all over again? Operation style twist The run to safe stocks in H was more extreme than in 07/08 Value saw its longest stretch of UK weakness – 9 negative quarters By late 2011 quite a lot of bad news was 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 Are we in for a repeat of 2011 where the New Year Value rally gave way to weakness? *New * Volatility means there will be opportunities. Assessing the risk/reward trade off *New *
4 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 6 th April) 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 Pause, or back to defensives?
5 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 – 42/53 +ve quarters, +4.0% average Pan-Euro – 36/48 +ve quarters, +3.0% 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? 12 years of live triAngle history Value works in short sharp burst – normally when valuation dispersion is high. During the credit crunch, and in H2 2011, Quality and Momentum were the main drivers Top quintile minus bottom quintile on each factor on an equally weighted basis. Non-financials.
7 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 Top quintile minus bottom quintile on each factor on an equally weighted basis. Non-financials.
8 Factor by factor in Q – Mini dash for trash UK Large Top quintile minus bottom quintile on each factor on an equally weighted basis. Non-financials. Nov 2011-Feb 2012 worst since May 09 Worst since May 09 Value rally 2 nd worst in a decade 3 rd worst in last decade 1 st positive in 10 quarters Best since May 09 3rd worst ever worst since May 09
9 triAngle H in historic context: Highlights Best for 3 yrs 3 rd Best in a decade 9 neg quarters in a row 2 nd best in a decade 3 rd Worst ever Worst for 3 yrs Equal weightings dangerous at turning points Top quintile minus bottom quintile on each factor on an equally weighted basis. Non-financials.
10 Style matrix – markets back into risk-off mode in the last month Data to 13 th April 2012 Source: Top quintile minus bottom quintile on each factor on an equally weighted basis. Non-financials.
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 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 April 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 Current pattern looks like Sept 08 and Feb 09
13 But how much is now priced in?….. market valuation charts In late 2011, markets were as cheap as Oct 2008 & April But the new normal is quite close. Corporate action, policy response less likely to be as helpful this time, but less solvency risk. Prices as at 12 th April New normal?
14 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 April 18 CITN/ Newsletter articles Time to get into the Q Jostling about in the Q Still 10% below LRA Close to LRA Feb = 0.88 As at Apr 18
15 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
16 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
17 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
18 Pan-Euro market to book performance Quality filters dont help when the market takes off To 16 Apr 2012 Trough? But, will there be a dash for trash this time? Q discount has lagged behind Or did we see it in January?
19 Finding Value II: UK Quest market-to-book: Time to rejoin the Q? Updated weekly on Q-Files
20 Value Superscreen: Using Quest screening – Criteria Mkt to book below LRA Quality filters (optional) triAngle Value score Upside on Quest and cheaper than usual 15% more upside than 10y average
21 Value Superscreen: Using Quest screening – Stocks 16 April 2012 Criteria >0>15 AA-BB >5<0.8 Ranked by mkt cap Quality filters. 1) Lots of debt/quasi debt. 2) Negative EPS momentum. Signal of risk of a profit warning? Companies which meet the quality filters ? Plus…Chemring, N Brown, Supergroup, Interserve
22 Over-extended 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
23 Over-extended valuations: The other side of the Value trade <5>15>1 16 April 2012 Ranked by mkt cap
24 Consumer goods – Expensive or defensive? (Pan-Euro) A-B Inbev, AB Foods, Beiersdorf, BAT, Carlsberg, Christian Hansen, CSM, Diageo, Danone, Givaudan, Heineken, Henkel, Imperial Tobacco, Kerry, Nestle, LOreal, Pernod, PZ Cussons, Reckitt Benckiser, SAB, Tate, Unilever Quest valuationCash Flow Returns triAngle Value score (/33) triAngle Quality score (/33) Equally weighted 25 January
25 Consumer goods Value scores rel 5y average Current minus 5 year average Downgrades by consumer team Jan January Downgraded by consumer team Feb 2012
26 Consumer goods CFROC deciles rel 5y average Current minus 5 year average Top 3 buys by consumer team Jan January
27 Consumer goods Quality scores rel 5y average Current minus 5 year average 25 January
28 Margins bite, leverage hurts – Reporting season poses risks Designed to explore the risks associated with over-optimism in analysts forecasts March/June 2011 articles: GDP slowing, commodity prices rising. Peak margins screen combined full valuation. Forecasts and valuations have fallen but consensus forecasts show forecasts remain high. Output: Q-File. Excel spreadsheet (searchable + Filters) + CITN articles 23 June 2011 CITN 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).
29 Margins plus other risk factors UK Screen as at 12 th April
30 Performance of the Q-discount screen from Nov 08- Pan-euro Source: Datastream Rel to WIEROP$
32 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)
33 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
34 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
35 UK companies within 10% of 5-year trough Quest market-to-book – by size Rank by market cap Updated regularly on Q-Files <10% 13 April Data from the Quest triAngle