Measuring consistency: the retailers cases study

As mentioned in my article “How to measure stock reputation”, communicating on strategy and targets is critical, but actually realizing this strategy and achieving targets is even more critical for stock reputation. Say what you do and do what you say. For this study, I decided to analyze the consistency of the largest listed retailers in the world, namely Walmart (US), Costco (US), Carrefour (France), Tesco (UK), The Kroger (US), Metro (Germany), The Home Depot (US) and Target Corporation (US).

Consistency in strategy

To start, I looked at the announced strategy for these companies at the end of 2011. Then I reviewed their communication over the last three years in order to spot inconsistencies, strategic changes and more broadly, all initiatives that were not in line with this announced strategy. According to the frequency and importance of those changes (either major or minor), I rated the consistency in strategy from zero to seven.

Overall, American retailers get good ratings on this criterion. Costco and The Home Depot are perfectly consistent throughout their publications. Their strategy and priorities have remained the same over the last three years and remain valid today.

On the contrary, the Europeans have been particularly inconsistent during the last three years. They all changed their CEOs and, with them, their strategy. This occurred at Carrefour in 2012 and it adjusted it strategy again in 2013. The CEO of Tesco was appointed in 2011, put in place a new strategy in 2012, and made a further adjustment in 2013, before being sacked in 2014.

The achievement of guidance and targets

The achievement of targets and guidance represents the second level of consistency analysis. A profit warning will of course strongly impact reputation but systematically better results than guidance is also not a positive. Not giving guidance is not a solution as it increases uncertainty. As previously, I reviewed in detail the publications from the last three years (12 quarters) for each company in order to spot profit warnings and revised targets. Then, I rate from zero to seven each company according to the frequency and importance of their profit warning (or any difference with expectation).

Over the last three years, The Kroger and The Home Depot have not issued any profit warnings. On the contrary, almost every quarter, they have done better than their guidance. It is for this reason that they do not receive the maximum points. This  raises investor expectations and increases potential disappointment risk for the day when those companies will only just make guidance.

Target and Tesco are at the bottom of the ranking. In three years, Tesco has been forced to issue two major profit warnings (at the beginning of 2012 and during the last change of CEO). Target did the same in the first quarter 2013 and during the second quarter 2014.

It should be noted that Carrefour and Cosco obtained a below average rating because they do not give guidance.

Reporting consistency

Reporting consistency is the last factor to analyze and rate. Once again, I reviewed in detail results publications, presentations and reporting in order to spot changes that would negatively impact understanding and visibility. Depending on the importance (major or minor) and the frequency of those change, I rated reporting consistency from zero to six (this criterion is slightly less important than the two others).

Just like the other criteria, the American retailers are doing much better than their European competitors. The annual report and accounting presentation of Costco in 2014 are identical to those of 2012 (no restatement). The Home Depot and the Kroger are also particularly consistent from one publication to the next.

This is not the case for Metro. Over the last three years, the German retailer’s reporting has been extremely difficult to follow. Metro made some accounting adjustments in 2012, but most importantly changed its divisional reporting and its reporting calendar in 2013 (the reporting year end changed from December to September). Carrefour has not been much better with accounting revisions and important reporting changes taking place almost every year.

Conclusion

By adding the results on these three criteria, it was possible to rate the consistency for each company. This rating gives the last measure of stock reputation.

Overall, the American retailers appear to have done much better than their European competitors. The Home Depot, The Kroger and Cosco are particularly consistent in their strategy, reporting, targets and achievements. On the contrary, the Europeans have issued multiple profit warnings, and changed their strategy and reporting many times. Their operational difficulties and CEO changes are, without a doubt, the reason for this.

Measuring the quality and effectiveness of the equity story communication: the cement industry case study

As mentioned in my article “How to measure stock reputation”, the quality and effectiveness of communication is the fourth criteria to rate stock reputation. For this case study and to follow the news, I decided to analyze the communication of the seven largest listed cement producers in the world, namely Anhui Conch (China), Lafarge (France), Holcim (Switzerland), CNBM (China), HeidelbergCement (Germany), Italcementi (Italy) and Cemex (Mexico). For this review, I mainly referred to information available on their websites (annual reports, investor presentations, financials results…).

Note that although the needed documentation was available in the Investor Relations website section for the western companies, it was not always the case for the Chinese companies. Their English language websites do not work well, are not up-to-date and disclose very limited information. To make my analysis and study the latest annual reports and results press releases, I had to go to the Hong Kong Stock Exchange website, where it is mandatory for listed companies to publish.

Business model communication

The first thing to look at in order to measure the quality and effectiveness of communication is the way companies communicate of their industry, their business model and their key profit drivers. Based on their disclosure, I rated communication by these companies from zero to four, with four being the highest.

Overall, western companies describe their activities and positioning relatively well. They highlight their strengths, but do not say much about their risks and weaknesses. Similarly, they could communicate more about their industry and are not specific enough on their key profit drivers. They do not explain much about price and volume dynamics and do not give details on their costs.

Saying that, HeidelbergCement is better rated than the average on this criterion due to a detailed presentation made for their investor day and specific slides which comment on key profit drivers. On the contrary, Anhui Conch and CNBM are poorly rated due to the limited description of activity in their annual report, which, beyond financial numbers, does not allow the investor to really understand and analyze their business model.

Strategy communication

The communication of the strategy is the second element to study. The strategy has to be properly explained and communicated, has to go beyond day-to-day management, and has to include quantitative targets. As I did previously, based on disclosures, I rated the quality and effectiveness of this communication from zero to four.

Holcim’s communication on strategy is excellent. The Swiss producer gives a good explanation of its strategy in its documentation (in particular its investor day presentation), clearly highlighting its priorities, and precisely quantifying its targets. Also, Holcim goes beyond its day-to-day management and explains its long-term vision with the Lafarge merger. Also, if the merger would not take place, this will represent a major set back for the group.

Alternatively, the Chinese communication on strategy is particularly poor. Anhui Conch explains that its strategy is to adapt and CNBM to reduce cost and debt (the contrary would have been surprising!). The two producers are willing to expand their activity internationally and to participate in M&A activity but are not providing any rationale for this.

Capital allocation communication

Besides strategy disclosure, capital allocation– including the dividend policy – needs to be formerly disclosed and explained. Once again, I rated this communication from zero to four.

Once again, Holcim and HeidelbergCement obtain the best rating on this criterion. HeidelbergCement is the only company of our sample to formally disclose a dividend policy (a targeted pay-out ratio). Holcim only provides some indication about its dividend intention but, on the other hand, is explicit on its approach to capital allocation and priorities for the use of cash (a section is dedicated to this area in its investor day presentation). 

On the other end, despite distributing a dividend, the Chinese groups do not mention cash allocation or dividend policy anywhere in their publications.

Results and performance communication

Beyond communication on business model, strategy and capital allocation, the way that results and performance are communicated is critical. As before, this communication was rated from zero to four.

Overall, western companies have a good level of disclosure and very similar communication results. All publish detailed quarterly results, with investor presentations, and the investor conference call is available on replay. Holcim is also adding a downloadable Excel model of its accounts.  They all communicate on outlook and annual trends but, unfortunately, none provide formal and quantified quarterly guidance.

Once again, Chinese corporate are at the bottom of the ranking. Their quarterly communication (outside annual and interim results) is extremely limited. In addition, no presentation is available and they do not organize any calls with investors (at least officially).

Communication coherence

Coherence is the last thing to look at in order to judge the quality and effectiveness of communication: not only the overall coherence of the equity story but also the right information, which allows the building of a good financial model. One last time, I rated this communication from zero to four.

Until yesterday, Holcim and Lafarge would have been excellent on this criterion. Both gave all necessary information needed to generate a good financial model, but mainly they were presenting a convincing equity story resulting, in particular, from their merger project. Their announcements that they may not pursue their merger impact strongly their communication coherence and credibility.

Chinese companies are also again badly rated but CNBM is doing better than its domestic competitor due to the annual disclosure of several divisional indicators allowing for the building of a proper financial model.

Conclusion

By adding the results on these criteria, it was possible to globally rate the quality and effectiveness of the equity story communication of each company. This rating will give the fourth stock reputation measurement.

As expected the Chinese cement producer are at the bottom of the ranking. Clearly, they seem willing to only disclose the strict minimum required under Hong Kong securities law. As a matter of fact, they are primarily China's state-owned companies and do not have to be concerned about private shareholders.

On the contrary, until yesterday, Holcim would have obtained the best rating and Lafarge a good rating. Not everything was perfect, but the two companies were explaining their equity story in detail and extensively communicate on the merger benefit. Their latest statement re-challenging their merger is a strong setback. This shows to investors that they have been subjected to months of misinformation. Whatever happens (the deal does go ahead or not), this story will impact their reputation on the stock market for long.

Measuring shareholder structure quality: the Dax case study

As mentioned in my article “How to measure stock reputation”, the quality of the shareholder register is the third criteria to rate stock reputation. In this case study, I have decided to examine the 30 companies of the DAX, the largest German stock index.

“Major” institutional investors ownership

The shareholder structure of a listed company is indicative of stock reputation. Indeed, the more prestigious the shareholder base, the better it is for the company’s reputation on the stock market. Generally, the most prestigious investors are the largest (even if there are exceptions to this rule). Therefore, I identified the 150 largest institutional investors (including sovereign wealth funds) managing assets of more than USD 100 billions and named them the “major” ones. Then, for each company of the DAX, I measured how much of the free float those “major” institutional investors owned.

Without surprise, the “major” institutional investors are the main shareholders of the DAX companies. The German economy remains the reference in Europe and attractive to these investors. On average, they own more than 20% of the German blue-chip stocks.

Volkswagen is the company, which has the greatest percentage of these prestigious shareholders. The car manufacturer benefits notably from a significant ownership by the Qatari sovereign funds (QIA). Volkswagen also has the Norwegian sovereign funds (Norges) and Capital Research in its shareholder register. Similarly, the semiconductor manufacturer Infineon, has an excellent rating on this criterion due to its long-term shareholders Dodge & Cox, Capital Research and Allianz Global Investors.

On the contrary, the fertilizer and salt producer K+S has relatively few large institutional shareholders. That can be explained partly by its relatively small size compared to the other DAX companies, but is probably not the only explanation.

Shareholder loyalty

The shareholder register quality also has to be measured in terms of shareholder loyalty. To measure this, I looked at a period of two years to see how many funds were selling their positions each quarter and how many remained as shareholders. By comparing these two pieces of data, I was able to measure the proportion of funds exiting the shareholder register.

Overall, the shareholders of the German DAX companies are relatively loyal. On average, only one shareholder out of 13 leaves a register each quarter. Nevertheless, there exist major differences between companies.

Bayer’s shareholders are particularly loyal to the chemical and pharmaceutical company. Only one shareholder out of 25 sells its position each quarter. More generally, the chemical companies (Henkel, BASF) have succeeded to retain their shareholders.

Alternatively, Commerzbank is suffering from high shareholder turnover. 12% of its investors are leaving the company each quarter, which is three times more than Bayer. This lack of loyalty is also visible in the share performance. Commerzbank has significantly underperformed the DAX index over the last two years.

Conclusion

By combining results concerning the ownership of “major” institutional investors and the ones concerning shareholder loyalty, it is possible to rate the shareholder structure quality of each company. This rating will give the third stock reputation measurement. Within the DAX companies, the car manufacturer BMW has the best rating. This is due to the important ownership of large and long-term funds such as Dodge & Cox and Harris Associates, but also to the high loyalty of its shareholders. On the contrary, the K+S shareholders are not very prestigious or loyal. 

Measuring shareholder value focus: the Dow Jones case study

As mentioned in my article “How to measure stock reputation”, the focus on shareholder value is the second thing to look at in order to measure stock reputation. For this case study, I looked at American companies on the Dow Jones Index.

Focus of the Board

To begin with, the focus on shareholder value has to come from the board of Directors.  In order to rate this focus, I looked in detail at board composition and governance for several companies. In particular, I identified the presence (or not) of significant shareholders on the board and the separation (or not) of the CEO and Chairman roles. To refine my analysis, I looked at other secondary criteria to answer the following questions: Is a significant shareholder the Chairman of the Board? Is the CEO the main shareholder of the company? Is there a State shareholder with a representative present on the Board? In case on a combined CEO and Chairman role, is there a Lead Independent Director on the Board? Is a majority of the board composed of independent board members? Are there only independent board members when excluding the CEO and significant shareholders? Finally, based on these two main criteria, as well as secondary ones, I rated the shareholder value focus of each board.

This analysis showed that few boards have a strong focus on shareholder value, but that is not the case for the majority. Two-thirds of Dow Jones companies are rated below average and two elements explain this.

First, most of these companies were founded decades ago and do not have any reference shareholder. They are fully public and owned by institutional investors who do not sit on the board.

Second, most of the time, the CEO is also the Chairman of the Board. Despite corporate governance best practices and shareholder pressure, American CEOs cling to this traditional model that gives them the power and allows them to control the board. Facing criticism, they have recently accepted to name Lead Independent Directors to their boards, but those board members still do not have enough power to really threaten CEOs in the case of share price underperformance.

Focus of the CEO

Next, to measure how much of a priority is given to shareholder value, the CEO’s incentive linked to the share price performance needs to be analyzed. Indeed, the best way to align the interests of executives and shareholders is to pay executives a high proportion of shares and stock options. Also, I looked at the number of shares (and stock options) owned by each CEO. More precisely, I measured the value of the CEO’s stocks ownership and compared it to his annual salary (including bonus). On this basis, I was able to rate and rank the shareholder value focus of each CEO.

*Before recent change of CEO

Overall, this analysis is very positive for US companies. Three-quarters of the CEOs analyzed own shares equivalent to more than five years’ worth of salary. Therefore, they are extremely incentived by the performance of their share price.

Among them, JP Morgan and UnitedHealth CEOs are the most incentivized. Their stock ownership represents more than 80 years of salary. In part, this can be explained by their seniority as CEOs (for almost 10 years they have cumulated shares and stock options), and in the case of JP Morgan’s CEO by his relative low annual salary (he did not receive a bonus in 2014). Yet, this shows above all the boards willingness to align CEO interest with that of shareholders.

On the contrary, McDonald’s and IBM’s CEOs owned relatively few shares compared to their salaries. This is due partly to their relatively limited seniority in their positions but also because they have sold many shares over the last years. Whatever the reason, at the end, their wealth is not linked to share performance and this may worry investors.

Investor Relations intensity  

Investor Relations activity is the last thing to analyze in order to measure shareholder value focus. Even without board pressure and without financial incentives, management can involve itself in an active IR program. To measure these actions, the best approach is to measure the time dedicated by management (CEO and CFO) to investors (results, roadshows, conferences, investor days…). It is unfortunately difficult to obtain precise information on the management timetable from outside of the company. Also, to get an idea of management involvement in IR activities, I listed the number of investor’s events to which the company participated (excluding the mandatory ones such as quarterly results and AGM). This allowed me to rate IR intensity.

On average, Dow Jones’ companies participated in six events per year. However, some are much more active than that. For example, General Electric and Cisco have participated in more than 20 events per year. Alternatively, Nike seems to have participated in a limited number of events.

Conclusion

By adding the results on these three criteria, it was possible to rate the shareholder value focus for each company.

Microsoft and Wal-Mart obtained the best rating due to the presence of important shareholders on their boards, the separation of the CEO and Chairman roles and an significant share ownership of their CEOs. To the contrary, Chevron was at the bottom of the ranking as its CEO was also Chairman and owned very few shares on its company.

More broadly, these American companies have relatively good ratings as regard to their shareholder value focus. On the negative side, CEOs are often Chairmen and there is not much threat in theory from their boards. On the positive side, they are highly incentivized by their share price performance. This is not often the case in Europe or Asia.