all over again? Operation style twist The run to safe stocks over the summer was more extreme than in 07/08 Value has seen its longest stretch of UK weakness How much bad news is priced in? Value approach in Nov 08 Quest Newsletter delivered strong performance Value started working before the trough in 08/09 Which Value tools to use? (Stable measures) Stock screens to find value opportunities and overextended (expensive) situations
4 Q-files *New*
5 Q-files performance highlight the exponential shift to quality High Q-score companies outperforming Volatile companies underperforming Quest Risk Rater Aggressive defensive indicator UK large caps (to 3 Jan) Aggressive Defensive indicator Identifies the most/ least cyclical and volatile companies Based on three measures: EBITDA stability CFROA stability Share price volatility Measured over 12 years (including forecasts) High deciles (10) indicate defensive, more stable stock
6 Factors and triAngle composition Quest valuation Quest market-to-book EV/sales rel. LRA Dividend yield rel. LRA P/E rel. LRA CFROC spread Capital growth Equilibrium growth Fixed charge cover CFROC change 9m-relative trend 100/200-day switch 12m-relative range 30/90 day switch Earnings momentum triAngle ValueQuality Momentum 33% Quest triAngle Excellent 12- year track record 3-pronged approach improves consistency UK Large – 42/52 +ve quarters, +4.3% average Pan-Euro – 36/47 +ve quarters, +3.1% average UK small – 34/41 +ve quarters, +6.4% average Value, Quality and Momentum baskets are dynamic – driven by current rankings UK large caps
all over again? 11 years of live triAngle history Value works in short sharp burst – normally when valuation dispersion is high. During the credit crunch, and now ….Quality and Momentum are the main drivers Top quintile minus bottom quintile on each factor on an equally weighted basis. Non-financials.
8 9 negative Q in a row 2 nd best in a decade 3 rd best in a decade 2 nd best in a decade Yield holding up UK Large Factor by factor in H – Quality and Momentum strong May-Aug 2011Aug-Nov 2011 best for over 3 years More mixed
9 triAngle H in historic context: Highlights Best for 3 yrs 3 rd Best in a decade 9 neg quarters in a row In Europe: May-Aug 2011: Value, 2 nd worst ever Fixed charge cover, best since 2003 Quality 2 nd best ever Earnings Momentum: best for 3 yrs 9 out of 10 positive quarters 2 nd best in a decade
10 The trough V,Q neutral, Mmtm -ve Crisis developing Value –ve, Qual +ve, Mmtm +ve History rhymes – where are we now? UK Large Now ( ) to 13 Jan 2012 Then ( ) Market rallying Value +ve, Qual neutral, Mmtm -ve Top quintile minus bottom quintile on each factor on an equally weighted basis. Non-financials. Value made an absolute low in Nov 2008
11 UK end Nov 08-end Feb 09: Value rallied before the market More stable value measures leading the way Fixed charge cover: Feb-May %, May-Aug % A sign of rotation Quality held up
12 Style matrix Data to 13 th January 2012 Source: Top quintile minus bottom quintile on each factor on an equally weighted basis. Non-financials.
13 But how much is now priced in?….. market valuation charts Markets as cheap as Oct 2008-May 2009 Corporate action, policy response less likely to be as helpful this time, but less solvency risk. Prices as at 5 Jan 2012
14 Finding value I: Cheap on Quest for the first time in a long time Rank by market cap (>$250m) Criteria>4>0>3 16 Jan 2012 Warning signals
15 Finding Value II: Time to rejoin the Q Quest market-to-book A variation on Tobins Q which compares market value of a company to the replacement cost of assets Profits, sales, cash flows and dividends are all unpredictable at present. Valuation relative to the asset base is more stable. Excellent track record at market turning points. (Time to get into the Q note – November 2008) Total market capitalisation (equity + debt + quasi debt) Quest mkt-to-book = Estimated replacement cost of assets
16 Kept outperforming after the other value measures waned. M&A, just –in-time capex support a sustained rally Quest market-to-book: the market recovery and beyond Price to book worked well (Pan Euro) Market to book headed the Value charge and sustained performance Mkt trough March 09 Mkt peak Feb 11
17 Quest market-to-book: What is the opportunity? level + dispersion Time to rejoin the Q Who is still left in the Q? Market level Dispersion Europe ex UK small Uses avg mkt cap for yr UK Large cap Slowly moving up the Q As at Jan 16 CITN/ Newsletter articles Time to get into the Q
18 UK companies within 10% of 5-year trough Quest market-to-book – by size Rank by market cap 9 January
19 Pan-Euro market to book performance Quality filters dont help when the market takes off To 5 Dec 2011 Trough?
20 Quest market-to-book strategies Cheapest companies on market to book Current pricing relative to a long-term view of assets productive capacity over their lifetime (Nov 08 note) Quest mkt-to-book Q-discount (10yr) = Cyclical average CFROC / WACC Avoid value traps: Solvency, historic average may overestimate future potential, asset write downs/ badwill What if no mean reversion? – need to consider valuation relative to the new normal Quest mkt-to-book Q-discount (+12m) = m CFROC / WACC
21 Finding Value II: UK Quest market-to-book: Time to rejoin the Q?
22 Value Superscreen – using Quest screening - Criteria Cheap on Quest for 1 st time in a long time Mkt to book below LRA Quality filters (optional)
23 Value Superscreen – using Quest screening – Stocks Ranked by mkt cap <0.8>5>1>3 Quality filters. 1) Lots of debt/quasi debt. 2) Negative EPS momentum. Signal of risk of a profit warning? Criteria 16 Jan 2012 Companies which meet the quality filters ?
24 Overextended valuations – the other side of the value trade Outperformed Mkt to book above LRA Mkt to book/ returns analysis Lacks value support Other value metrics Other risks
25 Overextended valuations – the other side of the value trade <5>15>1 Rank by market cap 16 Jan 2012
26 Margins bite, leverage hurts – Reporting season poses risks 23 June CITN Designed to explore the risks associated with over-optimism in analysts forecasts March/June articles: GDP slowing, commodity prices rising. Peak margins screen combined full valuation. Forecasts and valuations have fallen but consensus forecasts show forecasts remain high. Consensus forecasts down c3% for 2011, 3% for 2012 (3m, median), but… 33% of companies still forecast to be at peak margin. Output: Q-File. Excel spreadsheet (searchable + Filters) + CITN articles Original articles March/June: 79 names. CITN article highlighted Siemens, Volvo, Aker, Daimler, WH Smith, Philips, PPR, Fiat, Ferrovial, Clariant, Cookson, Lanxess, Sandvik, Pernod Ricard, ABB. Margin stability definition: average historical EBITDA margin (10 years) divided by standard deviation of EBITDA margin over the same period (minimum 5 years required for calculation).
27 Margins plus other risk factors UK Screen as at 9 th Jan
28 Performance of the Q-discount screen from Nov 08- Pan-euro Source: Datastream Rel to WIEROP$
30 What is Cash Flow Return On Capital? Cash Flow Return On Capital (CFROC) Real Post-tax Return On Gross Invested Capital Shifts from accrual accounting towards cash Better insight into corporate performance and valuation (takes into account all the capital used, asset life, asset mix)
31 CFROC: Step 1 – Accounting to cash EBIT + Investment & non-operating income + Interest income – Current tax NOPAT + Depn & Amortn + Rental expense – Tax shield on interest & rent + Monetary working capital adjustment Non-depreciating assets Land & investment property Fixed asset investments Stock Monetary working capital + Depreciating assets Fixed assets at gross cost Fixed assets current cost (adjusted) Capitalised operating leases Intangible assets Cumulative goodwill w/off Gross cash flow Gross investment Cash in Cash out = Operating income Operating assets
32 Quest valuation Cash Flow Return On Capital in a DCF model Use Consensus forecasts 2-years forward Forecast Cash Flow Return On Capital existing assets Forecast growth rate reversion to mean Forecast Cash Flow Return On Assets future investment returns (reversion to mean) Forecast net cash flows implicit Discount back using WACC for Enterprise Value
33 Quarterly relative performance% of positive quarters by decile UK Large cap non financials. Quarterly rebalancing. Performance relative to FT All share Performance summary by decile (Nov 2001-Aug 2011)