savings Sales growth is steady, but SG&A ratio also continues should reduce COGS and, in turn, boost profits over to go up. Wacom aims to get SG&A ratio under control the medium-term. from FY3/18, but its ability to do so remains unclear. Kyocera (6971, Neutral) Aims to achieve profitability in the photovoltaic cell, display, telecom equipment and organic substrate businesses However, it has yet to reveal growth strategy for the post-profitability period. TDK (6762, Neutral) In midst of an acquisition spree in sensor business in preparation for carve-out of high-frequency component business. Initiatives to improve sensor business’s earnings likely to capture market’s attention.

2017 Japan Outlook 14 13 January 2017

6) Secular Themes Nidec (6594, Outperform), Rohm (6963, Ibiden (4062, Neutral) Outperform), TDK (6762, Neutral), Murata Mfg. Similar to its fan-out WLP business, its semiconductor (6981, Outperform), Japan Aviation Electronics packaging business is facing increased competition Industry (6807, Neutral) from front-end / back-end SPE players. Sensors, motors, passive components, analog ICs and other products are expanding as Electrification, Automation and Informatization progress. (6770, Outperform), Nissha Printing (7915, Outperform), Murata Mfg. (6981, Outperform) Value of component contents (camera-related, OLED- related, etc.) per smartphone (e.g. iPhone 8) is growing as specs improve.

7) Valuation Electronic components sector overall Sector-average P/E (based on FY3/18 I/B/E/S consensus EPS) has risen to nearly 20x. While we believe I/B/E/S consensus is lagging yen depreciation, the sector’s overall bargain appeal has been greatly diminished by its rally since last Aug–Sep.

2017 Japan Outlook 15 13 January 2017

Industrial Electronics / Hideyuki Maekawa

Factor Favorable Unfavorable 1) Yen Depreciation Toshiba (6502, Outperform) Tokyo Electron (8035, Outperform), Hitachi Kokusai Toshiba's OP forex sensitivity is the highest for stocks Electric (6756, Outperform), SCREEN Holdings in our sector coverage. The company’s US dollar (7735, Neutral) income has declined due to contraction in the PC, SPE makers have almost no exposure to US dollar and household electronics and TV businesses, increasing euro forex rates, as most business is denominated in Toshiba's exposure to forex rates. For every ¥1 change yen. in the value of the yen, OP fluctuates ¥4bn vs. the US dollar and ¥0.6bn vs. the euro. Based on FY3/17 OP guidance, that equates to a combined fluctuation of 2.6%. Guidance assumes ¥100/USD and ¥110/EUR. JEOL (6951, Outperform) JEOL generates a high proportion of sales overseas (50–60%). For every ¥1 weakness, OP increases ¥280mn vs. the US dollar and ¥40mn vs. the euro.

2) Higher Interest Rates & SPE makers overall Toshiba (6502, Outperform) Inflation Almost all SPE makers are debt-free and therefore As of end-Sep 2016, interest-bearing debt stood at have limited exposure to higher interest rates. Any ¥1.18tn (net debt-to-equity ratio of 180%). Interest increase in inflation is also likely to have minimal payments on that debt totaled ¥8.7bn in 1H FY3/17 impact. (¥17.3bn annualized), equating to around 10% of OP guidance. Debt levels could rise following revelations in December that it may have to write down goodwill booked by its Westinghouse unit. Other negatives for earnings include prospects of higher borrowing costs after a string of rating downgrades. Hitachi (6501, Outperform), (6503, Neutral) Both companies could see OP fluctuate by around 10% on a consolidated basis due to decreases/increases in the price of raw materials such as steel, copper and aluminum affecting COGS in businesses such as social infrastructure and air conditioning.

3) High Operating DISCO (6146, Neutral) Leverage & Stronger DISCO has the highest marginal profit ratio in the SPE Economic Growth sector (over 55%). If the economy expands, the company is likely to see higher demand for consumables (25% of sales) on the back of rising demand for semiconductors, raising prospects for further improvement in profitability.

2017 Japan Outlook 16 13 January 2017

4) Improved Corporate Tokyo Electron (8035, Outperform) Toshiba (6502, Outperform) Governance & Tokyo Electron is targeting a dividend payout ratio of Revelations that Toshiba may have to write down Shareholder Returns 50% and plans to use some of its more than ¥250bn in goodwill of several ¥100bn booked by its cash reserves to buy back shares. However, it Westinghouse unit suggest it still needs to work on forecasts cash on hand will increase from ¥262bn at corporate governance systems. We had expected end-FY3/17 to ¥327bn at end-FY3/18. We see dividend payments to resume at end-FY3/17, but that increased prospects for share buybacks in FY3/18. timing could now be delayed due to the risk of impairment losses. NuFlare Technology (6256, Neutral) NuFlare has close links with Toshiba. Of the company’s 13 directors, 11 are originally from Toshiba. The sole outside director is also from Toshiba. Toshiba is NuFlare’s parent company with a stake of 50%, and as a group company, NuFlare has cash reserves entrusted with its parent company.

5) Self Help & Hitachi (6501, Outperform) NEC (6701, Neutral) Structural Change The company is focusing on its social innovation NEC is under pressure to restructure its energy business while continuing to sell off non-core business, which has made no progress in reducing operations. Financial and logistics operations were losses. However, we expect only half-hearted attempts spun off in 2016, and Hitachi is currently looking for a to turn around the business. buyer for its SPE business. Management wants to complete business restructuring in 1H 2017, so more moves are probably imminent.

6) Secular Themes Mitsubishi Electric (6503, Neutral), NEC (6701, NuFlare Technology (6256, Neutral) Neutral) , (6702, Neutral), Anritsu (6754, NuFlare has roughly 90% of the market for single- Neutral) beam mask writers. However, JEOL/IMS have taken On-site testing for 5G should ramp up beyond 2017, the lead in the development of next-generation multi- towards the goal of launching commercial service in beam mask writers. NuFlare’s margins are likely to 2020 and beyond. In Japan, NTT DoCoMo is trying to come under pressure due to emerging competition in launch 5G services in time for the 2020 Tokyo multi-beam equipment. Olympics / Paralympics, but coverage will likely be limited to specific areas in 2020. However, base station demand should pick up after 2019. Anritsu will also likely have business opportunities after the specifications for 5G are set. Hitachi (6501, Outperform), NEC (6701, Neutral), Fujitsu (6702, Neutral) Artificial intelligence (AI) is likely to remain a prevailing theme in 2017, with sector companies seeing significant business opportunities in areas such as AI- based solutions for big data utilization and IoT platforms. Progress with AI standardization could also translate into significant earnings growth. 7) Valuation Hitachi (6501, Outperform) DISCO (6146, Neutral), (6857, In a value-focused market, Hitachi’s share price has Underperform) recovered from its recent bottom, but the company’s Profits and ROE are improving at almost all the SPE TOPIX-relative P/B is still stuck at around 0.8–0.9x, makers. P/Bs are also trending at the high end of the compared with the plus-1.0x level in 2009–15. We think historical range since the collapse of Lehman the multiple could recover to 1.0–1.2x if there are signs Brothers, but on an ROE-P/B basis, P/B valuations of renewed growth. look slightly high for DISCO and Advantest.

2017 Japan Outlook 17 13 January 2017

Consumer Electronics / Mika Nishimura

Factor Favorable Unfavorable 1) Yen Depreciation Japan Display (6740, Neutral), Canon (7751, Pioneer (6779, Neutral), Sony (6758, Outperform) Neutral) Yen depreciation vs. USD is negative for both JDI’s annual OP rises ¥2bn for every ¥1/$ companies, but weakness vs. the euro is positive and depreciation; Canon’s rises ¥5.6bn for every ¥1/$ they could offset. depreciation and ¥3.2bn for every ¥1/€ depreciation. However, both could see this partially canceled out by price declines.

2) Higher Interest Rates & Sony (6758, Outperform) Precision equipment sector overall Inflation Rising interest rates are positive for consolidated DSCs, printers, etc. have no pricing power, and prices subsidiary Sony Financial’s insurance business. will stagnate even in a deflationary environment.

3) High Operating Sony (6758, Outperform) Japan Display (6740, Neutral), Sharp (6753, Leverage & Stronger We expect growth in CMOS image sensor (CIS) Underperform) Economic Growth volume as smartphone cameras take on higher Both companies’ display businesses require ongoing resolutions and dual lenses. The supply–demand investment to maintain and enhance competitiveness. environment also looks favorable for now, and we We also expect continued investment in development therefore expect downward pressure on prices to ease. toward mass production of OLEDs and think this could We are focused on the trend in CIS capital expenditure squeeze profits. JDI has commenced operation of its but see the possibility of Sony using the Oita Fab new Hakusan plant and we think fixed costs could acquired from Toshiba. We also expect improved increase . profitability in the game segment as network service revenues increase. Clarion (6796, Outperform) We expect sales of automotive camera systems to reaccelerate from 2H FY3/17 and look for a new camera system to contribute from 2H FY3/18. With R&D costs under control, we expect topline growth to drive up profitability.

4) Improved Corporate Canon (7751, Neutral) Sharp (6753, Underperform) Governance & The dividend yield is currently 4.5%, and we see little Sharp continues to struggle as it goes through Shareholder Returns risk of a dividend cut. restructuring, and we forecast zero dividends for FY3/17 and FY3/18.

2017 Japan Outlook 18 13 January 2017

5) Self Help & Fujifilm Holdings (4901, Outperform) Structural Change Aggressively pursuing M&A to expand health care business. Recently decided to acquire Wako Pure Chemical Industries from Takeda Pharmaceutical (scheduled for consolidation from FY3/18). (7752, Underperform) Announced restructuring plan along with 1H results targeting ¥100bn in cost reductions in FY3/17–20 by revising sales channels and consolidating bases. However, hefty restructuring costs are also being budgeted for FY3/17–18 (amount to be decided). We expect the operating environment for MFPs to remain difficult following restructuring and think Ricoh needs to urgently cultivate new businesses. Sharp (6753, Underperform) Currently restructuring under Hon Hai’s direction. While we anticipate cost cuts and an expansion of sales channels via Hon Hai, we see lingering uncertainties in the core small/medium-size panel business (risks include falling sales to major customers and higher costs for OLED development).

6) Secular Themes Driving assistance/self-driving Office equipment sector overall: Clarion (6796, Outperform), Panasonic (6752, Canon (7751, Neutral), Ricoh (7752, Underperform), Neutral) Fujifilm (4901, Outperform), (4902, We expect Clarion to see growth in sales of Neutral) automotive camera systems. For Panasonic, we Growth is slowing for printer/MFP hardware and expect growth in infotainment and in sensors and consumables as the maturation of developed markets other automotive components. However, upfront drives increased competition. Growth therefore looks investment could weigh on FY3/18 profits. unlikely for these companies in our estimates.

7) Valuation Clarion (6796, Outperform) Sharp (6753, Underperform) Shares look undervalued given likelihood of profit Current P/B looks high at nearly 5x. We think this growth in FY3/18 driven by sales of automotive camera shows investors pricing in expectations for the Hon systems. P/E is currently 14x on FY3/18E EPS. Hai–led restructuring and improved profits. We think these expectations could remain in place but believe the shares already price in post-restructuring profit levels.

2017 Japan Outlook 19 13 January 2017

Internet & Games / Keiichi Yoneshima

Factor Favorable Unfavorable 1) Yen Depreciation (3659, Outperform) Internet/gaming sector overall Forex sensitivity Most of the sector companies we cover have limited China and Korea both account for around 40% of overseas exposure and thus are relatively immune to sales, with the remainder coming from Japan, the US, forex movement. GMO Internet (9449, Outperform) and Europe. The company thus has exposure to operates an online forex trading business through multiple currencies, including the Chinese yuan, the subsidiary GMO Click Holdings and is thus somewhat Korean won, and the US dollar, but in general, yen exposed to forex movement, although the exposure is weakness is a positive for earnings, with each one yen to currency market volatility, not the direction of the of weakness against the US dollar boosting quarterly yen-dollar rate. OP by roughly ¥100–150mn. Forex assumptions For Oct–Dec 2016, the company assumes ¥103.81/USD (¥15.42/CNY, ¥0.0923/KRW). Most employees are in Korea, and KRW depreciation can be a positive as it helps lower costs. Hedging Nexon does not hedge currency exposure, meaning that forex movements will have a direct impact on the company’s P/L. It's one of the few companies in the sector that are exposed to forex movement, but the impact is relatively small.

2) Higher Interest Rates & Internet/gaming sector overall Rakuten (4755, Neutral) Inflation Most of our coverage are service industry firms, and Steady growth in its business thus see limited impact from inflation. Within the company’s FinTech segment, the credit card In addition, many of the companies we cover have zero business in particular is growing rapidly. With the net debt, and thus see almost no impact from any continued growth in credit card transaction volume, increases or decreases in interest rates. Rakuten has raised funds to expand the business, so higher interest rates would be somewhat negative for credit card business earnings due to the higher financing costs. Support from online banking business However, Rakuten’s online banking business should be able to partially offset the higher funding costs. We think Rakuten faces relatively higher interest rate risk compared to other sector peers, but still think the impact is minimal overall.

2017 Japan Outlook 20 13 January 2017

3) High Operating Yahoo Japan (4689, Outperform) Gaming sector overall Leverage & Stronger Economic growth driving higher ad spending We think game-related companies such as Mixi (2121, Economic Growth Advertising is one of the sectors most affected by Neutral), DeNA (2432, Outperform), Gree (3632, business sentiment. Yahoo Japan generates a Underperform), COLOPL (3668, Neutral) and Nexon relatively high proportion of profit from advertising and (3659, Neutral) are relatively unaffected by economic is thus well positioned to benefit from an upturn in growth trends. advertising spending. Operating leverage for advertising revenue near 90% We expect advertising revenue growth at Yahoo Japan to remain in the mid- to high-single digits for the next few years, although growth could accelerate if economic growth pick up. With operating leverages relatively high, at around 90%, stronger advertising revenue growth would lead to stronger profit growth.

4) Improved Corporate Kakaku.com (2371, Neutral) Internet/gaming sector overall Governance & Dividends & payout ratio In our view, none of the companies under our Shareholder Returns The company continues to boost dividends, based on coverage are necessarily laggards when it comes to its payout ratio target of at least 30%. For an Internet shareholder returns. That said, it is a growth industry company enjoying double-digit earnings growth, the and we do see room for further improvement in payout ratio is high, and the company apparently shareholder returns for many of these companies. understands the importance of shareholder returns. Share buyback aimed at achieving 40% ROE target The company is targeting an ROE of 40%, and to this end has announced a share buyback plan. Management has clearly outlined its policy of securing sufficient working capital, while also returning surplus funds to shareholders.

5) Self Help & CyberAgent (4751, Outperform) DeNA (2432, Outperform) Structural Change Investing in new businesses Focusing resources on Nintendo alliance AbemaTV service was launched in April 2016, and DeNA recently announced the partial sale of its online CyberAgent plans to spend another ¥20bn in FY9/17 shopping business and the dissolution of its European as upfront investment. and US subsidiaries. We view this as evidence that the The company is introducing TV commercial-like company aims to focus resources on the tie-up with advertising to the AbemaTV service. It is trying to Nintendo. develop an internet TV advertising market similar to Suspension of curation media business the ¥2tn TV advertising market. DeNA withdrew all articles published on its 10 curation media websites in early December. The company said that it would consider whether to restart the business or not after a review of operations.

2017 Japan Outlook 21 13 January 2017

6) Secular Themes Online advertising: Catering to brand ads The amount of time being spent using PCs and smartphones are likely to surpass that spent watching television, and yet the online ad market remains slightly bigger than half the size of the TV ad market, which leaves room for expansion. Around 2016, online video ads have started to become popular. As internet users (both PC and smartphone) start accepting these new form of ads, advertisers are also expanding their use of these new mediums, by launching not just ads to promote products, but brands as well. The online ad market growth is anticipated to accelerate, and the top domestic media player Yahoo Japan (4689, Outperform) and online ad agency CyberAgent (4751, Outperform) will likely benefit.

Online finance: Analyzing and utilizing transaction data Transaction systems for internet-related companies are increasingly being used offline. Some companies such as Rakuten (4755, Neutral) and GMO Internet (9449, Outperform) have started providing services involving physical transactions, in addition to online transactions. Some like Recruit Holdings (6098, Outperform) also provide POS cashier applications to stores. In addition to the revenue from transaction fees, the collection and analysis of transaction data could lead to marketing insights and expansion in their financial businesses.

7) Valuation Yahoo Japan (4689, Outperform) Kakaku.com (2371, Neutral) While positive surprises are rare, earnings growth has Valuations not that attractive been relatively stable, and the company’s P/E and While the company gets high marks for its double-digit EV/EBITDA multiples thus look relatively attractive. profit growth, valuations are not that attractive in our view.

2017 Japan Outlook 22 13 January 2017

Chemicals / Masami Sawato

Factor Favorable Unfavorable 1) Yen Depreciation SUMCO (3436, Underperform) Nippon Shokubai (4114, Neutral) Every one yen weakness vs. the dollar boosts annual Earnings are not very sensitive to forex movement: no OP by ¥700mn. Based on our FY3/18 OP forecast of impact from dollar-yen movement, while each one yen ¥29bn, we estimate that each one yen movement vs. of weakness against the euro boosts annual OP by the dollar has a 2.4% impact on annual OP, the largest ¥80mn. sensitivity among the companies we cover in the sector.

2) Higher Interest Rates & Shin-Etsu Chemical (4063, Neutral) Tokuyama (4043, Neutral) Inflation Robust financial position with ample cash on hand; net End-Sep 2016 D/E ratio of 2.49x was significantly D/E ratio at end-FY3/16 was −0.4x. We estimate that higher than any other companies we cover in the for every 1% increase in interest rates, interest income sector. Financial risk is a major concern if interest rates is boosted by ¥8.2bn, equivalent to 3.7% of FY3/16 RP move higher. Tokuyama booked impairment write- (¥220bn). downs for its Malaysian unit and issued preferred shares, and the redemption premium (paid-in amount multiplied by a redemption coefficient) increases from next July: The redemption coefficient on the ¥20bn in preferred shares is 7% per year through 30 June 2017, but if redemption is delayed by a year, it rises to 13% per year. Tokuyama also procures around 2mn tonnes of coal each year for in-house power generation and cement production. A $10/MT rise in the cost of coal pushes up total costs by ¥2bn, equivalent to 5.6% of our FY3/18 OP forecast of ¥36bn.

3) High Operating SUMCO (3436, Underperform) Leverage & Stronger High marginal profitability for silicon wafers enables Economic Growth topline growth to translate directly into profit growth. The company is currently negotiating price increases due to continued tightness in the supply–demand balance which should also boost profit. Ample room to increase volumes via productivity improvements and continued capacity expansion could also further drive topline growth. Chemicals sector overall As very capital-intensive industries, chemicals and synthetic fibers tend to have high operating leverages. Growth in output / sales volume thus tends to lead directly to higher profit. That said, the electric materials industry (particularly materials used in displays) generally faces fierce downward pressure on prices, which can sometimes dampen the boost from higher volumes.

2017 Japan Outlook 23 13 January 2017

4) Improved Corporate (4061, Neutral) Tokuyama (4043, Neutral) Governance & Medium-term plan through FY2017 (DENKA100) Financial position hurt by impairment charges at its Shareholder Returns includes a commitment to bolster shareholder returns, Malaysian unit. For FY3/17 the company says it will with a total shareholder returns target of 50% and ROE not pay an interim or year-end dividend for the third target of at least 10%. consecutive year. JSR (4185, Neutral) Has maintained a total shareholder returns target of 50–100%. The total returns ratio continues to rise, going from 53.3% in FY3/14, to 64.5% in FY3/15 and 84.2% in FY3/16.

5) Self Help & Mitsui Chemicals (4183, Outperform) Structural Change The company has restructured its commodity petrochemicals business and is accelerating its shift to a focus on three core growth areas: automotive materials, healthcare, packaging & agriculture. Record profit likely in FY3/17. Mitsubishi Chemical Holdings (4188, Outperform) A new Mitsubishi Chemical will emerge on 1 April 2017 via the integration of three of its chemical subsidiaries into one company. The company estimates synergy benefits of the three-way integration at ¥50bn and is committed to achieving its FY2020 core operating profit target of ¥380bn. Chemicals/textile sector overall Chemicals & synthetic fiber companies are all implementing a range of restructuring initiatives, including expanding shale gas-based ethylene capacity and preparing for increasingly stiff competition in commodity chemicals as Asia chemical companies expand their petrochemicals businesses.

6) Secular Themes Toray Industries (3402, Outperform) (4004, Neutral) Development of lightweight automotive materials will As diversified chemical companies shift their business remain a medium-to long-term issue. Toray commands portfolios from commodities to specialty chemicals, the largest share of the global market for carbon fiber Showa Denko has bought a graphite electrodes and is also the global development and cost leader for business, which continue to face deteriorating supply– carbon fiber composite materials for use in automotive demand balance and increased competition. The applications. Looking ahead to 2017, we expect company expects graphite electrode supply–demand to increased adoption of Toray’s carbon fiber composite bottom in 2016 and improve towards 2018, but we materials in automotive structural components. expect competition to become even more severe as Mitsui Chemicals (4183, Outperform) Indian players grow larger. The company has the second largest share of the global market for polypropylene compound, a lightweight automotive material. We estimate that this product accounts for about 33% of total OP. We look for increased adoption of Polymetac, a new technology being developed by Mitsui Chemicals that allows the adhesion of various metals and resins.

2017 Japan Outlook 24 13 January 2017

7) Valuation Mitsui Chemicals (4183, Outperform) Mitsubishi Gas Chemical (4182, Underperform) Current P/E (FY3/18E) is the lowest since 2011 and The share price has rallied of late due to favorable below the average for the seven diversified chemical near-term earnings momentum and the upturn in companies. We think Mitsui Chemicals tends to trade methanol prices, which is closely correlated with the at an overly large discount in part due to the perception company’s share price performance. The shares are that it is relatively dependent on the commodities trading at a P/E of around 15x our FY3/18 estimates, business. well above the stock’s average since 2010 of 10.7x. Mitsubishi Chemical Holdings (4188, Outperform) We also expect a gradual decline in methanol prices If we subtract the market value of the company’s due to the fall in the price of coal. equity stakes in its two listed subsidiaries, the per- SUMCO (3436, Underperform) share value for the parent is under ¥200, which seems SUMCO’s share price has rallied on expectations for excessively small to us. The current EV/EBITDA 300mm silicon wafer price hikes; we think the market multiple of around 5x on our FY3/18 estimates also has already priced in price hikes of around 5−10%. looks attractive. Valuations already look somewhat demanding compared to the period around 2007 when wafer prices rose, and we think price hike expectations have been incorporated to an excessive degree.

2017 Japan Outlook 25 13 January 2017

Metals / Shinya Yamada

Factor Favorable Unfavorable 1) Yen Depreciation Osaka Titanium Technologies (5726, Neutral) Aichi Steel (5482, Neutral) Earnings are relatively sensitive to forex movement. Each one yen of weakness against the US dollar Each one yen of weakness against the US dollar adds lowers annual OP by around ¥60mn, equivalent to around ¥100mn to annual OP, equivalent to 8% of the roughly 0.5% of the company’s FY3/17 OP forecast of company’s FY3/17 OP target of ¥1.3bn. ¥1.3bn. Aichi Steel is a rare company in that yen The company’s export ratio for 1H FY3/17 was 38%, weakness is negative for earnings. with a high 57% ratio for the mainstay titanium The company’s export ratio was just 10% in 1H business. FY3/17, with the value of the company’s dollar- For FY3/18, the company forecasts over 30% growth in denominated imports (raw materials) below the value titanium export volume for aerospace applications. We of its exports. think that FY3/18 earnings will be even more sensitive Titanium (5727, Neutral) to forex movement. Each one yen of weakness against the US dollar Forex sensitivity is relatively high due to the low level of boosts annual OP by around ¥50mn. This is equivalent absolute profit, but we note that the correlation to roughly 1.7% of the company’s FY 3/17 OP forecast coefficient between yen/dollar movement and the of ¥3bn, suggesting relatively high forex sensitivity. company’s share price performance over the past 10 However, the correlation coefficient between yen/dollar years is 0.31, second-weakest correlation of the movement and the company’s share price performance companies under our coverage after Toho Titanium. over the past 10 years is 0.28, weakest of the sector Sumitomo Electric Industries (5802, Outperform) companies we cover. For both Toho Titanium and Each one yen of weakness against the US dollar adds Osaka Titanium Technologies (second-weakest around ¥1.2bn to annual OP, equivalent to around 1% correlation), share price performance is determined of the company’s FY3/17 OP target of ¥125bn. On the more by sales volume and price trends for titanium, not other hand, we note that the correlation coefficient forex movement. between yen/dollar movement and the company’s share price performance over the past 10 years has been 0.85, highest of the sector companies under our coverage.

2) Higher Interest Rates & Shimano (7309, Outperform) Furukawa Electric (5801, Underperform) Inflation A cash-rich company, with a net D/E ratio of −0.6x at Only company under our coverage with a net D/E ratio end-FY12/15. We estimate that each 1% increase in of over 1 (1.1x as of end-FY3/16). A 1% increase in interest rates boosts interest income by ¥1.9bn, interest rates pushes up interest paid by ¥2.7bn, a roughly equivalent to 3% of the company’s FY12/16 RP fairly significant burden equating to about 10% of the forecast of ¥65.4bn. However, higher inflation does not company’s FY3/17 RP forecast of ¥25.5bn. Products necessarily translate into higher profit, since such are not very sensitive to inflation, so the company inflation does not have much of an impact on sales usually struggles to raise prices, and earnings are prices for bicycle components and fishing gear. usually squeezed by higher fuel costs when crude oil JFE (5411, Outperform) prices go up. With a net D/E ratio of 0.7x as of end-FY3/16, JFE’s That said, we note that the correlation coefficients financial position is about average for Japan’s basic between 10yr yields on JGBs and US Treasuries and materials sector. That said, we note that the correlation the company’s share price performance over the past coefficients between 10yr yields on JGBs and US 10 years are 0.7 and 0.882, second highest of the Treasuries and the company’s share price performance companies under our coverage (behind only JFE). over the past 10 years are 0.703 and 0.883, highest amongst the companies under our coverage. This is probably because the steel industry is a classic example of a cyclical industry, with higher inflation leading to higher steel prices.

2017 Japan Outlook 26 13 January 2017

3) High Operating Shimano (7309, Outperform) Leverage & Stronger We estimate Shimano’s marginal profitability at around Economic Growth 45%; the company’s earnings structure is such that topline growth feeds directly to profit growth. The company’s fixed-cost and variable-cost are roughly 40% and 60% of total. Metals sector overall As capital-intensive industries, marginal profitability tends to be relatively high (25–40%) in the steel and non-ferrous metal industries, meaning that an increase in output volume generally leads to higher profits. However most companies are also price takers, meaning commodity price movements are more important when looking at earnings.

4) Improved Corporate (5803, Neutral) Kyoei Steel (5440, Neutral) Governance & In its latest medium-term plan (unveiled in May 2016), The company’s forecast as of 1H results called for a Shareholder Returns Fujikura stuck with its previous dividend payout target FY3/17 dividend payout ratio of 21%, below of at least 20%). However, the company also executed management’s target range of 25–30%. The company a ¥6.5bn share buyback in FY3/17. The total has zero net debt, making management’s passive shareholder returns ratio for FY3/17 is expected to stance on shareholder returns all the more reach 107.6%, evidence of the company’s proactive disappointing. stance towards shareholder returns. Fujikura management places a heavy emphasis on efficiency, and investors have given the company high marks for its focus on areas of core competencies.

5) Self Help & Hitachi Metals (5486, Outperform) Structural Change The company has taken a very proactive stance on cutting costs, including a target of ¥20bn in cost cuts over FY16–18 by promoting innovation in monozukuri (production process). Hitachi Metals is also aggressively focusing on its core areas of competence: just since 2015, the company has sold off a number of businesses, including the compound semiconductor materials business, Hitachi Tool Engineering, and the information systems business. The company also de-integrated its lead frame JV and turned the copper products JV into a wholly owned subsidiary.

6) Secular Themes (5406, Neutral) The shift to lighter-weight automotive materials remains a major medium-to long-term investment theme. Kobe Steel produces a number of products that we think are poised to enjoy strong growth over the medium and long term, including high tensile strength steel plates, aluminum products and bonding materials.

7) Valuation JFE (5411, Outperform) Furukawa Electric (5801, Underperform) Buoyed by the equity market rally over the second half Following the recent stock rally, the shares are now of 2016, many sector firms are now trading at price trading at an FY3/18E P/E of around 18x, which looks above book, but JFE continues to look undervalued somewhat demanding compared to sector peers such with a P/B of only around 0.6x. as Sumitomo Electric Industries and Fujikura (both around 11x). In P/B, Furukawa Electric’s 1.2x multiple also looks over-valued compared to Sumitomo Electric Industries (0.9x) and Fujikura (0.8x).

2017 Japan Outlook 27 13 January 2017

Defensives Pharmaceuticals & Biotechnology / Fumiyoshi Sakai & Yen Ting Chen

Factor Favorable Unfavorable 1) Yen Depreciation Takeda Pharmaceutical (4502, Neutral) Taisho Pharmaceutical Holdings (4581, Neutral) Annual OP gets a boost of roughly ¥800mn for each Japan’s largest OTC pharmaceuticals company. one yen of weakness against the dollar. Takeda also Starting to build a presence in Asia, but still relatively has relatively high exposure to the euro and emerging immune to forex movement. Taisho faces a difficult market currencies. In emerging market currencies, a earnings environment because of the steadily shrinking stronger dollar is a negative for earnings, but emerging market for energy drinks such as Lipovitan D. The markets are a key medium- and long-term strategic company is targeting the self-medication market, an focus for the company. Takeda was Japan’s first area of significant latent demand given the ongoing pharmaceutical company to expand globally. push to curb medical spending. The key for Taisho will Sysmex (6869, Neutral) be tapping into this latent demand. Largest and strongest hematology portfolio in the world, with 85% of sales generated outside Japan. Enjoys an earnings boost thanks to the recent yen weakness, with each one yen depreciation vs. the dollar boosting annual OP by around ¥350mn. Strong commitment to “made in Japan,” with 100% of medical equipment manufactured domestically, while reagents are manufactured at plants around the world. Key to the future is developing and expanding next-generation testing equipment, such as liquid biopsy technology.

2) Higher Interest Rates & Pharma, medical device, healthcare sector overall Inflation The majority of pharmaceutical companies and medical device makers are net cash or have no debt. Drug prices are determined by the National Health Insurance drug price list; up until now those prices have been revised based on surveys carried out every two years, but the current proposed shift to annual revisions is likely to lead to greater downward pressure on prices. Companies with relatively high dependency on imported ingredients include Chugai (4519, Outperform) and Tsumura (4540, Neutral), and most generic drug makers. Chugai earnings are relatively sensitive to forex movement, while volatility in raw material prices has a significant impact on earnings at Tsumura’s Chinese herbal medicine business.

2017 Japan Outlook 28 13 January 2017

3) High Operating Ono Pharmaceutical (4528, Outperform) Sawai Pharmaceutical (4555, Neutral) Leverage & Stronger Earnings likely to plummet in FY3/18 due to the out-of- Has benefited from efforts to promote the use of Economic Growth cycle 50% price cut announced for cancer drug generics by the Japanese government, which has set a Opdivo, although we expect a recovery from FY3/19 generics volume share target of 70% by end-2017. and beyond thanks to improved volumes. Opdivo Sawai also faces a rising capital expenditure burden as royalty revenue from overseas should also contribute. it tries to secure volumes, and pricing competition Nippon Shinyaku (4516, Outperform) continues to intensify. Growing risk that the next round Steady growth in royalty revenue for Uptravi, a of NHI drug price cuts (planned for April 2018) could be treatment for pulmonary arterial hypertension (PAH) larger than expected. which is also licensed to Switzerland’s Actelion Pharmaceuticals. Uptravi was also launched in Japan in November. Expect significant boost to profitability in the future.

4) Improved Corporate Eisai (4523, Underperform) Kyowa Hakko Kirin (4151, Outperform), Sumitomo Governance & Japan’s leading pharmaceutical company in its Dainippon Pharma (4506, Neutral), Mitsubishi Shareholder Returns commitment to environmental, social, and governance Tanabe Pharma (4508, Neutral) factors. No shareholder value is created if listing both the One of the first companies to adopt a committee parent and the subsidiary doesn't create synergies. governance structure and bring in outside directors. Parent-subsidiary listing structure takes away the Management targets for FY2020 include ROE of at flexibility to implement share buybacks due to the least 10%, equity spread (ROE minus cost of equity) of need to maintain capital relationship with the parent at least 2%, DOE (dividends on equity) around 8% company and to maintain the ownership ratio by its (maintaining dividend of ¥150/share), and an equity parent. ratio of at least 50%, while allowing for financial leverage flexibility with debt capacity of ¥230bn.

5) Self Help & Takeda Pharmaceutical (4502, Neutral) Mitsubishi Tanabe Pharma (4508, Neutral) Structural Change Has accelerated business streamlining efforts, Still facing lingering issue of inefficient assets (long- including the sale of off-patent long-listed products listed product portfolio, generics business, genetic business to Teva Pharmaceutical Industries, the sale of recombination blood-derived plasma fraction drug the non-core respiratory portfolio to AstraZeneca, maker subsidiary Bipha Corp). withdrawing from "metabolic syndrome"-related drugs (diabetes, etc.), and the sale of diagnostic reagents subsidiary Wako Pure Chemical Industries to Fujifilm. Takeda has also started restructuring its R&D operations, including outsourcing some of its development efforts and promoting global mobility of researchers. The key to the future will be the success of the company’s strategy of focusing its global business efforts to specific therapeutic areas (oncology and gastroenterology). One area of concern is possible “restructuring fatigue,” both for employees and the organization itself.

6) Secular Themes Takeda Pharmaceutical (4502, Neutral), , medical device, healthcare sector overall Pharma (4503, Neutral), Eisai (4523, Underperform), Increasingly difficult earnings environment, with (4568, Neutral), Otsuka Holdings ongoing efforts to curb medical costs, off-cycle drug (4578, Neutral), Shionogi (4507, Outperform) price cuts, fewer consultations, and intense global Key themes include innovation, oncology therapeutics, competition. Companies will need to find their own path and CNS (central nervous system) therapeutics (for to survive, leveraging their ability to innovate to Alzheimer’s, etc.). We will be watching to see if establish a firm global presence. Shionogi will continue to be a market favorite or if the other major pharmaceutical companies will fight back through R&D efforts.

2017 Japan Outlook 29 13 January 2017

7) Valuation Astellas Pharma (4503, Neutral) M3 (2413, Outperform) Valuations look attractive. The shares are trading at a Valuations look demanding, with a P/E of around 50x, P/E of around 15x and EV/EBITDA of around 8x, with EV/EBITDA of around 40x, and a dividend yield of a dividend yield of roughly 2.3%, compared to roughly 0.4%. The expensive valuation is partly a averages of roughly 25x P/E, 12x EV/EBIDTA and 2% reflection of the company’s hybrid nature as a dividend yield for all pharmaceutical companies under healthcare-related IT company. We forecast CAGR of our coverage. (In comparison, sector rival Takeda 23% for sales over the next three years. Pharmaceutical currently trades at a P/E of around 40x and an EV/EBITDA of roughly 22x, and a dividend yield of around 3.9%.)

2017 Japan Outlook 30 13 January 2017

Consumer Staples / Masashi Mori

Factor Favorable Unfavorable 1) Yen Depreciation (2801, Neutral) Morinaga Milk (2264, Outperform) Yen weakness vs. the US dollar is a tailwind, since the Imports cheese and other products from overseas, so a North America business accounts for a relatively high weaker yen tends to lead to higher ingredient costs. proportion of company-wide OP (roughly 55%). Each Each one yen weakness against the dollar reduces one yen depreciation vs. the dollar boosts annual OP annual OP by roughly ¥200mn. by around ¥100mn.

2) Higher Interest Rates & (JT: 2914, Outperform) Consumer staples sector overall Inflation Tobacco volume is on a declining trend globally, but Some raw materials have dropped in prices and there price hikes are easier to implement on the backs of are products that face downward pricing pressure. events such as tax hikes. However, by the expansion of sales in value-added products such as yogurts and chocolates will offset the effects and the overall impact will be limited.

3) High Operating Kose (4922, Outperform) Leverage & Stronger Reflects the high marginal profitability in the company’s Economic Growth cosmetics business

4) Improved Corporate Pigeon Corporation (7956, Neutral) Toyo Suisan (2875, Neutral) Governance & New medium-term plan expected to be unveiled in We think the company has significant room to boost Shareholder Returns FY3/18. Based on current financial position, we see shareholder returns thanks to its robust financial room to boost its dividend payout ratio. position, although any such moves seem unlikely at this point.

5) Self Help & Asahi Group Holdings (2502, Neutral) Structural Change Recent major European acquisitions should contribute to earnings growth from 2017 and beyond. Morinaga & Co (2201, Outperform), Morinaga Milk (2264, Outperform) Both companies were laggards compared to their peers in cutting manufacturing costs, but this also leaves more room and opportunity for them to push forward reforms and optimize production.

6) Secular Themes Morinaga Milk (2264, Outperform) JT (2914, Outperform) Probiotics likely to remain a key theme, with lactic acid Heat-not-burn cigarettes ("e-cigarettes"), which bacteria being used in an increasingly wide range of competes with traditional tobaccos, is expanding in foods. We think Morinaga Milk is likely to see faster Japan. JT's share in e-cigarettes is low. growth in external sales of its lactic acid bacteria.

7) Valuation PALTAC (8283, Outperform) Consumer staples sector overall P/E of just under 12x on our FY3/17 forecasts looks Valuations for consumer staple stocks are relatively relatively attractive for a company that is primarily demanding vs. the overall market. Still unclear involved in wholesale. whether the premium of the past few years will carry over into 2017.

2017 Japan Outlook 31 13 January 2017

Real Estate, Housing, Construction, REITs / Masahiro Mochizuki & Yasuko Fukuda

Factor Favorable Unfavorable 1) Yen Depreciation Sekisui Chemical (4204, Outperform) Sumitomo Osaka Cement (5232, Outperform) Should benefit from yen weakness more than any other Each one yen weakness vs. the dollar drags down housing company under our coverage, with each one annual OP by ¥80mn. yen weakness vs. the dollar and euro adding ¥600mn and ¥50mn to annual OP.

2) Higher Interest Rates & (8801, Outperform) Japan Real Estate Investment (8952, Underperform) Inflation Higher inflation could boost lease revenue at overseas Higher interest rates means higher funding costs, and leasing segment. Mitsui Fudosan has ¥150bn in real that would limit DPU capacity (although this is true of estate holdings in the UK and ¥330bn in the US. all J-REITs, not just Japan Real Estate).

3) High Operating Sumitomo Osaka Cement (5232, Outperform) Construction companies overall Leverage & Stronger Marginal profitability of around 60% in cement Marginal profitability of only 10–15%; upturn in real Economic Growth business; upturn in real construction investment construction investment spending thus less of an spending should boost earnings growth. earnings tailwind compared to the cement companies.

4) Improved Corporate Sekisui Chemical (4204, Outperform) Obayashi Corp. (1802, Neutral) Governance & Current shareholder returns policy is to maintain a Expectations are high that the company will announce Shareholder Returns dividend payout ratio of around 30% and implement a share buyback plan in FY3/18. However, we are buybacks when there are no attractive capital somewhat skeptical and think that the company’s expenditure options available. We expect that the new priority will be on shoring up its financial position. medium-term plan (scheduled to be unveiled in early FY3/18) will make clear the company’s future shareholder returns policy.

5) Self Help & Sekisui Chemical (4204, Outperform) TOTO (5332, Underperform) Structural Change We look for continued business consolidation at the Losses at its kitchen business is continuing, and the urban infrastructure & environmental products segment segment is unlikely to turn to a profit for the time to boost margins. being.

6) Secular Themes Holdings (1721, Outperform) Rinnai (5947, Underperform) Increases in mobile-related construction, which we Full-fledged start of deregulation of retail electricity estimate to have high GPM, should be the profit sales in 2017 could mean increased demands for price growth driver going forward. 4G-related construction cuts from clients. orders up until FY3/18, and 5G-related beyond FY3/19 are expected, and OP will likely continue to grow. Penta-Ocean Construction (1893, Outperform) High order volumes should continue beyond the Tokyo Olympics in the marine engineering field which the company excels in. We expect the company to obtain orders for maintenance, repair and refurbishments of ports, and the new runway at the Haneda Airport.

2017 Japan Outlook 32 13 January 2017

7) Valuation Sekisui House (1928, Outperform) TOTO (5332, Underperform) Total shareholder return yield of 6.2% based on our P/E, EV/EBITDA, and dividend yield all look relatively FY1/18 forecast (dividend yield 4.1%); income returns demanding compared to rest of the housing sector. suggest attractive valuations. Taisei (1801, Outperform) We believe Taisei will conduct another share buyback in FY 3/18. Total shareholder return yield for FY 3/18 is expected to be around 5%, compared to rivals at around 2%. From an income returns perspective, we believe Taisei's stock price is undervalued.

2017 Japan Outlook 33 13 January 2017

Financials Banks / Takashi Miura

Factor Favorable Unfavorable 1) Yen Depreciation Mitsubishi UFJ Financial Group (MUFG: 8306, Suruga Bank (8358, Neutral) Outperform) Domestic clients account for nearly 100% of loan Biggest profit boost from yen weakness among portfolio. In addition, marketable securities account for Japan’s banks, with each one yen of weakness just 5% of total assets, and foreign bonds only account against the dollar adding ¥5bn to annual RP. MUFG is for 9%. Suruga Bank thus sees almost no direct benefit also best positioned within the sector to benefit from from yen weakness. yen weakness thanks to the continued strong growth at its overseas business units MUFG Union Bank, Morgan Stanley (equity method affiliate), and Bank of Ayudhya.

2) Higher Interest Rates & Foreign interest rates Suruga Bank (8358, Neutral) Inflation MUFG (8306, Outperform) Loan portfolio dominated by individual retail loans, Largest exposure of Japan’s banks to foreign currency- which have either fixed interest rates or variable rates denominated assets and debt, and thus likely to benefit based on the short-term prime rate. Suruga has the the most from higher foreign interest rates. Has a lowest exposure to interest rate movement in the relatively high proportion of long-dated assets, making sector. yield curve steepening a tailwind. Corporate loans are mostly spread lending, and spreads are expected to improve as interest rates rise. We also expect a rise in mortgage balances at MUFG Union Bank as home owners rush to lock in rates before interest rates rise. Domestic interest rates and equity prices Bank of Kyoto (8369, Outperform) Domestic lending and domestic bonds account for a large proportion of AUM, making it the best positioned to benefit from a rise in domestic interest rates. Also best positioned to benefit from higher share prices, since it has the largest unrealized gains on equity holdings as a percent of their net assets.

3) High Operating MUFG (8306, Outperform) Regional banks overall Leverage & Stronger An easing of financial regulation in the US could help Cost structures at regional banks are relatively rigid, Economic Growth MUFG keep down compliance-related costs in the and most banks struggle to trim costs as gross profit bank’s rapidly expanding overseas business, resulting declines, keeping OHRs high. Costs are likely to rise in improved cost efficiencies. even further due to IT system development projects and other costs, which will also weigh on earnings.

4) Improved Corporate Sumitomo Mitsui Financial Group (SMFG: 8316, (8354, Underperform) Governance & Outperform) Fukuoka FG uses a performance-based dividend Shareholder Returns Outcome of new Basel regulations (could be policy (an annual dividend table) based on net income. announced as early as January) will have a key impact There is a risk that dividends will be cut if domestic on SMFG’s shareholder returns policy. Of particular interest rates fail to rise and lending growth in its home note, SMFG has cited the poor visibility on the new base of Fukuoka prefecture remains sluggish. capital requirements as a reason behind its decision to hold off on share buybacks. If the new Basel rules are generally in line with expectations, we think the bank could announce a share buyback before end-FY3/17.

2017 Japan Outlook 34 13 January 2017

5) Self Help & Megabanks: MUFG (8305, Outperform), SMFG Regional banks overall Structural Change (8316, Outperform), Mizuho FG (8411, Neutral) Regional banks are unlikely to acquire companies The megabanks are clearly targeting profit growth. outside the banking industry, and industry Improved visibility on the regulatory front should lead consolidation and reorganization has not progressed to heightened expectations for an earnings recovery, as quickly as had been expected. We think this is likely driven by yen weakness and higher overseas interest because banks are finding it harder to adjust cost- rates. This in turn could lead to an increase in M&A cutting plans, given the increasingly critical need to trim deals, particularly overseas. costs given the current business environment. Investor views of individual regional banks will likely hinge on to what extent banks are able to implement restructuring measures while equity market share prices are still moving higher.

6) Secular Themes Megabanks: MUFG (8305, Outperform), SMFG Regional banks overall (8316, Outperform), Mizuho FG (8411, Neutral) Population decline and aging in rural areas are bringing Japan’s megabanks have been investing heavily in stagnation to local economies, and regional banks are Fintech (e.g. transaction, money transfer, virtual in difficult environments. M&A amongst mid-to small- currency, asset management/investment advice), sized regional banks, who lag in non-interest income which we think holds the key to achieving operational and overseas profits, will likely accelerate. improvements in the future. In Japan, banks are likely to remain the core institutions handling the nation’s lending and settlement functions, and FinTech should provide opportunities for the megabanks to expand business and boost commissions.

7) Valuation Shinsei Bank (8303, Outperform) Shizuoka Bank (8355, Underperform) Lowest P/E amongst Japanese banks: we think Trades at third-highest P/E (behind only Bank of Kyoto investors have generally shunned Shinsei due to its and ), but likely has the highest P/E in low annual dividend (¥1/share) and historically, real terms after taking account of Bank of Kyoto’s Shinsei earnings have been relatively volatile. latent gains on equity holdings and Aozora Bank’s However, we expect a more robust shareholder high dividend yield. We also believe the stock is returns policy to emerge, starting with share buybacks overpriced because of the lack of earnings stability and a gradual rise in the total shareholder returns ratio (historically, capital gains have accounted for around to around 40%, which should drive Shinsei Bank’s 30% of RP). valuations higher.

2017 Japan Outlook 35 13 January 2017

Brokers, Insurance & Nonbank Financials / Takehito Yamanaka

Factor Favorable Unfavorable 1) Yen Depreciation Dai-ichi Life (8750, Outperform) Credit Saison (8253, Outperform) The company generally uses hedges in both its asset The company has started to establish a presence in management and underwriting operations to minimize Indonesia and Vietnam, but so far these businesses forex impact. Yen weakness is a positive when make essentially no contribution to earnings. We think converting profits generated at overseas businesses the company will continue to expand its overseas back into yen (partially offset by goodwill amortization). business presence, but we think Credit Saison is For 1H FY3/17, the company’s overseas businesses currently the least exposed to forex movement of the (US, Australia, etc.) accounted for around 30% of insurance, brokerages, and non-bank companies. company-wide NP. Dai-chi Life’s business unit in (Even brokerages with no overseas business are Vietnam is growing rapidly, but for the foreseeable indirectly affected by forex movement due to the impact future, we think the largest impact on earnings from that forex trends can have on the equity market.) overseas operations will be profit trends at Protective Life, a US subsidiary.

2) Higher Interest Rates & T&D Holdings (8795, Outperform) Japan Exchange Group (JPX: 8697, Neutral) Inflation Life insurance firms benefit the most in a rising interest Forex rates may have an indirect impact on Japan’s rate environment: the impact is actually quite small on equity market, but in general JPX's profits, along with profits for any single fiscal year, but higher interest equity market direction and share prices, are largely rates do have a significant impact on embedded value determined by the trading value of cash equities and (EV) and the economic value-based new contract derivatives. With almost no debt, interest rate value. movement has almost no impact on JPX’s earnings. Based on end-FY3/16 EV, we estimate that a 50bp rise in interest rates would boost EV by 13.3%. Note that the company uses yields on ultra-long JGBs (15– 20 years) as reference rates, and not the 10-year.

3) High Operating Monex Group (8698, Underperform) (8628, Neutral) Leverage & Stronger Monex has the highest fixed costs of Japan’s online Lowest break-even point of the online brokerages and Economic Growth brokerages, but margins are more likely to rise during high ROE. Share price also seeing support from the an equity market rally. Day-traders account for a company’s high payout ratio (70–100%), but in general relatively small proportion of the company’s core the company’s share price performance tends to lag domestic client base compared to the other online other sector peers during stock rallies. brokerages. This thus represents additional “leverage” of sorts: an equity market rebound is likely to see increased participation from individual investors not involved in day trading, which in turn should boost company profits. Higher US interest rates also a tailwind.

4) Improved Corporate MS&AD (8725, Outperform) JPX (8697, Neutral) Governance & One of the company’s medium-term business targets The company’s payout ratio has already risen to 60%. Shareholder Returns is to return approximately 50% of “core group profit” Some investors think the company could boost (as defined by the company) to shareholders. This dividends further, but we see any increase in core group profit is growing thanks to contributions shareholder returns as unlikely: (1) the capex burden is from MS Amlin. MS&AD had lagged the other two increasing as JPX tries to secure future growth, (2) the major non-life insurers in selling off strategic company may invest in peripheral businesses, (3) the shareholdings, but has stepped up such sales in company used debt to finance the previous share FY3/17, and we expect an increase in the sale of buyback, and (4) management is currently reluctant to strategic shareholdings in FY3/18 as well. raise the dividend payout ratio any further.

2017 Japan Outlook 36 13 January 2017

5) Self Help & (8604, Outperform) Acom (8572, Neutral) Structural Change The company has made steady progress towards its Acom is almost done with its cost cutting, and we think goal (announced with 4Q FY3/16 results) of lowering any M&A activity is unlikely. Interest refund claims wholesale business costs by 20% vs. FY3/15. The remain an issue, but overall we think it is only a matter company’s overseas business also returned to of time before the problem peaks out. We think the profitability in 1H FY3/17. We expect cost-cutting company’s share price is already starting to reflect progress over the second half and think the company investor expectations for the company without the will achieve its 20% cut target before the start of overhang of refund claim costs. A key focus for the FY3/18. Fixed income segment earnings are long term is how the company can team up with its recovering, and a rebound in retail operations as well parent company MUFG to offer new services, although could boost FY3/18 earnings. we do not expect any significant change for the foreseeable future.

6) Secular Themes Credit Saison (8253, Outperform) Tokai Tokyo Financial Holdings (8616, The credit card business continues to grow, and the Underperform) company has now launched new overseas businesses The company could see recent tie-ups with regional in locations such as Indonesia and Vietnam. Some banks start to contribute to earnings starting in investors seem to be concerned at the uncertainties FY3/18. However, we think that tie-ups based on surrounding the future growth prospects in the Tokai Tokyo’s current business model are mostly domestic card business. We, on the other hand, expect complete. With baby boomers now entering their continued profit growth, driven by an increase in new retirement, Japan is expected to see a significant services via tie-ups with Internet companies, credit increase in inheritances, Unless the company is able card transaction volume growth of over 7% / year, and to develop a new business model, we think it is at revolving credit balance growth of over 10%. The significant risk of being left behind, as financial assets branded prepaid card business still only makes limited are passed on to the next generation. In addition, contributions to earnings, but is expanding smoothly. margins at the company’s retail business are in a Cashless settlement is becoming increasingly medium-term downtrend, a difficult headwind to common, another tailwind for Credit Saison. In the navigate given that the retail business generates the long-term, if the current partnerships and investments majority of company-wide profit. with internet-related companies are successful, the contribution to profits will be relatively significant.

7) Valuation Dai-ichi Life (8750, Outperform) JPX (8697, Neutral) Share price has rallied thanks to the upturn in interest The shares are trading at P/E multiples in the 22–23x rates, but shares still trade at a P/EV of only 0.45– range, which looks demanding based on profit-based 0.50x (i.e. P/EV only reflects the upturn in EV). In fair value. Since 2013, the company’s share price has addition to the increase in interest rates, we see a tracked more closely to the equity market and not the number of factors that should support RoEV company's profit, in part due to investor expectations improvement, including product mix adjustments and for higher Japanese equity prices. higher premiums following the scheduled fall in the standard discount rate for level-premium products from 1.00% to 0.25% in April 2017. We expect the RoEV improvement to drive further upside for valuations.

2017 Japan Outlook 37 13 January 2017

Key stocks by factor 1) Yen Weakness

Figure 12: Favorable Consensus HOLT Scorecard Ticker Company Analyst Sector CS Rating Rating Quality Momentum Valuation Overall 6995 Tokai Rika Masahiro Akita Auto Parts Neutral 3.6 96 21 40 57 7270 Fuji Heavy Industries Masahiro Akita Autos Outperform 4.3 93 97 98 100 8306 Mitsubishi UFJ Financial Group Takashi Miura Banks Outperform 4.1 64 68 74 94 8750 Dai-ichi Life Takehito Yamanaka Brokers, Insurance & Nonbank Financials Outperform 3.8 91 60 58 88 3436 SUMCO Masami Sawato Chemicals Underperform 3.2 32 95 10 42 6740 Japan Display Mika Nishimura Consumer Electronics Neutral 3.2 74 38 1 19 7751 Canon Mika Nishimura Consumer Electronics Neutral 3.0 60 20 28 18 2801 Kikkoman Masashi Mori Consumer Staples Neutral 3.0 6 51 42 9 6967 Shinko Electric Industries Akinori Kanemoto Electronic Components Neutral 2.8 79 76 3 59 7915 Nissha Printing Akinori Kanemoto Electronic Components Outperform 3.8 32 50 72 51 6502 Toshiba Hideyuki Maekawa Industrial Electronics Outperform 3.7 40 90 16 49 6951 JEOL Yoshiyasu Takemura Industrial Electronics Outperform 4.3 25 70 43 32 3659 Nexon Keiichi Yoneshima Internet Neutral 3.4 61 6 85 53 7012 Kawasaki Heavy Industries Shinji Kuroda Machinery Neutral 3.0 35 8 40 12 5726 Osaka Titanium Technologies Shinya Yamada Metals Neutral 3.0 0 8 21 0 5802 Sumitomo Electric Industries Shinya Yamada Metals Outperform 4.1 75 38 11 31 4502 Takeda Pharmaceutical Fumiyoshi Sakai Pharmaceuticals & Biotechnology Neutral 3.0 65 75 17 48 6869 Sysmex Fumiyoshi Sakai Pharmaceuticals & Biotechnology Neutral 4.3 35 14 94 37 4204 Sekisui Chemical Masahiro Mochizuki Real Estate, Housing, Construction, REITs Outperform 4.0 54 92 54 82 Note: Consensus rating assigns a score of 5 to a Buy, 3 to a Hold, and 1 to a Sell as per Bloomberg methodology. HOLT® is not part of Credit Suisse Research. Source: Credit Suisse, the BLOOMBERG PROFESSIONAL™ service, HOLT®

Figure 13: Unfavorable Consensus HOLT Scorecard Ticker Company Analyst Sector CS Rating Rating Quality Momentum Valuation Overall 4246 DaikyoNishikawa Koji Takahashi Auto Parts Outperform 4.3 95 21 94 89 7269 Suzuki Motor Masahiro Akita Autos Outperform 4.1 76 97 47 94 8358 Suruga Bank Takashi Miura Banks Neutral 3.8 11 89 79 77 8253 Credit Saison Takehito Yamanaka Brokers, Insurance & Nonbank Financials Outperform 3.2 68 83 66 96 4114 Nippon Shokubai Masami Sawato Chemicals Neutral 3.7 44 16 48 21 6758 Sony Mika Nishimura Consumer Electronics Outperform 4.4 61 50 34 44 6773 Pioneer Mika Nishimura Consumer Electronics Neutral 3.4 84 35 62 71 2264 Morinaga Milk Masashi Mori Consumer Staples Outperform 5.0 37 91 11 42 6594 Nidec Akinori Kanemoto Electronic Components Outperform 4.4 8 84 88 71 6727 Wacom Akinori Kanemoto Electronic Components Underperform 2.0 44 10 77 36 6971 Kyocera Akinori Kanemoto Electronic Components Neutral 2.8 73 48 15 41 6756 Hitachi Kokusai Electric Hideyuki Maekawa Industrial Electronics Outperform 4.1 16 85 28 33 7735 SCREEN Hideyuki Maekawa Industrial Electronics Neutral 3.8 51 89 56 82 8035 Tokyo Electron Hideyuki Maekawa Industrial Electronics Outperform 4.0 65 91 49 88 9449 GMO Internet Keiichi Yoneshima Internet Outperform 4.8 13 40 63 21 6268 Nabtesco Corp Shinji Kuroda Machinery Neutral 3.3 12 30 53 17 6586 Makita Shinji Kuroda Machinery Neutral 3.1 21 51 73 46 6954 Fanuc Shinji Kuroda Machinery Underperform 3.4 9 69 76 51 5482 Aichi Steel Shinya Yamada Metals Neutral 3.0 87 30 27 45 5727 Toho Titanium Shinya Yamada Metals Neutral 3.5 4 5 95 17 4581 Taisho Pharmaceutical Holdings Fumiyoshi Sakai Pharmaceuticals & Biotechnology Neutral 1.9 54 73 11 33 5233 Masahiro Mochizuki Real Estate, Housing, Construction, REITs Neutral 4.4 26 21 60 19 Note: consensus rating assigns a score of 5 to a Buy, 3 to a Hold, and 1 to a Sell as per Bloomberg methodology. HOLT® is not part of Credit Suisse Research. Source: Credit Suisse, the BLOOMBERG PROFESSIONAL™ service, HOLT®

2017 Japan Outlook 38 13 January 2017

2) Interest Rates & Inflation

Figure 14: Favorable Consensus HOLT Scorecard Ticker Company Analyst Sector CS Rating Rating Quality Momentum Valuation Overall 5122 Okamoto Koji Takahashi Auto Parts Outperform 5.0 14 52 83 47 7270 Fuji Heavy Industries Masahiro Akita Autos Outperform 4.3 93 97 98 100 8306 Mitsubishi UFJ Financial Group Takashi Miura Banks Outperform 4.1 64 68 74 94 8369 Bank of Kyoto Takashi Miura Banks Outperform 3.5 96 15 17 30 8795 T&D Holdings Takehito Yamanaka Brokers, Insurance & Nonbank Financials Outperform 3.8 68 73 15 57 4063 Shin-Etsu Chemical Masami Sawato Chemicals Neutral 4.3 1 96 13 23 6758 Sony Mika Nishimura Consumer Electronics Outperform 4.4 61 50 34 44 2914 Japan Tobacco Masashi Mori Consumer Staples Outperform 4.4 89 8 75 71 6301 Komatsu Shinji Kuroda Machinery Neutral 3.2 43 82 59 74 6305 Hitachi Construction Machinery Shinji Kuroda Machinery Underperform 2.4 23 83 19 31 6841 Yokogawa Electric Corp Shinji Kuroda Machinery Outperform 3.8 54 64 51 68 5411 JFE Shinya Yamada Metals Outperform 3.6 75 17 6 14 7309 Shimano Shinya Yamada Metals Outperform 3.9 14 73 97 74 8801 Mitsui Fudosan Masahiro Mochizuki Real Estate, Housing, Construction, REITs Outperform 4.2 73 23 38 43

Note: Consensus rating assigns a score of 5 to a Buy, 3 to a Hold, and 1 to a Sell as per Bloomberg methodology. HOLT® is not part of Credit Suisse Research. Source: Credit Suisse, the BLOOMBERG PROFESSIONAL™ service, HOLT®

Figure 15: Unfavorable Consensus HOLT Scorecard Ticker Company Analyst Sector CS Rating Rating Quality Momentum Valuation Overall 5108 Bridgestone Masahiro Akita Auto Parts Neutral 4.2 98 42 77 93 5110 Sumitomo Rubber Industries Masahiro Akita Auto Parts Neutral 2.8 96 91 70 99 7201 Nissan Motor Masahiro Akita Autos Neutral 4.0 97 71 43 90 8358 Suruga Bank Takashi Miura Banks Neutral 3.8 11 89 79 77 8697 Japan Exchange Group Takehito Yamanaka Brokers, Insurance & Nonbank Financials Neutral 3.0 18 2 33 2 4043 Tokuyama Masami Sawato Chemicals Neutral 4.2 14 78 26 29 6501 Hitachi Hideyuki Maekawa Industrial Electronics Outperform 4.2 76 47 30 54 6502 Toshiba Hideyuki Maekawa Industrial Electronics Outperform 3.7 40 90 16 49 6503 Mitsubishi Electric Hideyuki Maekawa Industrial Electronics Neutral 4.6 53 83 34 61 4755 Rakuten Keiichi Yoneshima Internet Neutral 3.7 20 7 82 20 5801 Furukawa Electric Shinya Yamada Metals Underperform 3.3 64 86 38 76 4519 Chugai Pharmaceutical Fumiyoshi Sakai Pharmaceuticals & Biotechnology Outperform 4.0 51 13 57 24 4540 Tsumura & Co Fumiyoshi Sakai Pharmaceuticals & Biotechnology Neutral 3.7 57 62 25 38 8952 Japan Real Estate Inv Corp Masahiro Mochizuki Real Estate, Housing, Construction, REITs Underperform 2.7 30 45 60 45

Note: Consensus rating assigns a score of 5 to a Buy, 3 to a Hold, and 1 to a Sell as per Bloomberg methodology. HOLT® is not part of Credit Suisse Research. Source: Credit Suisse, the BLOOMBERG PROFESSIONAL™ service, HOLT®

2017 Japan Outlook 39 13 January 2017

3) Operating Leverage & Economic Growth

Figure 16: Favorable Consensus HOLT Scorecard Ticker Company Analyst Sector CS Rating Rating Quality Momentum Valuation Overall 5333 NGK Insulators Koji Takahashi Auto Parts Outperform 4.3 36 10 62 25 7269 Suzuki Motor Masahiro Akita Autos Outperform 4.1 76 97 47 94 8306 Mitsubishi UFJ Financial Group Takashi Miura Banks Outperform 4.1 64 68 74 94 8698 Monex Group Takehito Yamanaka Brokers, Insurance & Nonbank Financials Underperform 2.5 13 40 38 13 3436 SUMCO Masami Sawato Chemicals Underperform 3.2 32 95 10 42 6758 Sony Mika Nishimura Consumer Electronics Outperform 4.4 61 50 34 44 6796 Clarion Mika Nishimura Consumer Electronics Outperform 4.3 40 87 80 87 4922 KOSE Masashi Mori Consumer Staples Outperform 4.4 34 5 92 29 6963 ROHM Akinori Kanemoto Electronic Components Outperform 4.1 51 70 15 40 7915 Nissha Printing Akinori Kanemoto Electronic Components Outperform 3.8 32 50 72 51 6146 DISCO Hideyuki Maekawa Industrial Electronics Neutral 4.2 33 88 78 85 4689 Yahoo Japan Keiichi Yoneshima Internet Outperform 4.2 22 41 86 50 6273 SMC Shinji Kuroda Machinery Neutral 3.9 39 82 70 78 6471 NSK Shinji Kuroda Machinery Outperform 3.5 30 74 26 34 6472 NTN Shinji Kuroda Machinery Outperform 3.5 61 56 12 33 6506 Yaskawa Electric Corp Shinji Kuroda Machinery Neutral 3.4 38 81 71 79 7309 Shimano Shinya Yamada Metals Outperform 3.9 14 73 97 74 4516 Nippon Shinyaku Yen Ting Chen Pharmaceuticals & Biotechnology Outperform 4.8 16 97 24 30 4528 Ono Pharmaceutical Fumiyoshi Sakai Pharmaceuticals & Biotechnology Outperform 3.4 43 2 30 6 5232 Sumitomo Osaka Cement Masahiro Mochizuki Real Estate, Housing, Construction, REITs Outperform 3.7 82 3 35 30 Note: Consensus rating assigns a score of 5 to a Buy, 3 to a Hold, and 1 to a Sell as per Bloomberg methodology. HOLT® is not part of Credit Suisse Research. Source: Credit Suisse, the BLOOMBERG PROFESSIONAL™ service, HOLT®

Figure 17: Unfavorable Consensus HOLT Scorecard Ticker Company Analyst Sector CS Rating Rating Quality Momentum Valuation Overall 6674 GS Yuasa Corp Koji Takahashi Auto Parts Neutral 2.7 55 40 31 32 7203 Toyota Motor Masahiro Akita Autos Neutral 3.6 92 75 68 98 8628 Matsui Securities Takehito Yamanaka Brokers, Insurance & Nonbank Financials Neutral 3.0 15 6 62 2 6740 Japan Display Mika Nishimura Consumer Electronics Neutral 3.2 74 38 1 19 6753 Sharp Mika Nishimura Consumer Electronics Underperform 1.6 19 47 22 11 2121 Mixi Keiichi Yoneshima Internet Neutral 3.9 99 30 100 94 2432 DeNA Keiichi Yoneshima Internet Outperform 4.1 24 45 56 29 3632 Gree Keiichi Yoneshima Internet Underperform 2.8 77 87 67 95 3659 Nexon Keiichi Yoneshima Internet Neutral 3.4 61 6 85 53 3668 COLOPL Inc Keiichi Yoneshima Internet Neutral 3.0 43 1 97 44 4555 Sawai Pharmaceutical Fumiyoshi Sakai Pharmaceuticals & Biotechnology Neutral 3.7 94 17 84 89

Note: Consensus rating assigns a score of 5 to a Buy, 3 to a Hold, and 1 to a Sell as per Bloomberg methodology. HOLT® is not part of Credit Suisse Research. Source: Credit Suisse, the BLOOMBERG PROFESSIONAL™ service, HOLT®

2017 Japan Outlook 40 13 January 2017

4) Corporate Governance & Shareholder Returns

Figure 18: Favorable Consensus HOLT Scorecard Ticker Company Analyst Sector CS Rating Rating Quality Momentum Valuation Overall 5108 Bridgestone Masahiro Akita Auto Parts Neutral 4.2 98 42 77 93 7202 Isuzu Motors Masahiro Akita Autos Outperform 4.4 84 31 69 74 8316 Sumitomo Mitsui Financial Group Takashi Miura Banks Outperform 4.4 87 51 98 100 8725 MS&AD Insurance Group Holdings Takehito Yamanaka Brokers, Insurance & Nonbank Financials Outperform 4.2 90 77 45 90 4061 Denka Masami Sawato Chemicals Neutral 3.3 66 14 47 35 4185 JSR Masami Sawato Chemicals Neutral 2.9 36 35 56 34 7751 Canon Mika Nishimura Consumer Electronics Neutral 3.0 60 20 28 18 7956 Pigeon Masashi Mori Consumer Staples Neutral 3.7 22 86 97 89 8035 Tokyo Electron Hideyuki Maekawa Industrial Electronics Outperform 4.0 65 91 49 88 2371 Kakaku.com Keiichi Yoneshima Internet Neutral 3.3 15 9 99 26 6301 Komatsu Shinji Kuroda Machinery Neutral 3.2 43 82 59 74 6367 Daikin Industries Shinji Kuroda Machinery Outperform 4.0 34 85 91 85 5803 Fujikura Shinya Yamada Metals Neutral 3.4 44 28 23 17 4523 Eisai Fumiyoshi Sakai Pharmaceuticals & Biotechnology Underperform 2.9 33 68 14 21 4204 Sekisui Chemical Masahiro Mochizuki Real Estate, Housing, Construction, REITs Outperform 4.0 54 92 54 82

Note: Consensus rating assigns a score of 5 to a Buy, 3 to a Hold, and 1 to a Sell as per Bloomberg methodology. HOLT® is not part of Credit Suisse Research. Source: Credit Suisse, the BLOOMBERG PROFESSIONAL™ service, HOLT®

Figure 19: Unfavorable Consensus HOLT Scorecard Ticker Company Analyst Sector CS Rating Rating Quality Momentum Valuation Overall 7276 Koito Manufacturing Koji Takahashi Auto Parts Underperform 4.0 60 81 92 97 7269 Suzuki Motor Masahiro Akita Autos Outperform 4.1 76 97 47 94 8354 Fukuoka Financial Group Takashi Miura Banks Underperform 3.5 94 57 19 66 8697 Japan Exchange Group Takehito Yamanaka Brokers, Insurance & Nonbank Financials Neutral 3.0 18 2 33 2 4043 Tokuyama Masami Sawato Chemicals Neutral 4.2 14 78 26 29 6753 Sharp Mika Nishimura Consumer Electronics Underperform 1.6 19 47 22 11 2875 Toyo Suisan Masashi Mori Consumer Staples Neutral 2.8 77 38 35 55 4062 IBIDEN Akinori Kanemoto Electronic Components Neutral 2.1 78 7 17 15 6256 NuFlare Technology Yoshiyasu Takemura Industrial Electronics Neutral 3.7 98 58 77 97 6502 Toshiba Hideyuki Maekawa Industrial Electronics Outperform 3.7 40 90 16 49 6273 SMC Shinji Kuroda Machinery Neutral 3.9 39 82 70 78 7013 IHI Shinji Kuroda Machinery Underperform 2.4 56 22 27 22 5440 Kyoei Steel Shinya Yamada Metals Neutral 2.7 34 10 52 10 4151 Kyowa Hakko Kirin Fumiyoshi Sakai Pharmaceuticals & Biotechnology Outperform 4.1 63 43 46 44 4506 Sumitomo Dainippon Pharma Fumiyoshi Sakai Pharmaceuticals & Biotechnology Neutral 2.2 78 67 38 75 4508 Mitsubishi Tanabe Pharma Fumiyoshi Sakai Pharmaceuticals & Biotechnology Neutral 2.8 81 79 41 95 1802 Obayashi Corp Masahiro Mochizuki Real Estate, Housing, Construction, REITs Neutral 4.5 87 78 64 92 Note: Consensus rating assigns a score of 5 to a Buy, 3 to a Hold, and 1 to a Sell as per Bloomberg methodology. HOLT® is not part of Credit Suisse Research. Source: Credit Suisse, the BLOOMBERG PROFESSIONAL™ service, HOLT®

2017 Japan Outlook 41 13 January 2017

5) Self Help & Structural Change

Figure 20: Favorable Consensus HOLT Scorecard Ticker Company Analyst Sector CS Rating Rating Quality Momentum Valuation Overall 7244 Ichikoh Industries Koji Takahashi Auto Parts Outperform 5.0 85 97 47 91 7259 Aisin Seiki Masahiro Akita Auto Parts Outperform 4.4 85 74 24 72 7201 Nissan Motor Masahiro Akita Autos Neutral 4.0 97 71 43 90 8306 Mitsubishi UFJ Financial Group Takashi Miura Banks Outperform 4.1 64 68 74 94 8316 Sumitomo Mitsui Financial Group Takashi Miura Banks Outperform 4.4 87 51 98 100 8411 Takashi Miura Banks Neutral 3.5 72 66 64 91 8604 Nomura Holdings Takehito Yamanaka Brokers, Insurance & Nonbank Financials Neutral 3.0 30 98 36 55 4183 Mitsui Chemicals Masami Sawato Chemicals Outperform 4.2 40 87 61 78 4188 Mitsubishi Chemical Masami Sawato Chemicals Outperform 3.8 92 81 36 88 4901 Fujifilm Holdings Mika Nishimura Consumer Electronics Outperform 4.3 62 33 25 23 6753 Sharp Mika Nishimura Consumer Electronics Underperform 1.6 19 47 22 11 7752 Ricoh Mika Nishimura Consumer Electronics Underperform 1.8 48 13 9 3 2201 Morinaga & Co Masashi Mori Consumer Staples Outperform 5.0 32 98 20 52 2264 Morinaga Milk Masashi Mori Consumer Staples Outperform 5.0 37 91 11 42 2502 Asahi Group Holdings Masashi Mori Consumer Staples Neutral 4.6 85 55 68 91 6594 Nidec Akinori Kanemoto Electronic Components Outperform 4.4 8 84 88 71 6762 TDK Akinori Kanemoto Electronic Components Neutral 3.5 44 69 22 38 6971 Kyocera Akinori Kanemoto Electronic Components Neutral 2.8 73 48 15 41 6501 Hitachi Hideyuki Maekawa Industrial Electronics Outperform 4.2 76 47 30 54 4751 CyberAgent Keiichi Yoneshima Internet Outperform 4.0 64 22 98 73 7012 Kawasaki Heavy Industries Shinji Kuroda Machinery Neutral 3.0 35 8 40 12 5486 Hitachi Metals Shinya Yamada Metals Outperform 4.2 35 57 82 66 4502 Takeda Pharmaceutical Fumiyoshi Sakai Pharmaceuticals & Biotechnology Neutral 3.0 65 75 17 48 4204 Sekisui Chemical Masahiro Mochizuki Real Estate, Housing, Construction, REITs Outperform 4.0 54 92 54 82 Note: Consensus rating assigns a score of 5 to a Buy, 3 to a Hold, and 1 to a Sell as per Bloomberg methodology. HOLT® is not part of Credit Suisse Research. Source: Credit Suisse, the BLOOMBERG PROFESSIONAL™ service, HOLT®

Figure 21: Unfavorable Consensus HOLT Scorecard Ticker Company Analyst Sector CS Rating Rating Quality Momentum Valuation Overall 5949 Unipres Koji Takahashi Auto Parts Neutral 3.3 68 35 3 18 7267 Honda Motor Masahiro Akita Autos Neutral 3.7 99 74 33 85 8572 ACOM Takehito Yamanaka Brokers, Insurance & Nonbank Financials Neutral 4.3 21 79 77 74 6727 Wacom Akinori Kanemoto Electronic Components Underperform 2.0 44 10 77 36 6701 NEC Hideyuki Maekawa Industrial Electronics Neutral 3.2 83 13 43 43 2432 DeNA Keiichi Yoneshima Internet Outperform 4.1 24 45 56 29 7013 IHI Shinji Kuroda Machinery Underperform 2.4 56 22 27 22 4508 Mitsubishi Tanabe Pharma Fumiyoshi Sakai Pharmaceuticals & Biotechnology Neutral 2.8 81 79 41 95 5332 TOTO Masahiro Mochizuki Real Estate, Housing, Construction, REITs Underperform 2.4 9 29 45 12 Note: Consensus rating assigns a score of 5 to a Buy, 3 to a Hold, and 1 to a Sell as per Bloomberg methodology. HOLT® is not part of Credit Suisse Research. Source: Credit Suisse, the BLOOMBERG PROFESSIONAL™ service, HOLT®

2017 Japan Outlook 42 13 January 2017

6) Secular Themes

Figure 22: Favorable Consensus HOLT Scorecard Ticker Company Analyst Sector CS Rating Rating Quality Momentum Valuation Overall 6902 Denso Masahiro Akita Auto Parts Neutral 3.8 72 54 27 55 7203 Toyota Motor Masahiro Akita Autos Neutral 3.6 92 75 68 98 8306 Mitsubishi UFJ Financial Group Takashi Miura Banks Outperform 4.1 64 68 74 94 8316 Sumitomo Mitsui Financial Group Takashi Miura Banks Outperform 4.4 87 51 98 100 8411 Mizuho Financial Group Takashi Miura Banks Neutral 3.5 72 66 64 91 8253 Credit Saison Takehito Yamanaka Brokers, Insurance & Nonbank Financials Outperform 3.2 68 83 66 96 3402 Toray Industries Masami Sawato Chemicals Outperform 4.3 6 6 32 3 4183 Mitsui Chemicals Masami Sawato Chemicals Outperform 4.2 40 87 61 78 6752 Panasonic Mika Nishimura Consumer Electronics Neutral 3.9 63 36 29 33 6796 Clarion Mika Nishimura Consumer Electronics Outperform 4.3 40 87 80 87 2264 Morinaga Milk Masashi Mori Consumer Staples Outperform 5.0 37 91 11 42 6594 Nidec Akinori Kanemoto Electronic Components Outperform 4.4 8 84 88 71 6762 TDK Akinori Kanemoto Electronic Components Neutral 3.5 44 69 22 38 6770 Alps Electric Akinori Kanemoto Electronic Components Outperform 4.5 31 63 27 25 6807 Japan Aviation Electronics Industry Akinori Kanemoto Electronic Components Neutral 3.3 95 25 44 66 6963 ROHM Akinori Kanemoto Electronic Components Outperform 4.1 51 70 15 40 6981 Murata Manufacturing Akinori Kanemoto Electronic Components Outperform 4.0 56 56 75 76 7915 Nissha Printing Akinori Kanemoto Electronic Components Outperform 3.8 32 50 72 51 6501 Hitachi Hideyuki Maekawa Industrial Electronics Outperform 4.2 76 47 30 54 6503 Mitsubishi Electric Hideyuki Maekawa Industrial Electronics Neutral 4.6 53 83 34 61 6701 NEC Hideyuki Maekawa Industrial Electronics Neutral 3.2 83 13 43 43 6702 Fujitsu Hideyuki Maekawa Industrial Electronics Neutral 4.1 37 60 7 17 6754 Anritsu Hideyuki Maekawa Industrial Electronics Neutral 3.0 35 3 11 2 4689 Yahoo Japan Keiichi Yoneshima Internet Outperform 4.2 22 41 86 50 4751 CyberAgent Keiichi Yoneshima Internet Outperform 4.0 64 22 98 73 4755 Rakuten Keiichi Yoneshima Internet Neutral 3.7 20 7 82 20 6098 Recruit Holdings Keiichi Yoneshima Internet Outperform 4.4 31 81 91 83 9449 GMO Internet Keiichi Yoneshima Internet Outperform 4.8 13 40 63 21 5406 Kobe Steel Shinya Yamada Metals Neutral 3.1 79 9 0 9 4502 Takeda Pharmaceutical Fumiyoshi Sakai Pharmaceuticals & Biotechnology Neutral 3.0 65 75 17 48 4503 Astellas Pharma Fumiyoshi Sakai Pharmaceuticals & Biotechnology Neutral 4.3 83 40 71 87 4507 Shionogi Fumiyoshi Sakai Pharmaceuticals & Biotechnology Outperform 4.5 44 90 70 97 4523 Eisai Fumiyoshi Sakai Pharmaceuticals & Biotechnology Underperform 2.9 33 68 14 21 4568 Daiichi Sankyo Fumiyoshi Sakai Pharmaceuticals & Biotechnology Neutral 2.3 76 52 32 51 4578 Otsuka Holdings Fumiyoshi Sakai Pharmaceuticals & Biotechnology Neutral 3.9 60 89 37 78 1721 Comsys Holdings Masahiro Mochizuki Real Estate, Housing, Construction, REITs Outperform 3.0 69 95 47 87 1893 Penta-Ocean Construction Masahiro Mochizuki Real Estate, Housing, Construction, REITs Outperform 5.0 67 92 57 89 Note: Consensus rating assigns a score of 5 to a Buy, 3 to a Hold, and 1 to a Sell as per Bloomberg methodology. HOLT® is not part of Credit Suisse Research. Source: Credit Suisse, the BLOOMBERG PROFESSIONAL™ service, HOLT®

Figure 23: Unfavorable Consensus HOLT Scorecard Ticker Company Analyst Sector CS Rating Rating Quality Momentum Valuation Overall 7251 Keihin Koji Takahashi Auto Parts Neutral 3.4 90 59 6 55 7202 Isuzu Motors Masahiro Akita Autos Outperform 4.4 84 31 69 74 8616 Tokai Tokyo Financial Takehito Yamanaka Brokers, Insurance & Nonbank Financials Underperform 2.3 19 26 72 26 4004 Showa Denko Masami Sawato Chemicals Neutral 3.4 55 86 18 53 4901 Fujifilm Holdings Mika Nishimura Consumer Electronics Outperform 4.3 62 33 25 23 4902 Konica Minolta Mika Nishimura Consumer Electronics Neutral 4.1 49 39 13 14 7751 Canon Mika Nishimura Consumer Electronics Neutral 3.0 60 20 28 18 7752 Ricoh Mika Nishimura Consumer Electronics Underperform 1.8 48 13 9 3 2914 Japan Tobacco Masashi Mori Consumer Staples Outperform 4.4 89 8 75 71 4062 IBIDEN Akinori Kanemoto Electronic Components Neutral 2.1 78 7 17 15 6256 NuFlare Technology Yoshiyasu Takemura Industrial Electronics Neutral 3.7 98 58 77 97 6471 NSK Shinji Kuroda Machinery Outperform 3.5 30 74 26 34 6472 NTN Shinji Kuroda Machinery Outperform 3.5 61 56 12 33 5947 Rinnai Masahiro Mochizuki Real Estate, Housing, Construction, REITs Underperform 3.0 43 28 75 46 Note: Consensus rating assigns a score of 5 to a Buy, 3 to a Hold, and 1 to a Sell as per Bloomberg methodology. HOLT® is not part of Credit Suisse Research. Source: Credit Suisse, the BLOOMBERG PROFESSIONAL™ service, HOLT®

2017 Japan Outlook 43 13 January 2017

7) Valuation

Figure 24: Cheap Valuation Consensus HOLT Scorecard Ticker Company Analyst Sector CS Rating Rating Quality Momentum Valuation Overall 4246 DaikyoNishikawa Koji Takahashi Auto Parts Outperform 4.3 95 21 94 89 7201 Nissan Motor Masahiro Akita Autos Neutral 4.0 97 71 43 90 8303 Shinsei Bank Takashi Miura Banks Outperform 3.8 60 51 69 69 8750 Dai-ichi Life Takehito Yamanaka Brokers, Insurance & Nonbank Financials Outperform 3.8 91 60 58 88 4183 Mitsui Chemicals Masami Sawato Chemicals Outperform 4.2 40 87 61 78 4188 Mitsubishi Chemical Masami Sawato Chemicals Outperform 3.8 92 81 36 88 6796 Clarion Mika Nishimura Consumer Electronics Outperform 4.3 40 87 80 87 8283 PALTAC Masashi Mori Consumer Staples Outperform 5.0 65 48 57 63 6501 Hitachi Hideyuki Maekawa Industrial Electronics Outperform 4.2 76 47 30 54 4689 Yahoo Japan Keiichi Yoneshima Internet Outperform 4.2 22 41 86 50 6113 Amada Shinji Kuroda Machinery Neutral 3.0 50 56 45 48 5411 JFE Shinya Yamada Metals Outperform 3.6 75 17 6 14 4503 Astellas Pharma Fumiyoshi Sakai Pharmaceuticals & Biotechnology Neutral 4.3 83 40 71 87 1801 Taisei Corp Masahiro Mochizuki Real Estate, Housing, Construction, REITs Outperform 4.2 80 77 82 95 1928 Sekisui House Masahiro Mochizuki Real Estate, Housing, Construction, REITs Outperform 4.9 90 66 65 94

Note: Consensus rating assigns a score of 5 to a Buy, 3 to a Hold, and 1 to a Sell as per Bloomberg methodology. HOLT® is not part of Credit Suisse Research. Source: Credit Suisse, the BLOOMBERG PROFESSIONAL™ service, HOLT®

Figure 25: Expensive Valuation Consensus HOLT Scorecard Ticker Company Analyst Sector CS Rating Rating Quality Momentum Valuation Overall 7276 Koito Manufacturing Koji Takahashi Auto Parts Underperform 4.0 60 81 92 97 7211 Mitsubishi Motors Masahiro Akita Autos Underperform 2.7 18 0 41 3 8355 Shizuoka Bank Takashi Miura Banks Underperform 2.8 43 13 40 21 8697 Japan Exchange Group Takehito Yamanaka Brokers, Insurance & Nonbank Financials Neutral 3.0 18 2 33 2 3436 SUMCO Masami Sawato Chemicals Underperform 3.2 32 95 10 42 4182 Mitsubishi Gas Chemical Masami Sawato Chemicals Underperform 2.8 32 97 5 38 6753 Sharp Mika Nishimura Consumer Electronics Underperform 1.6 19 47 22 11 6146 DISCO Hideyuki Maekawa Industrial Electronics Neutral 4.2 33 88 78 85 6857 Advantest Hideyuki Maekawa Industrial Electronics Underperform 2.6 15 90 6 19 2371 Kakaku.com Keiichi Yoneshima Internet Neutral 3.3 15 9 99 26 2413 M3 Fumiyoshi Sakai Internet Outperform 4.4 8 33 98 35 6861 Keyence Shinji Kuroda Machinery Neutral 4.2 14 49 80 46 5801 Furukawa Electric Shinya Yamada Metals Underperform 3.3 64 86 38 76 5332 TOTO Masahiro Mochizuki Real Estate, Housing, Construction, REITs Underperform 2.4 9 29 45 12

Note: Consensus rating assigns a score of 5 to a Buy, 3 to a Hold, and 1 to a Sell as per Bloomberg methodology. HOLT® is not part of Credit Suisse Research. Source: Credit Suisse, the BLOOMBERG PROFESSIONAL™ service, HOLT®

2017 Japan Outlook 44 13 January 2017

HOLT The HOLT Scorecard takes a systematic approach to identify factor exposures, assessing companies on Operational Quality, Momentum and Valuation. As a corollary to the qualitative assessment offered by each analyst in this report, we also highlight the 50 highest (and lowest) scoring companies under the HOLT Scorecard framework (with a market capitalization greater than ¥100bn). Companies with higher gearing to the cycle are generally those with high scores on Valuation (i.e., cheaper) and Momentum (i.e., fundamentals improving), while Operational Quality can typically be deemphasized. In contrast, a hedged strategy (vis-à-vis the cycle) would focus on companies with higher Operational Quality. Outperform-rated stocks that score favorably are Fuji Heavy, SMFG, Olympus, Shionogi, Credit Saison, Taisei, and Sekisui House. Conversely, Underperform-rated stocks that score poorly include Japan Exchange, Mitsubishi Motors and Ricoh. Note: HOLT® is not part of Credit Suisse Research.

2017 Japan Outlook 45 13 January 2017

Figure 26: HOLT Scorecard – Top 50 Highest Scoring Consensus HOLT Scorecard Ticker Company CS Rating Rating Quality Momentum Valuation Overall 8840 Daikyo Not Rated 3.0 80 95 100 100 7270 Fuji Heavy Industries Outperform 4.3 93 97 98 100 1719 HAZAM ANDO Not Rated 5.0 99 99 95 100 4565 Sosei Group Neutral 4.7 75 54 92 100 8316 Sumitomo Mitsui Financial Group Outperform 4.4 87 51 98 100 1951 Kyowa Exeo Not Rated 3.5 98 98 78 100 1808 HASEKO Corp Neutral 3.7 94 93 96 99 1821 Sumi Mitsu Const Not Rated NA 77 88 97 99 6432 Takeuchi Mfg Not Rated 4.4 72 94 98 99 5110 Sumitomo Rubber Industries Neutral 2.8 96 91 70 99 4205 Zeon Neutral 4.4 94 69 86 99 1820 Nishimatsu Const Not Rated 5.0 92 99 67 99 7733 Olympus Outperform 4.2 49 84 83 98 1720 TOKYU CONST Not Rated 5.0 88 72 99 98 1812 Corp Neutral 3.8 85 87 77 98 6448 Brother Ind Not Rated 3.9 94 83 58 98 7203 Toyota Motor Neutral 3.6 92 75 68 98 8304 Aozora Bank Neutral 2.7 34 91 100 98 8370 Kiyo Bank Not Rated NA 59 81 91 98 8870 Sumitomo RE Sale Not Rated 4.0 83 88 98 98 4005 Neutral 4.2 99 56 88 97 7276 Koito Manufacturing Underperform 3.9 60 81 92 97 1959 Kyudenko Not Rated 4.5 95 57 93 97 6412 Heiwa Not Rated 3.0 90 83 81 97 9433 KDDI Not Rated 4.3 85 78 71 97 3088 Matsumotokiyoshi HD Not Rated 4.1 88 69 71 97 8425 IBJ Leasing Not Rated NA 72 71 82 97 4507 Shionogi Outperform 4.5 44 90 70 97 8630 SOMPO Holdings Neutral 4.3 84 72 67 97 1803 Shimizu Corp Underperform 4.3 87 90 65 97 7261 Motor Neutral 4.0 87 77 63 96 2440 Gurunavi Neutral 3.8 90 46 97 96 8253 Credit Saison Outperform 3.2 68 83 66 96 7224 ShinMaywa Indus Not Rated 5.0 94 85 60 96 4924 Ci:z Holdings Not Rated 3.7 26 94 98 95 7272 Yamaha Motor Neutral 3.9 86 94 45 95 2281 Prima Meat Pack Not Rated 5.0 61 92 78 95 4508 Mitsubishi Tanabe Pharma Neutral 2.8 81 79 41 95 3632 Gree Underperform 2.8 77 87 67 95 1801 Taisei Corp Outperform 4.2 80 77 82 95 8963 Invincible Inv Not Rated 4.7 78 80 58 95 6406 Fujitec Not Rated 5.0 73 73 89 95 4042 Neutral 4.5 88 100 44 95 8184 Shimachu Not Rated 2.3 91 95 36 95 6103 Okuma Corp Neutral 3.2 59 97 81 95 8366 Shiga Bank Not Rated 3.0 86 77 57 94 2730 Edion Not Rated 3.0 77 91 73 94 1928 Sekisui House Outperform 4.9 90 66 65 94 3349 Cosmos Pharm Not Rated 2.7 51 78 88 94 2121 Mixi Neutral 3.9 99 30 100 94

Note: Consensus rating assigns a score of 5 to a Buy, 3 to a Hold, and 1 to a Sell as per Bloomberg methodology. HOLT® is not part of Credit Suisse Research. Source: Credit Suisse, the BLOOMBERG PROFESSIONAL™ service, HOLT®

2017 Japan Outlook 46 13 January 2017

Figure 27: HOLT Scorecard – Bottom 50 Lowest Scoring Consensus HOLT Scorecard Ticker Company CS Rating Rating Quality Momentum Valuation Overall 9504 Chugoku Elec Pwr Not Rated 3.6 8 4 8 0 9010 Fuji Kyuko Not Rated 3.0 1 4 8 0 9509 Hokkaido ElecPwr Not Rated 3.8 0 0 0 0 9706 Japan Airpt Term Not Rated 3.0 1 2 6 0 7181 Japan Post Insurance Neutral 3.2 34 6 3 0 8703 Kabu.com Securities Neutral 3.0 9 36 30 0 2220 Kameda Seika Not Rated 4.5 11 9 12 0 8410 Seven Bank Not Rated 3.8 16 32 9 0 3289 Tokyu Fudosan Holdings Neutral 4.0 3 15 3 0 9708 Imperial Hotel Not Rated 3.0 9 12 8 1 3938 LINE Not Rated 3.4 8 15 0 1 9007 Odakyu Elec Ry Not Rated 2.1 3 7 29 1 2590 DyDo Drinco Not Rated 3.7 12 22 2 2 4681 Resorttrust Not Rated 4.3 8 5 21 2 7779 Cyberdyne Not Rated 4.7 5 10 8 2 8697 Japan Exchange Group Neutral 3.0 18 2 33 2 2331 Sohgo Sec Serv Not Rated 4.3 3 5 34 2 9603 HIS Not Rated 4.8 10 26 4 2 8628 Matsui Securities Neutral 3.0 15 6 62 2 9107 Kawasaki Kisen Not Rated 1.7 1 39 2 2 8976 Daiwa Office Inv Not Rated 3.8 35 18 18 3 3402 Toray Industries Outperform 4.3 6 6 32 3 3099 Isetan Mitsukoshi Not Rated 3.6 19 8 29 3 6965 Hamamatsu Photo Not Rated 4.1 11 11 29 3 2802 Neutral 4.3 25 12 49 3 7211 Mitsubishi Motors Underperform 2.7 18 0 41 3 8086 Nipro Not Rated 3.0 17 29 6 3 6474 Nachi-Fujikoshi Not Rated 3.3 14 27 8 3 7752 Ricoh Underperform 1.8 48 13 9 3 9601 Shochiku Not Rated 3.0 2 43 17 4 9505 Hokuriku Elec Pw Not Rated 2.7 31 0 0 4 3865 Hokuetsu Kishu Not Rated 2.5 58 4 4 4 8379 Hiroshima Bank Not Rated 3.5 23 21 45 4 9506 Tohoku Elec Pwr Not Rated 3.8 22 20 11 4 9008 Keio Not Rated 2.5 25 6 21 4 2212 Yamazaki Baking Not Rated 2.7 42 37 8 5 8136 Sanrio Neutral 3.0 14 2 46 5 9783 Benesse Hldg Not Rated 2.6 22 38 5 5 9101 Not Rated 3.3 16 41 4 5 4661 Oriental Land Not Rated 3.9 7 9 52 6 9104 Mitsui Osk Not Rated 3.7 4 50 11 6 2811 Kagome Not Rated 3.0 0 88 5 6 9715 Transcosmos Not Rated 4.3 58 17 13 6 9044 Nankai Elec Rwy Not Rated 5.0 16 14 33 6 4528 Ono Pharmaceutical Outperform 3.6 43 2 30 6 9003 Sotetsu Holdings Not Rated 4.5 11 16 41 6 8570 Aeon Financial Service Neutral 3.0 36 4 49 6 5901 Not Rated 2.0 60 13 3 6 9616 Kyoritsu Maint Not Rated 4.3 10 41 18 7 8876 Relo Group Not Rated 4.7 5 25 59 7

Note: Consensus rating assigns a score of 5 to a Buy, 3 to a Hold, and 1 to a Sell as per Bloomberg methodology. HOLT® is not part of Credit Suisse Research. Source: Credit Suisse, the BLOOMBERG PROFESSIONAL™ service, HOLT®

2017 Japan Outlook 47 13 January 2017

Companies Mentioned (Price as of 13-Jan-2017) ACOM (8572.T, ¥500) Actelion (ATLN.S, SFr228.8) Advantest (6857.T, ¥1,968) Aichi Steel (5482.T, ¥5,050) Aisin Seiki (7259.T, ¥5,080) Alps Electric (6770.T, ¥2,780) Amada (6113.T, ¥1,329) Amlin (APLCY.PK, $30.45) Anritsu (6754.T, ¥715) Aozora Bank (8304.T, ¥413) Asahi Group Holdings (2502.T, ¥3,762) Astellas Pharma (4503.T, ¥1,610) Bank of Ayudhya (Unlisted) Bank of Kyoto (8369.T, ¥874) Bridgestone (5108.T, ¥4,193) COLOPL Inc (3668.T, ¥1,029) Canon (7751.T, ¥3,338) Chugai Pharmaceutical (4519.T, ¥3,450) Clarion (6796.T, ¥440) Comsys Holdings (1721.T, ¥2,135) Credit Saison (8253.T, ¥2,115) CyberAgent (4751.T, ¥2,968) DISCO (6146.T, ¥14,440) Dai-ichi Life (8750.T, ¥1,999) Daiichi Sankyo (4568.T, ¥2,514) Daikin Industries (6367.T, ¥11,280) DaikyoNishikawa (4246.T, ¥1,467) DeNA (2432.T, ¥2,672) Denka (4061.T, ¥532) Denso (6902.T, ¥5,055) Eisai (4523.T, ¥6,632) Fanuc (6954.T, ¥20,545) Fuji Heavy Industries (7270.T, ¥4,838) Fujifilm Holdings (4901.T, ¥4,453) Fujikura (5803.T, ¥670) Fujitsu (6702.T, ¥679) Fukuoka Financial Group (8354.T, ¥519) Furukawa Electric (5801.T, ¥3,545) GMO Click Hldg (7177.T, ¥862) GMO Internet (9449.T, ¥1,592) GS Yuasa Corp (6674.T, ¥478) Gree (3632.T, ¥631) Hitachi (6501.T, ¥658) Hitachi Construction Machinery (6305.T, ¥2,597) Hitachi Kokusai Electric (6756.T, ¥2,614) Hitachi Metals (5486.T, ¥1,604) Hitachi Tool Eng (5963.OS^J12) Hitachi Tool Eng (5963.OS^J12) Hitachi Tool Eng (5963.OS^J12) Hon Hai Precision (2317.TW, NT$84.2) Honda Motor (7267.T, ¥3,446) IBIDEN (4062.T, ¥1,601) IHI (7013.T, ¥307) Ichikoh Industries (7244.T, ¥400) Isuzu Motors (7202.T, ¥1,520) JEOL (6951.T, ¥560) JFE (5411.T, ¥1,850) JSR (4185.T, ¥1,964) Japan Aviation Electronics Industry (6807.T, ¥1,743) Japan Display (6740.T, ¥333) Japan Exchange Group (8697.T, ¥1,692) Japan Real Estate Inv Corp (8952.T, ¥641,000) Japan Tobacco (2914.T, ¥3,870) KOSE (4922.T, ¥10,060) Kakaku.com (2371.T, ¥1,984) Kawasaki Heavy Industries (7012.T, ¥366) Keihin (7251.T, ¥2,091) Keyence (6861.T, ¥83,790) Kikkoman (2801.T, ¥3,675) Kobe Steel (5406.T, ¥1,098) Koito Manufacturing (7276.T, ¥6,190) Komatsu (6301.T, ¥2,682) Konica Minolta (4902.T, ¥1,188) Kyocera (6971.T, ¥5,800) Kyoei Steel (5440.T, ¥2,256) Kyowa Hakko Kirin (4151.T, ¥1,630) M3 (2413.T, ¥3,115) MS&AD Insurance Group Holdings (8725.T, ¥3,705) Makita (6586.T, ¥7,940) Matsui Securities (8628.T, ¥1,018) Mitsubishi Chemical (4188.T, ¥792) Mitsubishi Electric (6503.T, ¥1,646) Mitsubishi Gas Chemical (4182.T, ¥2,103) Mitsubishi Motors (7211.T, ¥674) Mitsubishi Tanabe Pharma (4508.T, ¥2,277) Mitsubishi UFJ Financial Group (8306.T, ¥730) Mitsui Chemicals (4183.T, ¥541) 2017 Japan Outlook 48 13 January 2017

Mitsui Fudosan (8801.T, ¥2,686) Mixi (2121.T, ¥4,600) Mizuho Financial Group (8411.T, ¥214) Monex Group (8698.T, ¥324) Morgan Stanley (MS.N, $43.63) Morinaga & Co (2201.T, ¥4,800) Morinaga Milk (2264.T, ¥810) Murata Manufacturing (6981.T, ¥15,105) NEC (6701.T, ¥327) NGK Insulators (5333.T, ¥2,314) NSK (6471.T, ¥1,364) NTN (6472.T, ¥483) NTT DoCoMo (9437.T, ¥2,760) Nabtesco Corp (6268.T, ¥2,812) Nexon (3659.T, ¥1,760) Nidec (6594.T, ¥10,495) Nintendo (7974.T, ¥23,750) Nippon Shinyaku (4516.T, ¥5,910) Nippon Shokubai (4114.T, ¥7,540) Nissan Motor (7201.T, ¥1,160) Nissha Printing (7915.T, ¥2,950) Nomura Holdings (8604.T, ¥703) NuFlare Technology (6256.T, ¥6,870) Obayashi Corp (1802.T, ¥1,092) Okamoto (5122.T, ¥1,077) Ono Pharmaceutical (4528.T, ¥2,506) Osaka Titanium Technologies (5726.T, ¥1,612) Otsuka Holdings (4578.T, ¥5,650) PALTAC (8283.T, ¥2,866) Panasonic (6752.T, ¥1,215) Penta-Ocean Construction (1893.T, ¥569) Pigeon (7956.T, ¥3,055) Pioneer (6773.T, ¥254) Protective Life (PL_pc.N, $25.7) ROHM (6963.T, ¥7,180) Rakuten (4755.T, ¥1,178) Recruit Holdings (6098.T, ¥4,780) Ricoh (7752.T, ¥1,011) Rinnai (5947.T, ¥9,620) SCREEN (7735.T, ¥6,740) SMC (6273.T, ¥28,470) SUMCO (3436.T, ¥1,527) Sawai Pharmaceutical (4555.T, ¥6,310) Sekisui Chemical (4204.T, ¥1,960) Sekisui House (1928.T, ¥1,978) Sharp (6753.T, ¥309) Shimano (7309.T, ¥19,090) Shin-Etsu Chemical (4063.T, ¥9,472) Shinko Electric Industries (6967.T, ¥870) Shinsei Bank (8303.T, ¥197) Shionogi (4507.T, ¥5,584) Shizuoka Bank (8355.T, ¥1,001) Showa Denko (4004.T, ¥1,764) Sony (6758.T, ¥3,549) Sony Financial (8729.T, ¥1,826) Sumitomo Dainippon Pharma (4506.T, ¥2,098) Sumitomo Electric Industries (5802.T, ¥1,659) Sumitomo Mitsui Financial Group (8316.T, ¥4,544) Sumitomo Osaka Cement (5232.T, ¥459) Sumitomo Rubber Industries (5110.T, ¥1,868) Suruga Bank (8358.T, ¥2,585) Suzuki Motor (7269.T, ¥4,301) Sysmex (6869.T, ¥7,000) T&D Holdings (8795.T, ¥1,578) TDK (6762.T, ¥7,980) TOTO (5332.T, ¥4,700) Taiheiyo Cement (5233.T, ¥385) Taisei Corp (1801.T, ¥838) Taisho Pharmaceutical Holdings (4581.T, ¥9,830) Takeda Pharmaceutical (4502.T, ¥4,875) Takeda Teva Yakuhin, Ltd. (Unlisted) Toho Titanium (5727.T, ¥777) Tokai Rika (6995.T, ¥2,333) Tokai Tokyo Financial (8616.T, ¥632) Tokuyama (4043.T, ¥454) Tokyo Electron (8035.T, ¥11,275) Toray Industries (3402.T, ¥977) Toshiba (6502.T, ¥287) Toyo Suisan (2875.T, ¥4,095) Toyota Motor (7203.T, ¥6,882) Tsumura & Co (4540.T, ¥3,275) Union bank of California (Unlisted) Unipres (5949.T, ¥2,335) Valeo (VLOF.PA, €54.45) Wacom (6727.T, ¥333) Wako Pure Chemical (Unlisted) Yahoo Japan (4689.T, ¥477) Yaskawa Electric Corp (6506.T, ¥1,881)

2017 Japan Outlook 49 13 January 2017

Yokogawa Electric Corp (6841.T, ¥1,743)

Disclosure Appendix Analyst Certification The analysts identified in this report each certify, with respect to the companies or securities that the individual analyzes, that (1) the views expressed in this report accurately reflect his or her personal views about all of the subject companies and securities 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 in this report. The analyst(s) responsible for preparing this research report received Compensation that is based upon various factors including Credit Suisse's total revenues, a portion of which are generated by Credit Suisse's investment banking activities As of December 10, 2012 Analysts’ stock rating are defined as follows: Outperform (O) : The stock’s total return is expected to outperform the relevant benchmark* over the next 12 months. Neutral (N) : The stock’s total return is expected to be in line with the relevant benchmark* over the next 12 months. Underperform (U) : The stock’s total return is expected to underperform the relevant benchmark* over the next 12 months. *Relevant benchmark by region: As of 10th December 2012, Japanese ratings are based on a stock’s total return relative to the analyst's coverage universe which consists of all companies covered by the analyst within the relevant sector, with Outperforms representing the most attractive, Neutrals the less attractive, and Underperforms the least attractive investment opportunities. As of 2nd October 2012, U.S. and Canadian as well as European ratings are based on a stock’s total return relative to the analyst's coverage universe which consists of all companies covered by the analyst within the relevant sector, with Outperforms representing the most attractive, Neutrals the less attractive, and Underperforms the least attractive investment opportunities. For Latin American and non-Japan Asia stocks, ratings are based on a stock’s total return relative to the average total return of the relevant country or regional benchmark; prior to 2nd October 2012 U.S. and Canadian ratings were based on (1) a stock’s absolute total return potential to its current share price and (2) the relative attractiveness of a stock’s total return potential within an analyst’s coverage universe. For Australian and New Zealand stocks, the expected total return (ETR) calculation includes 12-month rolling dividend yield. An Outperform rating is assigned where an ETR is greater than or equal to 7.5%; Underperform where an ETR less than or equal to 5%. A Neutral may be assigned where the ETR is between -5% and 15%. The overlapping rating range allows analysts to assign a rating that puts ETR in the context of associated risks. Prior to 18 May 2015, ETR ranges for Outperform and Underperform ratings did not overlap with Neutral thresholds between 15% and 7.5%, which was in operation from 7 July 2011. Restricted (R) : In certain circumstances, Credit Suisse policy and/or applicable law and regulations preclude certain types of communications, including an investment recommendation, during the course of Credit Suisse's engagement in an investment banking transaction and in certain other circumstances. Not Rated (NR) : Credit Suisse Equity Research does not have an investment rating or view on the stock or any other securities related to the company at this time. Not Covered (NC) : Credit Suisse Equity Research does not provide ongoing coverage of the company or offer an investment rating or investment view on the equity security of the company or related products. Volatility Indicator [V] : A stock is defined as volatile if the stock price has moved up or down by 20% or more in a month in at least 8 of the past 24 months or the analyst expects significant volatility going forward. Analysts’ sector weightings are distinct from analysts’ stock ratings and are based on the analyst’s expectations for the fundamentals and/or valuation of the sector* relative to the group’s historic fundamentals and/or valuation: Overweight : The analyst’s expectation for the sector’s fundamentals and/or valuation is favorable over the next 12 months. Market Weight : The analyst’s expectation for the sector’s fundamentals and/or valuation is neutral over the next 12 months. Underweight : The analyst’s expectation for the sector’s fundamentals and/or valuation is cautious over the next 12 months. *An analyst’s coverage sector consists of all companies covered by the analyst within the relevant sector. An analyst may cover multiple sectors. Credit Suisse's distribution of stock ratings (and banking clients) is:

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2017 Japan Outlook 50 13 January 2017

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2017 Japan Outlook 51 13 January 2017

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2017 Japan Outlook 52