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Quest™

Quest™. Quest Themes update – Pan Europe. 2 nd July 2012. Quest™ helpline +44 (0)20 7523 8493 quest@canaccordgenuity.com. Nigel Sedgley +44 (0)20 7523 8497 nsedgley@canaccordgenuity.com. Agenda. New quarterly backtest (Feb-May 2012) – extreme performance. Value opportunity widening.

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Quest™

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  1. Quest™ Quest Themes update – Pan Europe 2nd July 2012 Quest™ helpline +44 (0)20 7523 8493 quest@canaccordgenuity.com Nigel Sedgley +44 (0)20 7523 8497 nsedgley@canaccordgenuity.com

  2. Agenda • New quarterly backtest (Feb-May 2012) – extreme performance. Value opportunity widening. • Operation style twist – Updated screens. • Danone: The other side of the value trade Plus screen for stocks with high margin expectations + extended valuations • LBO Screen: Pockets of increased activity from corporates, private equity, overseas buyers Also supportive of valuations Page 1

  3. triAngle backtest: Pan-Euro: 3m to end May 2012: An extreme quarter 2nd best ever quarter Worst ever Best ever Best for a decade Top quintile minus bottom quintile on each factor on an equally weighted basis. Non-financials. Page 2

  4. Longer term context: triAngle quarterly backtest Recent trends in long-term context: Feb-May: Quality best ever, Value worst ever. Increased volatility Best ever Best since 2003 Previous extremes were before mkt rally Worst in a decade Equal weightings dangerous at turning points 2nd best ever 2nd best ever Worst for 3 yrs Worst and 3rd worst ever Top quintile minus bottom quintile on each factor on an equally weighted basis. Non-financials. Europe ex UK small • Value rallies tend to be short/sharp events (2-3 quarters) – 2010/12 very negative for Value. • What to do? Expect a Value snapback. High Quality provides insurance. Low weight on Momentum (risky) Page 3

  5. : What is triAngle? • Pan-euro triAngle performance • Market beating stock-picking tool • Company scores updated daily on www.canaccordquest.com • Combining Value, Quality and Momentum • Quest™ metrics mixed with conventional data • 12 years of live experience assessing style trends and themes • triAngle Escalator: Who’s moving up and down • Excellent 12- year track record • 3-pronged approach improves consistency • UK Large – 42/54 +ve quarters, +3.9% average • Pan-Euro – 36/49 +ve quarters, +3.2% average • UK Small – 34/42 +ve quarters, +6.3% average • North America – 18/35 +ve quarters, -0.3% average(Value and the Escalator dominate in the US) Equally weighted triAngle is the most consistent, but there have been a few short/sharp value rallies Top quintile minus bottom quintile on each factor on an equally weighted basis. Non-financials Page 4

  6. Operation style twist: Summary and conclusions 2008-2009 all over again? • What’s new? New quarterly backtest Feb-May 2012 – extreme performance • There are lots of similarities between events in 2008/9 and recent patterns. • During the 2008/9 trough style performance was volatile but Value ultimately dominated. • The trough in Value in 2008/9 was before the market bottom. • Value rallies tend to be short/sharp events (2-3 quarters) – if you are late, its easy to miss them. • Although the market does not look especially cheap, valuation divergence is high. • Lots of stocks are trading near their trough valuation of the last five years. • The run to safe stocks has left some valuations looking overextended – more than in 2008/9. • During times of profit and cash flow volatility you need to assess Value using stable measures:eg Quest™ market to book, EV/Sales. • Similar Value approach in Nov 08 Quest™ Newsletter delivered strong performance. • Volatility means there will be opportunities. Our screens assess the risk/reward trade off. Page 5

  7. History rhymes: Comparing 2007-2009 with 2010-2012 Value made an absolute low in Nov 2008, but there was lots of volatility around the trough. Pan euro Then (2007-2009) The troughV,Q neutral,Mmtm -ve Market rallyingValue +ve, Qual neutral, Mmtm -ve Crisis developingValue –ve, Qual +ve, Mmtm +ve Now (2010-2012)to 18th June 2012 Current pattern looks most like Sept 08 Top quintile minus bottom quintile on each factor on an equally weighted basis. Non-financials. Page 6

  8. Performance: Global Style Matrix: Risk off again – but signs of stabilisation Data to 28th June 2012 Source: Top quintile minus bottom quintile on each factor on an equally weighted basis. Non-financials. Page 7

  9. : Factors and composition Baskets are dynamic: They vary over time depending on what currently represents Value, Quality etc. 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 Value Quality 33% 33% triAngle 33% Momentum 9m-relative trend 100/200-day switch 12m-relative range 30/90 day switch Earnings momentum Page 8

  10. Pan-Euro end Nov 08-end Feb 09: Value rallied before the market A sign of rotation Quality held up Top quintile minus bottom quintile on each factor on an equally weighted basis. Non-financials. Page 9

  11. Which value measures? During times of profit/cash flow volatility you need to assess Value using stable measures:eg Quest market to book, EV/Sales. 2003-6 Kept outperforming after the other value measures waned.M&A, just –in-time capexsupport a sustained rally 2009-12Market to book headed the Value charge and sustained performance 1992-4Price to book worked well Mkt = Eurotop 300 Page 10

  12. What is Quest™ market to book? Total market capitalisation (equity + debt + quasi debt) Quest™ market-to-book = ------------------------------------------------------------------------- Estimated replacement cost of assets Page 11

  13. But how much is now priced in?... market valuation charts Median valuation not far off the trough but close to the ‘new normal’ Stock dispersion is high – lots of cheap stocks and expensive stocks look dearer than in 08/09 Corporate action, policy response less likely to be as helpful this time, but less solvency risk Expensive stocks have held up relative to 08 New Normal? New Normal? Prices as at 6th June Page 12

  14. Quest™ market-to-book: What is the opportunity? Level + dispersion There are as many cheap stocks as summer 2009. Market levelUses average market cap for the year As at May 24 UK Large cap Europe ex UK small 12% below LRA 16% below LRA Dispersion CITN/ Newsletter articles “Time to get into the Q” “Slowly moving up the Q” “Who is still left in the Q?” “Time to rejoin the Q” As at May 24 “Jostling about in the Q” Page 13

  15. Quest™ market-to-book strategies 1) Buy cheapest companies on market-to-book 2) Consider pricing relative to a long-term view of asset’s productive capacity over their lifetime. Take Value AND Quality into account. 3) What if no mean reversion? – need to consider valuation relative to the ‘new normal’ Desire to avoid Value traps: Solvency, asset write downs (badwill) See Page 46 for the historic performance of the different market to book strategies since 2008 Quest™ market-to-book Q-discount (10yr) = ------------------------------------------------------ Cyclical average CFROC / WACC Quest™ market-to-book Q-discount (+12m) = ------------------------------------------------------ +12m CFROC / WACC Page 14

  16. Value screen I: UK Quest™ market-to-book – Time to rejoin the Q? Favoured screen - links Valuation with Quality – worked well in 2008 Rank c.95 companiesin the full screen (>500m mkt cap). Available in excel See Page 36 forstocks in this screen at Nov ’08, and subsequent performance Updated weekly on Q-files. Page 15

  17. Value screen II: Trough valuations Stocks trading with 10% of five-year trough valuation on Quest™ market to book and EV/Sales* Cheap for a reason, or genuine opportunities? Priced 12th June Ranked by mkt cap 97 companies in full screen available in excel. (mkt cap >€250m) * EV/sales data rel to Long-run average. Note some stocks may have a short history. Data taken from Quest triAngle. Page 16

  18. Value screen III: Superscreen Criteria A broad based value screen using the Quest website screening function 15% more upside than 10y average Upside on Quest and cheaper than usual triAngle Value score Mkt to book below LRA Quality filters (optional) Page 17

  19. Value screen III: Value superscreen stocks Quality warnings Ranked by mkt cap 2nd July 133 companies in full screen available in excel and on Quest screening at www.canaccordquest.com Page 18

  20. Value screen III: Value superscreen stocks with quality filters Quality filters Ranked by mkt cap 2nd July 80 companies in full screen available in excel and on Quest screening at www.canaccordquest.com Page 19

  21. Over-extended valuations: The other side of the Value trade Companies which have outperformed but now lack value support Outperformed Lacks value support If EV/sales is higher than historic (long-run average), is that justified by higher margins. If so, is that margin sustainable? Compare with EV/sales Other risks Page 20

  22. Over-extended valuations: The other side of the Value trade Ranked by mkt cap 2nd July If EV/sales is higher than historic (long-run average), is that justified by higher margins. If so, is that margin sustainable? 85 companies in full screen available in excel and on Quest screening at www.canaccordquest.com Page 21

  23. Margins – not so stable? – Danone / Procter cutting guidance Page 22

  24. Pan Europe: Value summary: triAngle value scores (/33) Canaccord Genuity Quest™. Sept 2007 – May 2012. Europe (ex UK Small) universe. Sector scores are an unweighted average of company scores within that sector. Page 23

  25. M&A: Another way of thinking about value (LBO FCF yields) • Equity investors are not buying but others are starting to take a view • Buyers – Corporates, overseas buyers, pockets of private equity, activists – selected sectors “Valuations in Europe are making a lot of sense to us….. In times of crisis, people become much more short-term focused. [We are taking] a long-term view”Carlos García Moreno, CFO of América Móvil. Re Stakebuilding in KPN, Telekom Austria Global (debt + other)/EBITDAR Corporate sector debt is low Global free cash flow yield And cash flows are cheap to buy! Free cash after interest, tax and net capex but before acquisitions and dividends Page 24

  26. M&A Pan-Euro Hot Spots and themes • UK technology 3 takeovers by North American counterparts in a year: Logica/CGI (19% LBO FCF Yield), Autonomy/HP, Misys/Vista Equity Sector has high Cash flow returns + net cash. Top 30 US tech have potential US$430bn of cash outside US. Enough for top 10 European tech names twice inc. 30% premium. Deal rationale varies. To save on R&D, scale – global customer base, synergies, valuation. Other tech - SAP – cloud acquisitions, Dell cloud acquisition. • Health Care Buffett backed US dialysis clinic DaVita acquiring HealthCare Partners. Fresenius buying Rhoen Klinikum €3.1bn. • Telecoms Carlos Slim (America Movil stakebuilding – offer for 28% in KPN (€8 a share), + buying 23% Telekom Austria. Vodafone – Cable & Wireless Worldwide 12% LBO FCF yield. Private equity interest (Apax?) in VMed, Everything Everywhere (£8bn UK JV T-Mobile and Orange). Euro Telecoms: 4G auctions + high capex in next-generation networks (4G auctions). Traditional Revenues under pressure. • Overseas buyers BRIC Buying: China Three Gorges – EDP, Camargo (Brazil)/Cimpor (Portgual), Genivar (Canada)/WSP (11%), Alimentation Couche-Tard (Canada)/Statoil Fuel/Retail, Hong Kong Ex/LME US Tech buying UK Tech, Walgreen/Alliance Boots (KKR est making 2.7x investment) Hotels: Nelson Peltz/Stake in Intercontinental Hotels, Accor – Motel 6 chain sold to Blackstone • Consumer Buying Emerging growth: Pfizer Infant Nutrition (Nestle outbid Danone), Brand add-ons Diageo – Brazilian Cachaca maker • ResourcesGlencore/Xstrata, PTT (RD Shell)/Cove, Cairn/ Nautical Petroleum • Retail Plenty of Speculation but not many deals - Knight Vinke/Kesa • Financials Quiet • Others Elect Equip: Eaton Corp $12.6bn purchase of Cooper industries (9%)Pharma: Watson buying Actavis GDF Suez – International Power, UPS buying TNT express (19% FCF yield) Areas of high/Increasing activity Areas oflow activity Page 25

  27. Hot spots are often characterised by strong cash flows, low debt The Finance Director’s dilemma: • What to do with the cash? Increase investment – Capex or M&A (just in time capex) Remain cautious – Hoard/run ungeared balance sheet Return to shareholders – Increased dividends / buybacks • M&A route tempting, especially where organic growth is under pressure Global (debt+other)/EBITDAR Global CFROC +12m Page 26

  28. Value tools: Quest™ LBO FCF yields & screen High level screening metric of the type favoured by private equity – identifies pre-tax cash flow yield on EV. Assesses cash flow available to prospective purchasers, after meeting its operating and capex needs but before financing costs or tax May be compared with required rates of return to see if company initially meets its funding cost Uses historic and consensus forecasts of EBITDA, capex and working capital needs to estimate ‘normalised’ cash flow Good track record when there is a pick-up in M&A activity (first introduced by Quest™ in 2002 - Newsletter #11) Plenty of high (Double digit) yields DIY private equity toolkit – LBO superscreen - Identify companies which could generate significant value either off or on-market LBO FCF yield calculation • LBO spreadsheet data updated weekly Page 27

  29. Pan-Euro sector LBO FCF yields inc pension 6 June Page 28

  30. LBO Screens - Technology UK: 3 takeovers by North American counterpart in a year: Logica/CGI (19% LBO FCF Yield), Autonomy/HP, Misys/Vista Equity PartnersDeal rationale varies. To save on R&D, scale – global customer base, synergies, valuation. Page 29

  31. LBO Screens - Telecoms Telecoms Carlos Slim (America Movil stakebuilding – offer for 28% in KPN (€8 a share), + buying 23% Telekom Austria Vodafone – Cable & Wireless Worldwide 12% LBO FCF yield. Private equity interest (Apax?) in VMed, Everything Everywhere (£8bn UK JV T-Mobile and Orange). Euro Telecoms: 4G auctions + high capex in next-generation networks (4G auctions). Traditional Revenues under pressure. Page 30

  32. LBO Screens – Media – convergence? Page 31

  33. LBO Screens – Health Care • Health Care Buffett backed US dialysis clinic DaVita acquiring HealthCare Partners Fresenius buying Rhoen Klinikum €3.1bn. Page 32

  34. LBO Screen Industrials – top yields Page 33

  35. LBO Screen Selected yields in other sectors Page 34

  36. LBO framework: Summary of considerations Page 35

  37. Performance of the Q-discount screen from Nov 08- Q discount screen worked well In 2008. Source: Quest Newsletter Nov 2008 Source: Datastream Rel to WIEROP$ Page 36

  38. Appendices Page 37

  39. What is Quest™? Decision support tool for equity investors Impartial corporate financial analysis Idea generation and idea validation Combines conventional and proprietary metrics ‘Glass box’, not a black box Web-based products – www.canaccordquest.com Helping investors make money since 1996 Page 38

  40. What is Cash Flow Return On Capital? Cash Flow Return On Capital (CFROC) Real (replacement cost) Post-tax Return On Gross Invested Capital Better insight into corporate performance and valuation (takes into account all the capital used, asset life, asset mix, return of capital) IRR calculation not A/B Wealth creation Screening Risk management tools Stocks & Products (C) Non-depreciation asset release = €15 (A) Gross cash flow = €10 Value tools Performance M&A (D) Asset life = 14 years (B) Gross invested capital = €100 Cash Flow Return On Capital (IRR) = 6.0% Page 39

  41. Quest™ valuation overview Cash Flow Returns in a DCF model • Use consensus forecasts – 2-years forward • Forecast gross cash flows – existing assets wind-down • 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 Reversion to the mean High CFROA Low CFROA High growth Page 40

  42. Value • A broad-based view • Five Value factors: • Quest™ valuation • Quest™ market-to-book • EV/sales rel LRA • Dividend yield rel LRA • P/E rel LRA • Mix of absolute and relative measures Tesco: Quest™ valuation Centrica: Dividend yield relative to market and history Page 41

  43. : Quality • Aim to emulate the Quest™ Strategy page • Is it a good or a bad company? • High return/ growth stocks • Five Quality factors: • CFROC spread (5-year average) • Real capital growth (3-year average) • Equilibrium growth (3-year average) • Fixed charge cover (solvency FY1) • CFROC change (FY1) • Measures ability to generate shareholder value Tesco PLC: Cash flow returns Tesco PLC: Invested capital and equilibrium growth Page 42

  44. : Momentum • Combination of price and earnings • Five Momentum factors: • Nine-month relative trend • 100/200 day switch • 12-month relative range • 30/90 day switch • Earnings momentum (consensus) • Mixture of long, medium and short-term measures Page 43

  45. How the triAngle score is calculated • Each stock is compared to its universe • All 15 factors ranked in deciles • 10 = ‘good’, 1 = ‘bad’ • Add the five measures in each category and divide by 1.5 • Gives scores for Value, Quality and Momentum (/33) • Add together category score to get overall triAngle score • Rank all the stocks in the universe, then re-decile Page 44

  46. triAngle history: Value, Quality and Momentum 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. Page 45

  47. Pan-Euro market-to-book performance But, will there be a ‘dash for trash’ this time? Quality filters don’t help when the market takes off Or did we see it in January? Q discount has lagged behind To 23 May 2012 Page 46

  48. UK large cap – Impact of Miners UK Mining sector underperformed by 16% in the quarter. End Feb-End May 2012 Source: Top quintile minus bottom quintile on each factor on an equally weighted basis. Non-financials. Page 47

  49. Factor performance and consistency – Pan Euro Pan-Euro – Factor consistency (% pos quarters) Pan-Euro – Average performance per quarter (Feb 2000-) Top quintile minus bottom quintile on each factor on an equally weighted basis. Non-financials. Europe (ex UK small) universe Page 48

  50. Pan euro estimate revisions Page 49

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