Inside The Buy-side® 2Q12 by Corbin Advisors

INSIDE THE BUY-SIDE®

SECOND QUARTER| ISSUE DATE: APRIL 13, 2012

Following a strong performance in 4Q11, the DJIA and S&P 500 indices posted record first quarter point gains to kick-start 2012. Indeed, the S&P 500 closed out the quarter at a higher level than many predicted it would close out the year. Meanwhile, the NASDAQ surged 19%, narrowly missing its biggest point increase since 2000. With second quarter earnings season kicking off this week, investors report they are more confident about the US economy amid strengthening consumer and industrial markets, a more stable banking system and signs of life in resi markets. Corporate balance sheets are also in excellent shape. As reported in the WSJ 1, “Big US companies have emerged from the deepest recession since World War II more productive, more profitable, flush with cash and less burdened by debt”.

By Sector

17%

10%

17%

10%

30%

7% 3% 3%

By Investment Style

27%

10% 10% 7%

Europe’s sovereign debt issue remains a focal point, though investors are less concerned this quarter about a meltdown and the subsequent spillover effect. Meanwhile, China’s slowing growth continues to weigh on sentiment though investors are quick to point out, “I would take 8% growth any day of the week”. In our ongoing effort to stay at the forefront of current investor sentiment, Corbin Perception recently conducted interviews with 30 global financial professionals 2 across multiple industry segments and investment styles. Participating institutions aggregately manage upwards of $535 billion in equity assets.

1 2

Generalist Consumer Multi Financials Industrials Technology Healthcare REIT Energy

33%

7% 3%

Core Value Core Growth Growth Hedge Fund Deep Value GARP Sector Specific Yield

By Region

27% 67%

US Canada Europe

April 8, 2012 US, Europe and Canada

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Key Trends •

•

While 54% of surveyed investors remain “cautiously optimistic”, sentiment from the previous quarter has improved amid signs of a strengthening US economic recovery –

78% report that the housing market has bottomed

–

The majority see EPS and cash flow improving quarter-over-quarter, while organic growth should remain constant or modestly improve

Indeed, improving US economic data and corporate strength is fueling investor optimism while global debt, especially at the European national level, and the emerging market slow down, specifically in China, are causes for concern –

68% report that Europe has impacted investment decisions in multinationals with exposure; 23% remain cautious while 18% indicate they have a larger appetite for risk

•

For 2Q12, investors are looking for top-line growth and expect earnings to generally meet or beat expectations

•

Corporate managers are “less negative” in their conversations with investors and are focused on growing market share and operating their businesses as efficiently as possible

•

More investors are overweight equities than neutral though indicate the recent run-up has given them cause for pause

•

Dividends are seen as the best use of cash, surpassing buybacks by a good clip, which were more popular last quarter

•

Analyst days remain a good use of investor’s time and one of the best channels to broadly communicate the investment thesis

Trend in Investor Sentiment: Increasingly More Positive Current Quarter

Previous Quarter Bullish 27% Bearish 37% Cautiously Optimistic 36%

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Bearish 13% Cautiously Optimistic 61%

Bullish 26%

Expectations for Earnings Season As 1Q12 earnings season gets underway, surveyed buy-siders remain focused on growth and are eager to see signs that underlying fundamentals remain strong. On average, they expect results to be in-line with expectations. As “the cost-cutting scenario has played out to a large extent” and benefits have already fallen to the bottom-line, they now anticipate “somewhat muted earnings after two or three quarters of coming in strong”. While improving economic data in the US is bolstering sentiment, there is a level of concern over the “impact of the European slowdown and how much that is hurting business”.

Key Areas of Focus for Earnings Season – Quarterly Trend

61% 44% Previous

50%

44%

50%

33%

39% 26%

28% 26%

23% 13%

Current

Top-line

EPS

Cash Flow

Margins

Guidance

European Crisis Impact

“With regard to industrial companies, I anticipate industrial growth continuing on in the 2.5% to 3.0% range. I really like that because it is a moderate growth rate and it gives companies an opportunity to work on their operations, improve them and make them as efficient as possible. We expect to see continued good operational performance and improvement in cash flows, which I believe will lead to more acquisitions and investment in operations like CapEx and machinery because there is some favorable depreciation.” – Growth, Industrials “I will be looking for insights into the year ahead rather than what they are reporting and how cautiously they are setting their top-line expectations and margins.” – Core Growth, Consumer I “For the first quarter, we are still looking for companies to report decent results given the economic data that we have seen so far.” – Yield, Generalist “I will be focused on their outlook, guidance and whether they make their numbers. I am looking towards the top-line and, in particular, we want to see something other than cost cutting.” – Core Value, Generalist II

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“We are looking for sustainable, competitive advantages and longer-term outlooks for the respective markets rather than what happens in the current quarter.” – Core Value, Technology/Industrials

The Trend Is Your Friend Corbin Perception surveyed investors on trends they expect to see from companies for organic, EPS and cash flow growth. Regardless of sector coverage, expectations are for an improvement in all three areas with 52% seeing increases in cash flow generation. Continuing, 48% of those polled anticipate improving EPS growth, while 38% see organic growth picking up, albeit modestly. Organic Growth

Improving Staying the Same Worsening

EPS Growth

Cash Flow 19%

23% 38%

43%

19%

48%

52% 29%

29%

“I am quite lucky because I follow European and Western US companies that get at least 30% to 40% or even 50% of their sales from the emerging markets. They have some organic growth locally and are growing their organic growth via emerging markets. Increasing the exposure to emerging markets makes it easy to accelerate.” – Core Value, Consumer I

“Most EPS growth is in the form of buybacks these days and they are gaining a lot of accretion on that. If you look at last quarter’s earnings growth in the S&P 1500 Healthcare, net income grew maybe 2.5% and earnings growth was closer to 4%. There is a lot in there that is manufactured.” – Core Growth, Health Care “We like a lot of cash flow. We identify companies to invest in based on cash flow. The equity market is very cheap on that. If you take a company that makes 5% free cash flow every year and compare it to the market value, you understand that they are actually very cheap.” – Core Value, Consumer I

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Management Tone Slightly More Positive… Despite sustained economic woes, investors reveal they have been taking advantage of the recent market weakness to initiate or add to positions given strong corporate balance sheets, attractive P/E ratios, healthy dividend levels and low bond yields. Of note, 37% of study contributors report they are overweight equities, though this is down 19% from last quarter’s poll.

Executive Tone More Negative 4% Less Negative 61%

The Same 35%

“I have spent a lot of time in the last few days meeting with senior managers of publicly-traded companies and they are a little bit more optimistic.” – Growth, Industrials

“It was pretty negative last quarter. While it is not positive this quarter, it is not negative. It is an improvement but I would not call it bullish.” – Core Value, Financials

“Management tone is not necessarily improving but it is not getting worse.” – Core Value, Consumer/Health Care

…And Focus Remains On Operational Agility Executives remain focused on driving market share gains, in particular by expanding into emerging markets, say investors, adding that they continue to concentrate on operational efficiency. “Their businesses have been in a state of moderate improvement and they are making sure that that state continues.” – Core Value, Generalist I “A lot of the focus has been on high-growth markets regionally, a commitment to core businesses and a little bit more on shedding non-core assets. At the same time, they are focused on expanding those core assets in high-growth industries.” – Core Value, Generalist II

“It tends to be input costs, the fact that Chinese wages continue to go up, oil prices, what is going on with Europe and to a certain extent what is happening in China and the US. They are more optimistic about the US than they are China and they are very optimistic about emerging markets continuing to do well. That is where they are focusing their R&D expenditures and investment dollars.” – Core Value, Consumer/Health Care

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“A lot of banks that have TARP outstanding are focused on that. Everyone is focused on the economy and all the banks are focused on the regulatory environment.” – GARP, Financials

Investor Sentiment Increasingly More Positive On The US But Still Tempered… According to buy-side contributors, 1Q GDP predicted to be 2.2% Release date: April 27

At the time interviews were conducted, 3 study contributors reported being increasingly more positive on the US economy, which they considered to be in “decent shape” and “building momentum” amid modest improvements in consumer-centric economic data. Indeed, 78% of the surveyed group is of the opinion that the housing market has bottomed.

With that said, 20% of investors reported that the stock market, a leading indicator, reflected macroeconomic-related investor optimism and consequently had gotten ahead of itself. Enter April, which witnessed the biggest weekly decline of the year 4 for all three major indices amid concerns about Europe’s sovereign-debt woes and further exacerbated by a worse-than-expected jobs report released on Good Friday, while markets were closed. “Things are currently going well and seem to be improving on the job front but I am concerned about some of the austerity measures from a federal/fiscal standpoint that will have to be imposed to eventually pay down some of the debt.” – Core Growth, Consumer I

“There is a difference between the economy that we are seeing and the stock market. The stock market certainly suggests that things are fine and dandy but if you look at the unemployment rates and participation rates within the unemployment data, GDP growth and the price of commodities, it does not necessarily bode well for future growth.” – Core Growth, Health Care “I’d like to see some improvement in the construction markets. We still have the potential to get stomped by higher gas prices this summer.” – Growth, Industrials “There is improving employment, the manufacturing and auto sectors are doing well and domestic energy production is growing. For those reasons, I feel that that momentum builds on itself and becomes self-sustaining.” – Yield, Generalist While the majority of surveyed investors feel we are at an inflection point and moving in the right direction, overhangs such as the growing national debt, an unemployment rate north of 8% and rising gas prices continue to temper enthusiasm. 3 4

March 2 – 21, 2012 Week of April 2, 2012

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Top Investor Concerns 2Q11

3Q11

Global Economic Slowdown US Government Policy Cost Pressures Weak Consumer Weaker Than Expected Results

Global Economic Slowdown Decelerating Revenue Growth US Government Policy Commodity Inflation Market Volatility

4Q11

Current

European Crisis Spillover Effect on US Macro Impact on Consumer US Government Policy, Elections Healthcare Costs

European Crisis Spillover Effect on US US Government Policy, Debt Levels China Slowdown Oil Prices

“I am concerned about spillover from the European debt crisis to the US market, US political instability and debt levels. I have no causes for optimism.” – Hedge Fund, Consumer

“My top concerns are an unknown ‘unknown’, Iran and China. Oil and Iran go hand in hand. In China, I am concerned about inflation, GDP growth, how the property bubble still has not really pricked and how wages continue to increase. My top causes for optimism are improving labor figures and if the stock market continues to go up. Relative to expectations, profits have come in nicely although analysts have continued to ratchet down estimates, so they tend to beat lower expectations. The earnings have come in well and the stock market is a leading indicator.” – Core Value, Consumer/Healthcare “My top three concerns are Europe, oil prices and a hard landing in China. The top three causes for optimism include increased stimulus in the US, an improving employment picture and improving housing data.” – Hedge Fund, Healthcare/Technology

“My first concern is Europe, second is the US debt level with the caveat that I do not see any entitlement cuts and third would be the slowdown in China. My top three causes for optimism are that we are in a slow and steady recovery, that Europe has at least kicked the can down the road and that emerging markets will continue to do well.” – Core Value, Industrials II

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…And Further Kept In Check By Europe, China Contributors, especially those following financials, are less sanguine about the global economy, as Europe’s woes are offset by continued, albeit slower, growth in emerging markets. Investors continue to lament about Europe, which remains in a recession and “still has a period of adjustment to go through before they stabilize”.

Level of Optimism on Global Economy Optimistic 26%

Neutral 39%

Not Optimistic 35%

As well, the slowdown in China’s growth rate, even if the country does manage a soft landing, is a tough pill to swallow. Still, participants are quick to comment that 8% GDP growth is “nothing to sneeze at”, adding that emerging markets continue to offer attractive investment opportunities. “Europe is still a mess and they will continue to kick the can down the road for as long as possible but eventually they are going to have to do something. The growth rates that China and Brazil have had and the inflation that they haven’t necessarily seen yet will probably get worse. I would take 8% growth any day of the week but when you’re dropping from 9% and 10% growth in China, that is a big hit.” – Core Growth, Health Care

“I am a little less optimistic for the global economy. China is purposefully slowing and we are going to see Europe in recession for probably the next couple of quarters. Hopefully we will have the Greece issue resolved soon, they just keep pushing it out further and further. I do not know how many times we have almost had the Greek thing resolved.” – Growth, Industrials “Obviously Europe takes it down and then emerging markets brings it up.” – Core Value, Consumer/Health Care

“Overall I am probably more optimistic about the global economy given my views on emerging markets being a driver of growth. Europe is a problem and they will find a ‘kick the can down the road’ type of strategy and will continue to muddle along. At some point, they will have to address the impending sovereign debt issue.” – Core Value, Generalist II

A majority of surveyed investors reveal that the state of affairs in Europe continues to influence their investment decisions, explaining they are more cautious when modeling multinational companies, in particular factoring in revenue exposure to Europe and, in some cases, have reduced their investment weighting.

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Level of Concern Regarding Europe Modestly Concerned 43%

Not Concerned 19% Very Concerned 38%

One-third indicates there is cause for concern when multinationals boast more than 20% exposure to the plagued region. A minority, or 18%, asserts they have increased their appetite for risk when it comes to investing in European equities, asserting “all the bad news [about Europe] is out”. “That has impacted my decisions a little bit in the last three months. We have been prepared to take more risk because the risks have diminished.” – Core Growth, Consumer I

“It has not impacted my investment decisions that much because a lot of these big multinational companies do not have that much exposure based on the southern peripheral countries over there. Most companies we have do not have more than 30% exposure to Europe in general. Any companies over 50% exposure would certainly be a little worrisome.” – Core Growth, Technology “In terms of companies with revenue exposure to Europe, it is in our numbers that we are taking a cautious view on how the revenue in those sectors will grow and we are modeling for a mild recession in Europe. Most of the companies we deal with are assuming something similar, so it is baked into their guidance as well.” – Core Value, Technology/Industrials

Equities Seen as a Good Place to Park Cash Slightly more surveyed investors maintain that they remain overweight equities, adding that stocks “are pretty cheap at this point” though some report they are “probably headed to market neutral” given the recent run-up.

Equity Weighting

Overweight 56%

Market Neutral 44%

Those who are market neutral are of the mindset that “valuations reflect a recovery” with an investor 5 noting, “Considering that some of these markets have run 20% and that individual equities have run 30% to 40%, the risks are more evenly balanced and you want to be more neutral than overweight”. Of note, no contributing investor is underweight. “We have had a nice run here though the last couple of days have been a little bit less so. You have to be a little bit careful as you get closer to the summer. The markets tend to pull back in May. They tend to take a break. At this point it has become a self-fulfilling prophecy especially after the type of run that we have had.” – Growth, Industrials

Core Value, Consumer/Healthcare

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“There are definitely some attractive valuations but there is still uncertainty in the economy and the regulatory environment.” – GARP, Financials “We are overweight cyclicals. We are not overweight by a lot; overall we are pretty close to market weight.” – Core Growth, Technology “We see equities as pretty cheap at this point.” – Core Value, Consumer I

Investor Sentiment Bearish

Mixed

Bullish

Auto Components Commodities Consumer Staples Defense Low-end Apparel Pharmaceuticals Telecom Equipment Utilities

Financials Industrials

Biotechnology Consumer Discretionary Cyclicals Energy Luxury Goods Managed-care Manufacturing Technology

…And Speaking of Cash Corbin Perception’s quarterly poll on investor preferences for uses of cash reveals that dividends trumped share repurchases this quarter, reversing last quarter’s predilection for buybacks amid the market’s significant run-up. As noted in the previous issue of Inside The Buy-side®, S&P 500 constituents paid out $240.6 billion in dividends during 2011, up from $205 billion in 2010.

FCF Preferences - Quarterly Trend 37%

Dividends Previous

Buybacks

Current Reinvestment M&A

41%

59% 52%

28% 32% 27%

38%

Meanwhile, reinvestment in the business remains attractive and interest in M&A continues to wane amid increased corporate appetites for deals. “We have always been pretty comfortable and happy with companies that pay out dividends. We would rather they do that than buy back shares.” – Core Growth, Consumer I

“We have a growth fund, so we prefer when they invest it back in the business. I prefer to see companies growing and creating value that way. Sometimes there are

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stories where it is impossible to grow forever so a dividend or a stock buyback is always appreciated.” – Core Value, Consumer II “We would rather companies pay out a higher dividend. Obviously, companies like to have a consistent increase in the dividend over time. If they have a ton of excess net cash then pay out a special dividend. If we feel the shares are truly undervalued, we would definitely like to see buybacks.” – Core Value, Technology/Industrials “It depends on the sector but I would prefer to see them reinvest money than return it in the form of dividends or buybacks. However, I would rather them pay me than be sitting on gobs of cash, so I am okay with buybacks and dividends.” – Core Growth, Health Care

IR Best Practice: Analyst Days Whether you currently conduct an Analyst Day or are thinking about hosting one, recognize that these shareholder-friendly events, which require a significant amount of company time and resources, are generally viewed by the buy-side as a best practice. To be clear, the quality of information, as well as the means by which it is conveyed, can positively influence investment decisions, and consequently, valuation. While Analyst Days do serve as a catalyst in capturing investor mindshare, they can also result in damaged credibility and en masse shareholder exits. Select best practices for executing a successful event include: •

Plan early and develop a strategic roadmap and timeline: The amount of time required to execute a best-in-class Analyst Day is typically four to six months and requires input from multiple sources, including but not limited to senior executives, operating management and legal. Getting an early start is critical, as is ensuring management is onboard with the time commitment and supportive of the process. IR executives should secure senior executive buy-in at key milestones, especially with regard to the depiction of corporate and business unit strategies. Indeed, a disorganized or railroaded approach can result in management reluctance to go through the process again.

•

Ensure content presented is fresh and informational: Investors are keen on hearing new information and from new people noting, “Anytime they throw up the same old people and presentation, it is a waste of time”. While investor communication should remain consistent, collecting feedback on hot topics, concerns and questions ahead of the event, whether formally or informally, and addressing these matters during prepared remarks and/or Q&A will ensure the presentation incorporates fresh content and is well-received.

•

Recognize clear strategy communication is critical: In researching worst-in-class Analyst Days, the common thread throughout is investors and analysts leaving the event with more questions than answers about the strategy and growth trajectory of the company. Ensuring

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that your communication around strategy, business portfolio, growth platforms and financial model is clear and that long-term financial targets are provided is critical to receiving investor and analyst buy-in. •

Don’t skip the dress rehearsal: Analyst Days not only serve as the ideal platform to broadly communicate key information to the financial community, they are also an opportunity to demonstrate the breadth and depth of the management team. Ensuring that all of your speakers are comfortable with and confident in presenting their content in the time allocated is a critical factor in executing a best-in-class Analyst Day. Conducting a dry-run the day before or morning of makes certain everyone presenting is on the same page and also provides the IR manager the opportunity to review rules of conduct, as well as tips and pointers for interacting with the financial community.

•

Don’t employ a defensive approach to investor questions: Another worst practice from the investor standpoint is when management is defensive or hostile towards investor questions. Preparing your management ahead of time for hard-hitting and controversial issues that may come up during Q&A is critical to ensuring that this portion of the event runs smoothly and does not lead to tarnished credibility. Addressing investor questions head-on and in a constructive manner, no matter how shortsighted or contentious, can lead to enhanced credibility with the Street.

To be clear, Analyst Days continue to represent one of the most cost-effective means of capturing key investor mindshare and communicating the investment thesis. Best-case, attendees should walk away from these events with an increased understanding about the company strategy and direction, enhanced familiarity with the bench strength, greater conviction in the management team to execute on communicated objectives and thus a more compelling view of the company as an investment. “Anything they can do to give you clarity around the current financial model, their ability to hit it and the key assumptions that are built into that is helpful. I would like an in-depth analysis of future growth drivers. I want to know the risks they are thinking about as they execute their model. As far as worst practices, it is template stuff. I want to see something new. I want to meet new people on the management team and I want them to present. It is a great opportunity for them to show the depth of what they have.” – Core Growth, Health Care “There are clearly things that inspire or encourage people within companies or give them reason for optimism. When they talk about that in a very loose context, it is hard to get any ability to frame that in an investment concept. A best practice is to frame that, as well as the strategic objectives a company is embarking upon or has been embarking upon and why it will lead to the generation of robust profitability going forward. Generally, it is nice to have a new angle rather than something that has been repeated many times previously.” – Deep Value, Oil, Gas & Mining “There has to be a clear message and you must show the supporting characters who produce the results. A worst practice is minutia. In terms of content, I like to see the

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big picture and hear from a variety of folks who will be executing the plan.” – Hedge Fund, Consumer

Corbin Perception Group has a strong track record of collaborating with IR leaders and management to plan and execute Analyst Days that exceed investor expectations and maximize shareholder value. For more information and/or to schedule a consultation, contact Bronwyn Swanson at (203) 283-7997 or bronwyn.swanson@corbinperception.com.

Proven Methodology, Proven Results Corbin Perception is an IR research and advisory firm assisting public companies with unlocking their full market potential. We recognize the positive impact best-in-class investor relations has on valuation and partner with our clients to develop strategies that positively influence investor perception. Our comprehensive approach to research-driven counsel enables our clients to capture investor mindshare and differentiate their company as an investment. We have deep functional and industry expertise as well as a strong and consistent execution track record of value creation. Our core Advisory Services include:

• • • • •

Perception Studies Investor Presentation Development Strategy Communication Analyst Day Strategy and Execution IR Diagnostic Reviews, Strategy Development