Global Equity Research

December 8, 2005

Global Gambits - 2006 Chemicals

The Right Moves for Right Now chapter

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The following is a chapter from Global Gambits The Right Moves for Right Now, dated December 8, 2005. This chapter is presented for convenience,
and should be read in conjunction with the full report and its analyst certifications and important disclosures. The full report is available on MorganMarkets.
December 8, 2005
Global Sector Coordinator
Jeffrey J. Zekauskas
(1-212) 622-6644
jeffrey.zekauskas@jpmorgan.com
J.P. Morgan Securities Inc.
Full sector coverage details on
page 141
Global Equity Research
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Chemicals
We Prefer Specialty Situations in 2006
Key Drivers
Specialty Chemicals
In an environment of rising interest rates and uncertain
economic growth, we favor companies with capital
discipline and initiatives to improve financial returns. We
also prefer companies with promising product pipelines, which
should provide a steady flow of catalysts through 2006.
In addition, we prefer businesses that have demonstrated
good pricing momentum in a difficult raw material cost
environment and would be beneficiaries of a long-term
decrease in petrochemical pricing. During the first nine months
in 2005, average selling prices (including natural gas pass-
through) for DuPont, for example, improved 5% Y/Y.
Commodity Chemicals
We believe operating fundamentals in key petrochemical
markets could improve over the coming quarter. Unplanned
ethylene industry outages, stronger demand and the negative
effects of Hurricane Katrina on US Gulf Coast petrochemical
supply should leave petrochemical suppliers unusually well
positioned to benefit from tightness in MTBE, ethylene,
polyethylene, refining, TiO2 and other products.
Risks to these unusual conditions could stem from a
decelerating global economy, incrementally greater
ethylene capacity, and feedstock and energy cost pressure
for suppliers that include Dow Chemical, Georgia Gulf, Nova
Chemicals, Westlake, Lyondell, Huntsman, and Eastman
Chemical.
Our Non-Consensus Views
We favor large capitalization specialty chemical companies
in 2006 such as DuPont, Ashland and Akzo Nobel. We
believe these companies should begin to report improving
financial returns over the next 12-24 months reflecting
announced strategies for expense reduction, working capital
discipline, good capital management including share
repurchases, and new product introductions.
DuPonts cost initiatives remain large, and we see room for
appreciable improvement in return on assets. DuPonts goal
is a 300bps improvement in ROIC from 12-13% in 2004 by
2007. In addition, announced gross fixed cost reduction should
benefit earnings by US$600 million (US$0.65/share) and
reduce net working capital by US$1 billion over 2006-08.
Importantly, DD plans to repurchase US$2 billion in stock in
late 2006-07 in addition to US$3 billion in shares acquired at
the end of October in a one-time transaction, which would
shrink the share base by ~125 million shares, or 13%.
Ashlands transition to a specialty and construction
business from a conglomerate/refiner is complete, and
valuations should improve accordingly. We believe the
company has opportunities to improve its capital structure
through share buybacks, and to increase earnings in its APAC
construction business in the southern US.
In the European markets, we prefer Akzo Nobel to more
cyclical names. We believe the company should benefit from
an improvement in its pharmaceuticals business.
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Chemicals: Top Picks

Company Key Financials Rationale and Catalysts
DuPont
Recommendation: Overweight Fiscal EPS (Local): Year-end December DuPont is interested in raising returns through commercialization of technology; the company intends to grow through
Ticker: DD US / DD.N 2004 2005E 2006E less asset-intensive partnership routes. It intends to enhance shareholder value through active and substantial share
2.38 2.30 2.75 repurchases; it rejects meaningful acquisition, and looks to divest low-return businesses. However, it remains difficult
to accurately assess DuPonts progress given the sharply unfavorable raw material cost environment, which obscures
the effects of its major initiatives.
Exchange: NYSE P/E (Calendar)
Price (Local): US$43.15 2005E 2006E DuPont repurchased US$3 billion in shares (~80 million shares) in October in a one-time transaction, and the company
Mkt Cap (US$): 39.7 bn 18.7 15.7 plans to repurchase US$2 billion in stock (45 million shares at current prices) in late 2006-07. Accordingly, DuPonts
share count should decrease by a minimum of 7.5% in 2006, and by an additional 5% by 4Q07. The share repurchase
Analyst: Jeffrey J. Zekauskas EV/EBITDA (Calendar) should be accretive to earnings by US$0.10 in 2006 and by US$0.07 in 2007.
Phone: (1-212) 622-6644 2005E 2006E We rate DuPont Overweight with a June 2006 price target of US$55, representing a 20x P/E multiple based on our
Email: jeffrey.zekauskas@jpmorgan.com 8.9 7.8 2006 estimate, or an EV/EBITDA multiple of 9.7x. Based on our 2006 projections, DD trades at a P/E multiple of 15.7x
versus 17.6x for the average. On an EV/EBITDA basis, DD trades at an EV/EBITDA multiple of 7.8x versus 8.6x for
the average. Income-oriented investors may find DuPont attractive due to its 3.4% dividend yield.
Risks to target price: If DuPont fails to execute its cost reduction initiatives, and SG&A costs as a percentage of sales
remain flat or increase over the next three years, the shares are likely to come under pressure. Moreover, if Duponts
new product introduction efforts meet various obstacles and if general economic growth begins to slow meaningfully,
DuPonts earnings could lag our expectations and underperform the average chemical equity.
Ashland Inc.
Recommendation: Overweight Fiscal EPS (Local): Year-end September We rate Ashland Overweight. Ashlands balance sheet is in a strong net cash position, and the company is actively
Ticker: ASH US / ASH.N 2004 2005 2006E repurchasing shares and is capable of sharp earnings growth should it turn around its Ashland Paving and
4.72 5.62 3.35 Construction (APAC) operations. We believe positive pricing trends should boost Ashlands chemicals specialty and
chemical distribution businesses.
Exchange: NYSE P/E (Calendar) Ashland Paving and Construction (APAC): We believe the APAC business has underperformed given rising costs and
Price (Local): US$55.45 2005E 2006E poor weather. Since the construction business depends on weather conditions, drier-than-normal weather would
Mkt Cap (US$): 4.0 bn 9.9 16.5 significantly increase the construction volume, resulting in higher-than-expected revenue growth.
Valuation: Ashland currently trades at 6.1x 2006E EV/EBTIDA, and we believe the valuation of Ashland is poised to
Analyst: Jeffrey J. Zekauskas EV/EBITDA (Calendar) improve sharply as investors focus on its transformation from a refiner/conglomerate to a simpler chemicals and
Phone: (1-212) 622-6644 2005E 2006E construction company. Operating cash flow is set to accelerate due to improved operations. Based on the trading
Email: jeffrey.zekauskas@jpmorgan.com 3.6 6.0 multiples of comparable companies, we believe Ashland is undervalued.

Source: Company data, Datastream, JPMorgan estimates, JPMorgan SaVanT. Prices as of November 22, 2005.

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Chemicals: Top Picks (contd)

Company Key Financials Rationale and Catalysts
Akzo Nobel
Recommendation: Overweight Fiscal EPS (Local): Year-end December Akzo Nobels shares price has not yet fully recovered from the effects of the 2002-03 economic downturn, the
Ticker: AKZA NA / AKZO.A 2004 2005E 2006E expiration of the patent on Remeron (Organons most important drug), a series of pipeline failures and the de-rating of
2.78 2.56 2.71 the global pharmaceutical sector. Chronic underperformance, however, has now been reversed by the more stable
pharma sector valuations and the stabilization of Akzos pharma earnings, in our view. We see re-rating potential as
the pipeline maturesparticularly, the potential blockbuster Asenapine, an antipsychotic currently in Phase III trials.
Exchange: Amsterdam Stock Exchange P/E (Calendar)
We expect the re-rating to be driven by a series of clinical trial results, starting with the publication of further Phase II
Price (Local): 38.46 2005E 2006E data on Asenapine in December. An extensive programme of Phase III trials currently under way should provide a
Mkt Cap (): 12.9 bn 15.0 14.2 steady flow of further catalysts through 2006.

Akzos current valuation is well supported by its cash flow and the company has an above average dividend yield. Its
Analyst: Colin Isaac EV/EBITDA (Calendar)
more defensive earnings profile is increasingly attractive, in our view, as the cycle matures with at least 10% real
Phone: (44-20) 7325-9740 2005E 2006E
growth should Asenapine be approved. However, we see some risk given our view that the FDA is unlikely to remove
Email: colin.a.isaac@jpmorgan.com 7.0 7.9 the proposed black box warning on Livial, effectively preventing this drug from being launched in the US market.
Furthermore, we see short-term earnings risk for the coatings business following further sharp increases in raw
material prices.
Source: Company data, Datastream, JPMorgan estimates, JPMorgan SaVanT. Prices as of November 22, 2005.

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Chemicals: Stocks to Underweight

Company Key Financials Rationale and Catalysts
Cabot Corporation
Recommendation: Underweight Fiscal EPS (Local): Year-end September We rate Cabot Corporation (CBT) Underweight. A good part of CBTs current valuation appears to be based on
Ticker: CBT US / CBT.N 2004 2005 2006E anticipated future success in its currently small Cesium Formate business (~12-13% of F2005 pretax income) and its
1.98 1.72 1.85 inkjet operation (estimated 4-8% of pretax income). Accordingly, we believe there is risk to Cabots share price given
the difficult operating environment in its key business segments. CBTs shares sell at an EV/EBITDA multiple of 7.8x
based on FY06 estimate versus 7.9x for its peer group.
Exchange: NYSE P/E (Calendar)
Price (Local): US$34.08 2005E 2006E CBTs earnings from continuing operations decreased approximately 13% in FY05, reflecting negative comparisons in
Mkt Cap (US$): 2.1 bn 19.9 18.4 the supermetals business and raw material cost in the Carbon Black operations. We believe near-term challenges (low
predictability in profitability for Tantalum in FY06 and higher oil and natural gas prices for the Carbon Black business)
could cause lumpiness in future operating profits and hamper upward movement in the share price over the next 12
Analyst: Jeffrey J. Zekauskas EV/EBITDA (Calendar) months.
Phone: (1-212) 622-6644 2005E 2006E
Email: jeffrey.zekauskas@jpmorgan.com 9.2 7.8
Ecolab, Inc.
Recommendation: Underweight Fiscal EPS (Local): Year-end December Ecolabs core challenge, in our view, is to increase its sales at a multiple of the 2-3% average annual expansion pace
Ticker: ECL US / ECL.N 2004 2005E 2006E of the underlying global industries it serves. Given a reliance on acquisition activity as key to its growth prospects, mis-
1.20 1.35 1.50 steps or delays in the purchase or integration of acquisitions could pressure Ecolabs earnings and stock price. Ecolab
is a well-run company, in our opinion, with a strong business franchise. However, we believe there are more attractive
investment opportunities elsewhere in our universe of specialty and commodity chemical companies. Various chemical
Exchange: NYSE P/E (Calendar)
companies offer comparable long-term EPS growth rates at more attractive valuations or greater cyclical exposure to
Price (Local): US$33.35 2005E 2006E recovering markets. Moreover, ECLs stock price, in our view, discounts a successful long-term acquisition effort.
Mkt Cap (US$): 8.5 bn 24.8 22.2
Ecolab trades at a premium to our specialty and commodity chemical universe at 24.8x our 2005 EPS estimate and
22.2x our 2006 EPS estimate versus its peer group multiples of 17.6x and 15.9x our 2005 and 2006 EPS estimates,
Analyst: Jeffrey J. Zekauskas EV/EBITDA (Calendar)
respectively.
Phone: (1-212) 622-6644 2005E 2006E
Email: jeffrey.zekauskas@jpmorgan.com 10.8 9.7
Nalco
Recommendation: Underweight Fiscal EPS (Local): Year-end December 2005 is proving to be a trying year for Nalco. Volumes, margins, and working capital management are all likely to fall
Ticker: NLC US / NLC.N 2004 2005E 2006E short of initial expectations by a wide margin. The paper markets proved weaker than expected; the European
0.45 0.47 0.85 economies slowed; overall water treatment chemical volume growth in the mature economies was weak; Nalco was
slow to raise prices in the early part of the year; and raw material price inflation and hurricane-related outages added to
difficulties.
Exchange: NYSE P/E (Calendar)
Price (Local): US$16.97 2005E 2006E 2006 should show improvement, in our view. The new year should begin with a high level of product prices and the
Mkt Cap (US$): 2.4 bn 36.1 20.0 earnings comparisons for the first and second quarters of the year should not be strenuous. The second half,
particularly the fourth quarter, should not be saddled with US$0.12 per share of hurricane-related costs. We expect
earnings to benefit from substantially lower amortization charges. Nalcos challenge will be to increase its level of
Analyst: Jeffrey J. Zekauskas EV/EBITDA (Calendar) demand growth through new product introduction despite the high prices and weakness in its key paper end-market.
Phone: (1-212) 622-6644 2005E 2006E
We rate Nalco Underweight. It is a high quality specialty chemical company with a leading share of the global water
Email: jeffrey.zekauskas@jpmorgan.com 9.4 8.4 treatment and process chemical markets, trading at a high multiple. At its current share price of US$16.97, Nalco
trades at a 9.4x 2005E and 8.5x 2006E EBITDA multiples. Comparable chemical companies such as Air Products and
Rohm and Haas (both rated Overweight) trade at 2005E 8.9x and 7.4x multiples of EBITDA and 2006E 8.4x and 6.7x,
respectively. Nalcos debt to total capital ratio for 2005 is 80%.
Source: Company data, Datastream, JPMorgan estimates, JPMorgan SaVanT. Prices as of November 22, 2005.

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JPMorgan Global Chemicals Team Research

Equity Research Credit Research
Major Chemicals Specialty Chemicals Ag Chemicals and Fertilizers
Jeffrey J. Zekauskas Americas Americas Americas Americas
Global Sector Coordinator United States Jeffrey J. Zekauskas United States Jeffrey J. Zekauskas United States David C. Silver, CFA United States Christopher Miller (HY-Chemicals)
David C. Silver, CFA David C. Silver, CFA Jeffrey J. Zekauskas Saqib Deen (HY-Chemicals)
Silke Kueck Silke Kueck Silke Kueck
Karen Buchkovich-Sass Karen Buchkovich-Sass Karen Buchkovich-Sass
William Hunter William Hunter William Hunter
Olga Guteneva Olga Guteneva
Latin America Pablo Mautone
EMEA EMEA EMEA EMEA
Pan Europe Colin Isaac Pan Europe Colin Isaac Pan Europe Colin Isaac Pan Europe Nachu Nachiappan (HG/HY)
Alex Comer Alex Comer Alex Comer Alex Ayoub (HG/HY)
Asia Pacific Asia Pacific Asia Pacific
Pan Asia Pacific Graham Cunningham, CFA Japan Mikiya Yamada Japan Rie Kajiyama
Yoshio Teramoto
China Thomas Wong, CFA
Japan Mikiya Yamada
South Korea Apurva Choudhary
Taiwan Graham Cunningham, CFA
Thailand Sukit Chawalitakul
See page 193 for team member contact details.

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