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INSIDE THE BUY-SIDE®
THIRD QUARTER| ISSUE DATE: JULY 13, 2012
On
the heels of a strong first quarter fueled by investor optimism about the strengthening US economy, the second quarter witnessed a sharp pullback with the Dow sliding 2.5%, the S&P 500 losing 3.3% and the NASDAQ giving up 5.1%.
By Sector
10%
Amid sustained global uncertainty and market volatility, surveyed investors indicate they will be acutely focused on management’s discussion of the business climate on 2Q12 earnings calls and, in particular, the impact of Europe, the consumer and costs. Profitability remains front and center given growing concerns about “cost creep and the ability to pass it on”.
13%
10%
Macro and geopolitical issues continued to move stocks, and the quarter ended with an “agreement” by European leaders to stabilize the Continent’s banking sector and a historic US Supreme Court ruling largely upholding the constitutionality of ‘Obamacare’. Moreover, a spate of unimpressive jobs reports cast doubt on the US recovery, promising to shape the presidential election in coming months. In our ongoing effort to stay on top of current trends in investor sentiment, we recently conducted interviews with 30 global financial professionals across multiple industry segments and investment styles. Participating institutions aggregately manage upwards of $834.8 trillion in equity assets.
7%
7% 7%
33%
7% 3% 3%
Generalist Energy Multi Consumer Financials/REIT Healthcare Industrials Technology Commodities Sustainability
By Investment Style
23%
17% 13%
34%
7% 3% 3%
Core Growth Core Value Hedge Fund GARP Deep Value Agg. Gr. Income Value
By Country
38% 50%
US UK Germany Ireland Brazil Hong Kong
3% each
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Key Trends •
1Q12 results came in largely better-than-anticipated but investors exhibit some level of apprehension about 2Q12; 70% reveal they will be acutely focused on management outlooks and forward-looking guidance
•
The vast majority, or 72%, describes their current outlook as cautiously optimistic; this compares to 61% last quarter
•
Surveyed investors universally portray management outlooks as increasingly more cautious to negative from last quarter’s channel checks
•
On a positive note, an overwhelming number, or 83%, continues to believe the housing market has bottomed –
With that said, a “fast-paced” recovery is not in the cards, they maintain, as people are not “optimistic about buying a house as an investment anymore”
•
Contributors report a penchant for margins over top-line growth by 2:1
•
On average, financial professionals see organic and EPS growth metrics worsening this quarter; cash flow should hold up albeit grow at a slower pace
•
50% consider the current US government to be anti-business, while 64% believe a change in presidential leadership is needed
•
38% reveal they have been buying through the recent market weakness, a group that includes those covering healthcare, industrials, technology as well as generalists
•
56% assert they have become even more cautious toward multinationals with European exposure over the last three months
•
Overwhelmingly, canvassed industry professionals confirm that corporate strategy is critical to their investment decisions; the most important aspect to communicate is how the strategy will be executed Trend in Investor Sentiment: Tempered Optimism Previous Quarter
Current Quarter Bullish 6%
Bullish 26%
Bearish 13%
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Cautiously Optimistic 61%
Bearish 22%
Cautiously Optimistic 72%
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Investors Brace For What Could Be A Bumpy 2Q12 Earnings Season While participants report that 1Q12 results were in-line (36%) to better than expected (55%), recent interviews reveal cracks in investor optimism fueled by disappointing US economic data, continued disorder in Europe and more signs of an emerging market slowdown. Key Areas of Focus for Earnings Season – Quarterly Trend
70%
61% 50%
Previous Current
26%
50%
50%
50% 30%
26%
13% Mgmt. Outlook
Margins
Top-line
EPS
20%
Macro Issues
10% Cash Flow
“It is just the differentiation of the story more than anything. We tend to follow small- to mid-caps so it tends to be the quality of the story and the deliverables. We focus on deliverables because we hear so much about what they aim to do but actually being able to deliver matters. It is clearly the differentiation of the story and the ability to deliver.” – Hedge Fund, Healthcare “I will be paying close attention to top-line growth and margins. There is more of a negative sentiment out there and I think investors will be looking for the growth rates companies are seeing out of Europe and China. The expectation is that Europe is in a recession and growth rates will be negative, China is slowing but the US is a mixed picture. Some areas look fairly strong while others look like they might be getting weaker. Despite some weak data recently, the US is relatively strong versus other places around the world.” – Deep Value, Industrials “I will be focused on how the companies are doing, their fundamental outlooks going forward, any impact from Europe, the consumer slowdown and the government uncertainty. I will be focused on all of the things we have been talking about for the past six months. I see revenue growth worsening.” – Hedge Fund, Generalist
“As usual, I will be focused on the current trading and management outlooks. I will also be focused on the cost side and what that is going to mean for margins.” – Core Growth, Consumer
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Management Tone Becomes Increasingly More Cautious Reversing last quarter’s trend when 61% of investors reported that management’s tone was becoming “less negative”, participants this time around universally characterize conversations with corporate executives as more cautious to downbeat even. “I would not say they are negative but they are becoming more negative; they are cautious just like us”, explains an investor. Previous Quarter's Tone
Current Quarter's Tone
More Negative 4% Less Negative 61%
The Same (Still Cautious) 35%
More Negative 50%
The Same (Still Cautious) 50%
“On the aggregate, people are talking about costs and so far some are having trouble. On a strong, high-end basis it is still very positive.” – Core Value, Consumer “They are definitely more cautious. It is hard to say negative because management is never negative and business is always great. They would describe themselves as being conservative, which in my opinion means that they are increasingly cautious.” – Aggressive Growth, Technology
“For the most part, it depends but they’ve been a little more negative because there’s been a little bit of a slowdown.” – Hedge Fund, Generalist “It depends on where you are looking. In the US, the tone is not that bad; it is decent. Companies with exposure to Asia, specifically China, and Southern Europe will tell you that it is slow.” – Deep Value, Industrials According to contributing investors, dialogues with corporate managers have focused largely on: •
Macro issues, especially “low rates and low economic growth” as well as Europe’s debt conundrum
•
Plans to offset cost pressures, operational efficiency measures
•
ROIC “They are most focused on three things. First, they are focused on returns. Companies are very keen to getting an attractive return on capital investment. That has come back as a key investor and management metric rather than something that
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you could just pass off for cheap debt in the past. Second, companies are very focused on the balance sheet and cash flow. They are focused on making sure that debt is not growing materially and that they are generating sufficient cash. Third, they are focused on offsetting cost pressures.” – Core Growth, Consumer “They are focused on the Euro situation and if there will be a resolution. If there is no resolution then what measures should they take?” – Core Value, Energy “They are mostly focused on the same things we are. The one positive is that gas prices are coming down, which is good for the consumer.” – Hedge Fund, Generalist
Amid Market Sell-off, Investors Buy On Weakness 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. Recent Activity
Equities Weighting Underweight 13%
Rotating 31% Holding 25% Buying 38%
Selling 6%
Neutral 50%
Overweight 37%
“We’ve sold some names and we’ve added to some names. Cash may have gone up by maybe 1.5% over the past three to six months and we typically remain 96% to 99% invested so you’re looking at 1% to 4% cash position typically.” – GARP, Industrials/Healthcare
“I am more negative on the economy and I am more positive on the stock market because it is reflecting a lot of that negativity.” – Deep Value, Industrials “We are investors so we do not get shaken out. I have been holding the positions and I have a positive short-term view.” – Hedge Fund, Generalist “We never go to cash; we are always invested. If I had cash I would be starting to put it into European equities.” – Deep Value, Industrials
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Sector Snapshot Bearish
Mixed
Bullish
Financials REITs
Industrials Healthcare Technology Energy
Consumer Auto Luxury Goods P&C Insurance
Views On Performance Metrics Trends Reverse Course Corbin Perception surveyed investors on trends they expect to see from companies for organic growth, EPS growth and cash flows and, across the board, expectations are down versus last quarter. Views on EPS growth are the dourest with 69% of those polled expecting it to worsen this quarter, an opinion held by analysts across every represented sector. Of note, 48% of investors predicted improvement in this metric last quarter. Continuing, 65% anticipate declining organic growth, while 40% see cash flow ebbing, though an equal number forecast it staying the same. Again, prior quarter research found that both of these metrics were largely expected to increase. Organic Growth
EPS Growth
23%
Cash Flow 40%
8%
Improving Staying the Same
12%
23%
Worsening
69%
20%
65%
40%
“Most people have downgraded their forecasts to account for either the strength in the dollar or the weakness in the Euro zone. It is the outlook. Some people’s outlooks have been impacted going forward because they are a bit worried that the negative impacts from China, the US and Euro zone will still overhang companies through the end of this year.” – Core Growth, Energy “Organic growth will be lower because of the slowdown in China, the Euro zone impact and because the US is not growing as fast as we thought it would two or three months ago.” – Hedge Fund, Generalist “EPS growth will be flat to lessening a little bit. It will be difficult to maintain the high growth rates that we’ve seen. You start to lap some of those high growth rates of the past year.” – GARP, Industrials/Healthcare
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It’s A Small World After All: Concerns Abound Surveyed investors are evenly split with regard to their level of concern about the looming “fiscal cliff”. Half of the group expresses apprehension about the “consequences of the government being fiscally irresponsible” with many averring that “it is not appropriately discounted into the markets”. Conversely, the remainder does not view it as an imminent threat and point out that the only real negative is that the headline risk continues to serve as an overhang. Separately, as the presidential election heats up, 50% of study contributors perceive the current US government as being anti-business, while 64% believe a change in leadership is needed. “I am concerned about the ‘fiscal cliff’. Anyone who was alive for the last debtceiling debacle should be concerned about it. It is not being properly discounted. The consensus viewpoint is that Congress will ultimately be a grown-up about it and things will get worked out. Maybe it will but it is hard to have a lot of faith in anything Washington does after the fiasco last July and August.” – GARP, Healthcare Europe and China 1 remain overhangs as uncertainty overseas looms large: •
64% remain concerned about the European economy in the short-term though are quick to note that they have “adjusted their expectations”
•
50% consider it possible that the crisis that has touched Spain, Italy and especially Greece could spread to France and Germany
•
42% are confident that the “Euro saga” will eventually see a resolution, with more investors predicting a “tighter fiscal union with the removal of some of the weaker countries” versus a broad-based bailout
•
60% are concerned about slowing growth trends in China but few believe it will result in a “hard landing”; part of their apprehension stems from the view that “no one really knows what is going on over there” “It is hard to know what is going to happen. There is no question that China is slowing but I do not think it will be a hard landing because the government will pull out all the stops to make sure there will be growth. I am a long-term believer in China and that growth rates will be above average. I am worried about the real estate market and the banks. I do not think it is going to be a horrible disaster.” – Deep Value, Industrials
“I always want to see growth. In the past, I was looking for companies with high exposure to China and today I am not.” – Hedge Fund, Industrials
1
Interviews were conducted prior to the release of China’s GDP, which slowed to 7.6% y-o-y, down from 8.1% in the first quarter and its lowest level since the beginning of 2009
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View On Multinationals With European Exposure
More than half of participants, or 56%, say they have become more cautious toward multinationals with European exposure in the last three months. Investors remain keenly aware of the importance of factoring in a company’s revenue exposure to Europe when studying investment decisions. Still, 22% of those surveyed maintain their sentiment towards such companies is unchanged, while a portfolio manager 2 asserts, “I like them more now because the stocks have been knocked down”.
More Cautious 56%
Less Cautious 22% Depends on % of Rev. 22%
Meanwhile, a solid majority of investment professionals, or 80%, reports that despite global malaise, they have not curbed their enthusiasm toward US-based companies seeking international growth. Rather, investors remain focused on the long-term adding, “For the next 20 years, emerging markets are going to be an amazing place to be”. Bolstering positive views on developing nation investments, contributing investors universally assert the US is “nowhere near close” to resuming its role as the engine of global growth. “We want to better understand the exposure that they currently have so that we know how much it is. Sometimes there is a lot more exposure than you thought.” – Aggressive Growth, Technology
“Recently, GE said it will actively target investing less in European growth but it will invest a lot more in South America and Asia. It is international growth with less of a focus on the European markets. We are a lot more positive on that strategy than we are on the opposite of devoting more resources to Europe.” – GARP, Industrials/Healthcare
Top Investor Concerns
2
3Q11
4Q11
Global Economic Slowdown Decelerating Revenue Growth US Government Policy Commodity Inflation Market Volatility
European Crisis Spillover Effect on US Macro Impact on Consumer US Government Policy, Elections Healthcare Costs
1Q12
Current
European Crisis Spillover Effect on US US Government Policy, Debt Levels China Slowdown Oil Prices
European Crisis US Political Paralysis Pause In US Momentum Margin Pressures China Slowdown
Deep Value, Industrials
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A Return You Can Bank On: Dividends Conversations with investors on capital allocation preferences this quarter further emphasize concern over the near-term with several suggesting companies “stash cash on the balance sheet” and 40% preferring companies shore up their debt levels. Still, the majority of this group remains committed to the dependable return of dividends, with a contributor 3 noting, “The companies that have been holding up are the ones with high dividend yields”. Free Cash Flow Preferences - Quarterly Trend
Dividends Debt Reduction
59%
52% 28%
M&A Reinvestment
41%
38%
37%
Buybacks
52% 27%
42% 42% 32% 21% 21%
5%
0% 1Q12
2Q12
3Q12
IR Best Practice: Strategy Communication Ongoing research indicates that a company’s strategy is “important to critical” to high-quality long-term investors’ decision-making process yet 82% of surveyed financial professionals reveal they regularly come across companies with indistinguishable business plans. As a contributor 4 notes, “Every company has a strategy but not every company has a clear strategy”. Indeed, coherent strategy communication can serve as an investment differentiator and, as management executes on goals outlined, result in increased investor confidence and bolstered credibility. When discussing strategy, investors hold that the most important aspect is how management will implement the strategy or, more importantly, “how they will deliver returns”. Details on how international expansion will be executed, the role of M&A versus organic growth, dividend growth and plans for operating under adverse conditions are critical to the decision-making process. Establishing a timeframe for executing a strategy is important, say investors, though a “typical” timeframe differs from industry to industry. Necessary, say those surveyed, is to be
3 4
Hedge Fund, Industrials Core Growth, Generalist
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realistic. Indeed, the maxim “under promise and over deliver” is as relevant to timeframes as it is to delivering on results. Select best practices when communicating strategy include: •
Provide a clear view of both short-term tactical objectives and long-term goals; high-quality, long-term investors are keen on seeing a three- to five-year plan
•
Dedicate several slides to strategy beginning with a high-level overview of the five to seven key focus areas that are going to drive long-term shareholder value
•
For each strategic initiative, provide details on the path forward, explain how your business model is going to support your goals and highlight your competitive advantages
•
Ensure strategy is a consistent theme throughout your investor pitch; address corporate (e.g., expansion plans), business unit (e.g., product/service plans) and financial (e.g., capital structure and objectives) strategies
•
Include realistic long-term financial targets and metrics by which the Street can measure your progress; highlight your execution track record
•
Provide scenario analyses that address adverse conditions
•
Remain consistent in your communication “It is very important to have a clear view of where you are trying to go over the medium-term rather than just the short-term because there are going to be bumps in the road. If we believe that management has the acumen to maximize shareholder returns then that is somewhere where we would probably like to put our money rather than a management with not such a clear view.” – Core Growth, Energy “What I really like to see is what the company thinks about the business. I like to see a clear delineation of the strategy. I like to see how the company looks at the market and segments the market, and I want to know how much the company thinks the markets are growing. I like to see an honest discussion of where it thinks it can improve and not just highlights of where it thinks it is strong. I like to see a clear discussion of financial strategy. I like to see honest and clear discussion of the tactical approach for whatever time period the company is discussing.” – Core Value, Generalist
“You want to know what the goal is and as much detail as they can provide in terms of how they see themselves getting there.” – Core Value, Healthcare/Industrials “Generally speaking, companies should communicate something that makes sense. It is important to have realistic goals that are well thought out and attainable. Many
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times, I feel like companies feel that a strategy is telling investors what they want to hear. That is not really helpful from my perspective.” – GARP, Healthcare “I want to hear the details for how they are going to grow. It is not enough to say you are going to move to a certain country. How are you going to do business there? How are you going to cope with cost inflation and Europe falling off the cliff?” – Core Value, Consumer “Part of a strategy is to communicate where the company is going and how it is going to get there. Strategy assumes a strategic objective, which can be articulated, such as, ‘In 10 years we want to be this, we want a position in this market and we want to be in this business’. Financial objectives are important as well. That is part of having a strategy. What is strategy? It is accessing your corporation’s resources, the strengths and weaknesses, and putting that against an opportunity that you see in the marketplace. Then, exploiting that combination, using resources against the opportunity to maximize or optimize the return to the owners of capital.” – Core Value, Multi
“It has to be a coherent strategy. In terms of best practices, keep talking about the same things. Be clear with the message and be consistent with that message. Benchmark how the company is performing against that.” – Deep Value, Industrials
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
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