22 Feb Feb Feb Allen Good, CFA, Analyst, 22 November 2016

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1 Morningstar Equity Analyst Report Report as of 23 Feb :10, UTC Page 1 of 14 Morningstar Pillars Analyst Quantitative Economic Moat None None Valuation QQQ Fairly Valued Uncertainty High Medium Financial Health Moderate Source: Morningstar Equity Research Important Disclosure: The conduct of Morningstar s analysts is governed by Code of Ethics/Code of Conduct Policy, Personal Security Trading Policy (or an equivalent of), and Investment Research Policy. For information regarding conflicts of interest, please visit Danger Zone: Coming Shale Growth Poses Major Risks to Oil Prices Quantitative Valuation BP Current 5-Yr Avg Sector Country Price/Quant Fair Value Price/Earnings Forward P/E Price/Cash Flow Price/Free Cash Flow Trailing Dividend Yield% Source: Morningstar Bulls Say OBP reached a settlement with the U.S. federal government and Gulf States earlier in 2016, resulting in a reliable estimate of all its remaining Gulf of Mexico liabilities and eliminating the uncertainty about future obligations. OWhile BP will run a cash flow deficit through 2017, we forecast it can cover a full cash dividend at $55/ bbl oil in 2018, one of the lowest levels among European integrateds. OLiquids comprise over 60% of BP s production, one of the highest levels of its peers, giving it greater leverage in an oil price recovery. Bears Say OThe remaining Gulf of Mexico liabilities remain substantial with payments due through Present value of these payments reduces our fair value estimate by $4 per ADS. OWith a relatively small downstream footprint, BP has less ability to capitalize in a falling oil-price environment and offset the earnings lost by the upstream segment. OBP holds a relatively high level of political risk, with about 35% of its reserves coming from its 20% ownership in the government-controlled Russian oil company Rosneft. GBR Undervalued Fairly Valued Overvalued o Investment Thesis Allen Good, CFA, Analyst, 22 November 2016 The settlement reached with the U.S. federal government and Gulf states earlier this year was a major step for BP in putting the 2010 Deepwater Horizon accident behind it. While BP remains on the hook for $23 billion, to be paid over the next 17 years, the recognition of a reliable estimate for all remaining liabilities removes a key element of uncertainty for the company. With outlays of about $2.5 billion due through 2018 and $1.1 billion per year thereafter, BP should be able to meet its liabilities with proceeds from targeted asset sales of $2 billion-$3 billion per year, which we view as a rather low hurdle. With that issue largely resolved, BP is now turning its focus to positioning the company to compete in a world of lower oil prices. Its first step is to improve its cost structure and reduce its capital outlays so that it can cover its dividend at $55/barrel oil by While we estimate that this goal is slightly ambitious, it is likely achievable by 2018, making it one of the safest dividends among the European integrateds. BP is targeting cost reduction of $7 billion, or 20%, from 2014 levels, primarily in the upstream segment, where it is planning to reduce the workforce by a third. With the firm already one of the lower-cost producers of its peer group, the cost reductions will improve margins further. Meanwhile, capital spending will fall to $15 billion-$17 billion on average from 2017, a sharp reduction from the peak in 2013 of nearly $25 billion. At this level, BP will continue to invest the least among the peer group for its level of production. However, it will continue to grow through a mix of projects already under construction or nearing completion and those who have qualified for a final investment decision due to cost reduction. In total, BP plans to add 800 thousand barrels of oil equivalent of new gross production capacity by 2020, 85% of which is at least under construction. With these new volumes sporting margins 35% greater than the existing portfolio, BP s upstream margin should improve further over time. Analyst Note Stephen Simko, CFA, Sector Director, 22 February 2017 OPEC's production cuts and strong demand growth have 2017 crude fundamentals in their best shape since oil prices crashed two years ago. The consensus outlook is that fundamentals are now strong enough to remain healthy even after OPEC's cuts lapse. This might have been possible a few months ago, but the odds of this scenario playing out have markedly worsened since. The reason is that major increases in shale activity now have U.S. production firmly on a path of rapid growth, even if rig counts don't increase further. This growth plus the eventual supply increases from OPEC is likely more than enough to erase any market tightness and throw crude markets back into oversupply. What's obvious by now is that current oil prices provide economics that are very attractive to the major U.S. shale producers. This has created the conditions that will allow tight oil to grow rapidly and is a reality that even looming cost inflation will not change. Unless shale producers become more disciplined or OPEC resigns itself to permanently ceding share to the U.S., oil markets have major problems looming. Neither of these is likely to occur. Nonetheless, there remains a good chance that oil prices could rise in the coming months if OPEC compliance remains high or production cuts are extended. Because surging shale output won't truly begin to move the supply needle until the second half of the year, these would allow for further inventory draws. This could bolster the perception that oil market fundamentals are improving. In reality, oil prices above current levels at any point in the coming months would in fact be pouring gasoline on the flames since it would certainly encourage even higher levels of U.S. shale investment. Nothing is certain in the world of oil, but clouds appear to be gathering on the horizon. We our maintaining our forecast for strong oil prices in 2017, with West Texas Intermediate averaging $58 per barrel, followed by a meaningful pullback to $45 in Economic Moat Allen Good, CFA, Analyst, 22 November 2016 BP does not earn an economic moat in our opinion, as its

2 Morningstar Equity Analyst Report Page 2 of 14 Close Competitors Currency (Mil) Market Cap TTM Sales Operating Margin TTM/PE Exxon Mobil Corp XOM USD 335, , Chevron Corp CVX USD 208, , Total SA FP EUR 118, , asset base is not capable of delivering sustainable excess returns at our long-term oil price assumption of $60/bbl. Based on an evaluation of its oil- and gas-producing assets using our exploration and production moat framework, BP s upstream portfolio fails to qualify for a moat. It managed to deliver upstream returns on capital employed of only 9% during the past five years, below average relative to other integrated firms, as production fell while it shed assets to meet liabilities associated with the 2010 Macondo incident. While we expect BP to reduce spending, cut production costs, and resume production growth, we do not think those efforts will prove sufficient to overcome our expectations for lower commodity prices and deliver sustainable excess returns for the upstream segment. BP s downstream segment will also likely prove to be an obstacle to delivering excess returns. The segment has delivered returns of only 7% during the past five years, and we do not expect material improvement, despite BP s efforts to restructure the segment and reduce capital employed. The bulk of BP s refining assets are located in Europe, where structural challenges including overcapacity, susceptibility to low-cost imports, and lack of a cost advantage will continue to weigh on margins and returns. Valuation Allen Good, CFA, Analyst, 22 November 2016 We are raising our fair value estimate to $35 from $33 per share, which corresponds to a forward enterprise value/ebitda multiple of 5.1 times our 2017 EBITDA forecast of $26.2 billion. Our fair value estimate is derived using Morningstar s standard two-stage discounted cash flow methodology. With this methodology, a terminal value is derived using our assumptions for long-term earnings growth and return on new invested capital. This valuation methodology also more explicitly incorporates our moat rating, which reflects how long we expect a given firm to deliver excess returns on invested capital from a discounted cash flow analysis. In our DCF model, we assume natural gas prices of $2.43 per thousand cubic feet in 2016, $3.07 in 2017, and $2.95 in Our long-term assumption is $3.00 beginning in For oil, we assume Brent prices of $45 per barrel in 2016, $51 in 2017, $68 in 2018, and $65 in Our long-term oil-price assumption is $60. We assume a cost of equity of 9% and a WACC of 7.4%. We forecast production to grow during the next five years at a CAGR of 2%, which is toward the lower end of the peer group. That said, it marks a change from the past several years, when divestitures and field decline have resulted in falling volumes. BP plans to add 500 mboe of gross production capacity by year-end 2018 and 800 mboed by We forecast downstream earnings to recede from their 2015 levels as the strength in European refining conditions proves unsustainable. Risk Allen Good, CFA, Analyst, 22 November 2016 BP's profits and cash flow are largely tied to hydrocarbon production and highly leveraged to movements in the price of oil. Periods of prolonged low oil prices weaken returns on capital, and new oil and gas projects would be unlikely to generate their projected economic results. BP employs huge amounts of capital in building out its production portfolio, and cost overruns and/or completion delays are continued sources of uncertainty. Greater reliance on highly technical projects is likely to increase these risks. Our valuation carries heightened uncertainty because of exposure to the Russian government through its Rosneft partnership. With respect to BP's 20% interest in Rosneft, the firm's status as a Western company that holds such a large stake in Russia's national oil company creates significant sovereign risk, although this is somewhat reflected in Rosneft's share price. Management Allen Good, CFA, Analyst, 22 November 2016 Current CEO Robert Dudley took over in late 2010, in the wake of the Gulf of Mexico incident, after a long career that has included a variety of roles with the company. His initial task was to improve safety and governance at BP, which has demonstrated poor judgment and lax operating controls in a number of incidents during the past 15 years. In addition to the Gulf of Mexico blowout, these incidents include a pipeline leak in Alaska, a fine for trying to corner the propane market, and an explosion at its Texas City

3 Morningstar Equity Analyst Report Page 3 of 14 refinery. Though BP has yet to suffer another material event and has overhauled its processes, its too early to judge Dudley s efforts. Also, the number of incidents suggests a flawed culture that will take time to transform. With the downturn in oil prices, Dudley must now add reducing BP s cost base to his task list. His early efforts are promising, as BP is targeting some of the greatest cost reduction among its peers. Meanwhile, efforts to reduce new project costs are allowing BP to proceed with final investment decisions on several projects, ensuring future growth. Ability to execute on these plans in the coming years will ultimately determine whether Dudley is a success. Despite the numerous operational issues, we award BP a Standard stewardship rating.

4 Morningstar Equity Analyst Report Page 4 of 14 Analyst Notes Archive OPEC Cuts, U.S. E&Ps Drill: Our Oil Price Outlook Remains Unchanged Allen Good, CFA, Analyst, 29 September 2016 In a somewhat surprising development, OPEC members have tentatively agreed to a production target of between 32.5 million and 33.3 million barrels per day, representing a reduction of up to 700 mb/d from current production levels of 33.2 mmb/d. Oil prices rallied on the news, but our view for continued low prices of $50/bbl in 2017 (detailed in our Aug. 26 report) remains unchanged, as we do not believe the potential reduction will have a meaningful sustainable impact on oil prices. While the low end of the target range is nearly 1 mmbd lower than our 2017 forecast for OPEC production, and if realized, it would balance markets and reduce inventories sooner than our original expectations, we see numerous risk factors that we think prevent a sustained recovery in prices until First, no agreement has formally been reached, with details to be agreed upon at the November meeting. Even though the low end of the target range only marks a retreat to first-quarter levels, apportioning the production cuts could prove problematic, given the pre-existing political tensions, namely between Iran and Saudi Arabia, which could ultimately scuttle a deal or delay implementation. Second, OPEC has a poor track record of coordinating production cuts among its members, with quotas often breached or outright ignored. There are also indications that any deal might exclude Libya or Nigeria, where disruptions have already reduced production and a return of volumes would offset the proposed cuts. It s also unclear how long any agreement would remain in place, potentially setting the stage for resumption of growth in The biggest risk factor, however, remains the potency of U.S. shale. We expect any OPEC production cut and subsequent price response to be met with an acceleration of U.S. activity. BP Q3 Earnings Fall, but Delivery on Cost Reductions Sets Up 2017 for $55/Barrel Break-Even Allen Good, CFA, Analyst, 01 November 2016 BP reported a decline in third-quarter earnings as low prices continued to weigh on upstream earnings while downstream earnings deteriorated further amid weakening market conditions. Underlying replacement profit after tax fell to $933 million from $1.8 billion a year ago. The upstream segment posted a loss of $224 million, compared with earnings of $823 million last year on lower realizations and a 5.9% decline in volumes, owing largely to maintenance and turnaround activity. Downstream earnings continued to generate the bulk of earnings, as it has over the past two years, but its contribution fell to $1.4 billion during the quarter from $2.3 billion, as the fuels business suffered from narrowing margins and turnaround activity. Rosneft profit fell to $120 million from $382 million last year, primarily due to lower oil prices and increased government take. Our view on BP, including our fair value estimate and moat rating, is unchanged, as the quarterly results were largely as expected and guidance items were left intact outside a slight reduction in 2016 capital expenditure (from $17 billion to $16 billion). BP remains on track to achieve its $7 billion cost-reduction target by 2017, with $6.1 billion in reductions achieved to date. The cost reduction, combined with slightly lower capital expenditure, should allow operating cash flow to cover capital spending and dividend at about $55/barrel in 2017, although continuation of the scrip will be necessary. By 2018, however, BP should be in a position to cover a full cash dividend at $55/bbl. Oil and Gas Sector Likely to Fare Well Under Trump Administration Allen Good, CFA, Analyst, 11 November 2016 For global energy markets, the potential knock-on impacts of a Donald Trump presidency could be meaningful in a few areas. With respect to U.S. oil and gas producers, we can say that the tail risk for regulation of hydraulic fracturing and methane emissions is now somewhat lower. Thus far, the Environmental Protection Agency has maintained that the systemic environmental impact of hydraulic fracturing is benign. A Trump-led EPA is less likely to reverse this view than a Hillary Clinton-led EPA. More tangibly, certain high-environmental-impact upstream segments could benefit from a lighter touch, such as sand mining to supply hydraulic fracturing proppant. Overall, however, state and local governments rather than federal authorities have had the lion s share of impact on upstream economics. Additionally, exploration and production firms producing

5 Morningstar Equity Analyst Report Page 5 of 14 in areas with disadvantaged transportation economics due to incomplete pipeline infrastructure could benefit if Trump-led regulatory agencies accelerate approval of new projects (for example, the controversial Dakota Access Pipeline, which would service the Bakken). We also believe the likelihood that pipelines carrying Canadian heavy oil to the United States, such as Keystone XL, will proceed has increased, which could address the potential takeaway issues that loomed on the horizon for Alberta s oil producers. However, Trump s desire for the U.S. government to capture a bigger piece of the profits could be a barrier to breaking ground on new pipeline infrastructure. Nothing Novel About It: OPEC Adds a Twist to the Plot, but the Ending Is Unchanged Stephen Simko, Sector Director, 02 December 2016 OPEC's announced production cuts this week represent a positive near-term development for world oil markets, removing more than 1 million barrels per day from an oversupplied system. Even after factoring in the inevitable U.S. shale response to higher crude prices, OPEC's cuts point to a meaningful supply deficit next year. Consequently, we are raising our 2017 WTI price to $60 per barrel, up from $50 previously. Improved near-term fundamentals come at a cost, however. Even a modest recovery in oil prices will incentivize U.S. shale producers to further ramp activity so that they eventually replace almost all "removed" OPEC barrels with their own. Increased near-term shale activity means that oil prices are unlikely to remain elevated for long. The industry is awash in low-cost oil, and temporary OPEC cuts cannot alter this reality. Our long-term oil price assumption of $55/bbl WTI remains unchanged. BP's Fourth Quarter Underwhelming but Setting up for Improved 2017 Allen Good, CFA, Analyst, 07 February 2017 Higher oil prices and the benefit of reduced operating costs allowed BP to return its upstream segment to profitability in the fourth quarter. However, the improvement in total earnings was limited by a decline in downstream earnings that resulted from weak margins and heavy turnaround activity. Upstream segment earnings swung to a profit of $400 million from a loss of $728 million last year, while downstream profit slipped to $877 million from $1.2 billion leaving total profit to increase modestly to $400 million from $196 million. Outside the weaker downstream result, the report largely met expectations. We are leaving our fair value estimate and moat rating unchanged. During the quarter and for the full year, BP failed to cover its cash dividend with free cash flow. The gearing ratio the end of the year rose to 27% from 22% a year ago. Despite capital spending set to modestly rise to $16 billion-$17 billion from $16 billion this year, we anticipate BP s cash flow generating ability to improve given the cost reductions that combined with higher oil prices should result in it achieving cash flow neutrality in Danger Zone: Coming Shale Growth Poses Major Risks to Oil Prices Stephen Simko, Sector Director, 22 February 2017 OPEC's production cuts and strong demand growth have 2017 crude fundamentals in their best shape since oil prices crashed two years ago. The consensus outlook is that fundamentals are now strong enough to remain healthy even after OPEC's cuts lapse. This might have been possible a few months ago, but the odds of this scenario playing out have markedly worsened since. The reason is that major increases in shale activity now have U.S. production firmly on a path of rapid growth, even if rig counts don't increase further. This growth plus the eventual supply increases from OPEC is likely more than enough to erase any market tightness and throw crude markets back into oversupply. What's obvious by now is that current oil prices provide economics that are very attractive to the major U.S. shale producers. This has created the conditions that will allow tight oil to grow rapidly and is a reality that even looming cost inflation will not change. Unless shale producers become more disciplined or OPEC resigns itself to permanently ceding share to the U.S., oil markets have major problems looming. Neither of these is likely to occur. Nonetheless, there remains a good chance that oil prices could rise in the coming months if OPEC compliance remains high or production cuts are extended. Because surging shale output won't truly begin to move the supply needle until the second half of the year, these would allow for further inventory draws. This could bolster the perception that oil market fundamentals are improving. In reality, oil prices above current levels at any point in the coming months would in fact be pouring gasoline on the flames since it would certainly encourage even higher

6 Morningstar Equity Analyst Report Page 6 of 14 levels of U.S. shale investment. Nothing is certain in the world of oil, but clouds appear to be gathering on the horizon. We our maintaining our forecast for strong oil prices in 2017, with West Texas Intermediate averaging $58 per barrel, followed by a meaningful pullback to $45 in 2018.

7 Quantitative Equity Report Release:, 19:10, GMT-06:00 Reporting Currency: USD Trading Currency: USD Exchange:XNYS Page 1 of 1 Page 7 of 14 Q 02:00 UTC BP PLC ADR BP QQQ Last Close Fair Value Q Market Cap Sector Industry Country of Domicile 02:00 UTC Bil o Energy Oil & Gas Integrated GBR United Kingdom There is no one analyst in which a Quantitative Fair Value Estimate and Quantitative Star Rating are attributed to; however, Mr. Lee Davidson, Head of Quantitative Research for Morningstar, Inc., is responsible for overseeing the methodology that supports the quantitative fair value. As an employee of Morningstar, Inc., Mr. Davidson is guided by Morningstar, Inc. s Code of Ethics and Personal Securities Trading Policy in carrying out his responsibilities. For information regarding Conflicts of Interests, visit Company Profile BP PLC provides energy products and services. The Company explores for oil and natural gas and also engages in supply and trading of crude oil, petroleum, petrochemicals products and related services. Quantitative Scores Scores All Rel Sector Rel Country Quantitative Moat None Valuation Fairly Valued Quantitative Uncertainty Medium Financial Health Moderate GBR BP Undervalued Fairly Valued Overvalued Source: Morningstar Equity Research o Price vs. Quantitative Fair Value Quantitative Fair Value Estimate Total Return 140 Sales/Share Forecast Range Forcasted Price 112 Dividend 84 Split Momentum: Standard Deviation: Liquidity: High Wk Yr Total Return % / Market (Morningstar US Index) Trailing Dividend Yield % 7.08 Forward Dividend Yield % Price/Earnings Price/Revenue Morningstar Rating Q QQQQQ QQQQ QQQ QQ Q Valuation Current 5-Yr Avg Sector Median Country Median Price/Quant Fair Value Price/Earnings Forward P/E Price/Cash Flow Price/Free Cash Flow Trailing Dividend Yield % Price/Book Price/Sales Profitability Current 5-Yr Avg Sector Median Country Median Return on Equity % Return on Assets % Revenue/Employee (Mil) TTM Financials (Fiscal Year in Mil) 386, , , , , ,718 Revenue % Change 39,817 19,733 31,310 5,982-7,918-7,056 Operating Income % Change 25,700 11,582 23,451 3,780-6,482-3,689 Net Income 22,154 20,397 21,100 32,754 19,133 14,069 Operating Cash Flow -17,845-23,078-24,520-22,546-18,648-17,169 Capital Spending 4,309-2,681-3,420 10, ,100 Free Cash Flow % Sales EPS % Change Free Cash Flow/Share Dividends/Share Book Value/Share 3,404 3,039 3,059 3,153 3,153 Shares Outstanding (Mil) Financial Health Current 5-Yr Avg Sector Median Country Median Distance to Default Solvency Score Assets/Equity Long-Term Debt/Equity Profitability Return on Equity % Return on Assets % Net Margin % Asset Turnover Financial Leverage Gross Margin % Operating Margin % 35,169 38,767 40,811 45,977 45,567 53,308 Long-Term Debt 111, , , ,441 97,216 91,376 Total Equity Fixed Asset Turns Growth Per Share 1-Year 3-Year 5-Year 10-Year Revenue % Operating Income % Earnings % Dividends % Book Value % Stock Total Return % Quarterly Revenue & EPS Revenue (Bil) Mar Jun Sep Dec Total Earnings Per Share () Revenue Growth Year On Year % Morningstar All Rights Reserved. Unless otherwise provided in a separate agreement, you may use this report only in the country in which its original distributor is based. The information, data, analyses and opinions presented herein do not constitute investment advice; are provided solely for informational purposes and therefore is not an offer to buy or sell a security; are not warranted to be correct, complete or accurate; and are subject to change without notice. Except as otherwise required by law, Morningstar shall not be responsible for any trading decisions, damages or other losses resulting from, or related to, the information, data, analyses or opinions or their use. The information herein may not be reproduced, in any manner without the prior written consent of Morningstar. Please see important disclosures at the end of this report. ß

8 Morningstar Equity Analyst Report Page 8 of 14 Research Methodology for Valuing Companies Qualitative Equity Research Overview At the heart of our valuation system is a detailed projection of a company s future cash flows, resulting from our analysts research. Analysts create custom industry and company assumptions to feed income statement, balance sheet, and capital investment assumptions into our globally standardized, proprietary discounted cash flow, or DCF, modeling templates. We use scenario analysis, in-depth competitive advantage analysis, and a variety of other analytical tools to augment this process. Moreover, we think analyzing valuation through discounted cash flows presents a better lens for viewing cyclical companies, high-growth firms, businesses with finite lives (e.g., mines), or companies expected to generate negative earnings over the next few years. That said, we don t dismiss multiples altogether but rather use them as supporting cross-checks for our DCF-based fair value estimates. We also acknowledge that DCF models offer their own challenges (including a potential proliferation of estimated inputs and the possibility that the method may miss short-term market-price movements), but we believe these negatives are mitigated by deep analysis and our long-term approach. Morningstar s equity research group ( we, our ) believes that a company s intrinsic worth results from the future cash flows it can generate. The Morningstar Rating for stocks identifies stocks trading at a discount or premium to their intrinsic worth or fair value estimate, in Morningstar terminology. Five-star stocks sell for the biggest risk-adjusted discount to their fair values, whereas 1-star stocks trade at premiums to their intrinsic worth. Four key components drive the Morningstar rating: (1) our assessment of the firm s economic moat, (2) our estimate of the stock s fair value, (3) our uncertainty around that fair value estimate Morningstar Research Methodology for Valuing Companies Economic Moat Financial Health Stewardship Uncertainty Moat Trend Morningstar Fair Value and (4) the current market price. This process ultimately culminates in our single-point star rating. 1. Economic Moat The concept of an economic moat plays a vital role not only in our qualitative assessment of a firm s long-term investment potential, but also in the actual calculation of our fair value estimates. An economic moat is a structural feature that allows a firm to sustain excess profits over a long period of time. We define economic profits as returns on invested capital (or ROIC) over and above our estimate of a firm s cost of capital, or weighted average cost of capital (or WACC). Without a moat, profits are more susceptible to competition. We have identified five sources of economic moats: intangible assets, switching costs, network effect, cost advantage, and efficient scale. Companies with a narrow moat are those we believe are more likely than not to achieve normalized excess returns for at least the next 10 years. Wide-moat companies are those in which we have very high confidence that excess returns will remain for 10 years, with excess returns more likely than not to remain for at least 20 years. The longer a firm generates economic profits, the higher its intrinsic value. We believe lowquality, no-moat companies will see their normalized returns gravitate toward the firm s cost of capital more quickly than companies with moats. To assess the sustainability of excess profits, analysts perform ongoing assessments of the moat trend. A firm s moat trend is positive in cases where we think its sources of competitive advantage are growing stronger; stable where we don t anticipate changes to competitive advantages over the next several years; or negative when we see signs of deterioration. 2. Estimated Fair Value Combining our analysts financial forecasts with the firm s economic moat helps us assess how long returns on invested capital are likely to exceed the firm s cost of Margin of Safety Market Pricing Morningstar Rating TM For Stocks QQQQQ capital. Returns of firms with a wide economic moat rating are assumed to fade to the perpetuity period over a longer period of time than the returns of narrow-moat firms, and both will fade slower than no-moat firms, increasing our estimate of their intrinsic value. Our model is divided into three distinct stages: Stage I: Explicit Forecast In this stage, which can last five to 10 years, analysts make full financial statement forecasts, including items such as revenue, profit margins, tax rates, changes in working-capital accounts, and capital spending. Based on these projections, we calculate earnings before interest, after taxes (EBI) and the net new investment (NNI) to derive our annual free cash flow forecast. Stage II: Fade The second stage of our model is the period it will take the company s return on new invested capital the return on capital of the next dollar invested ( RONIC ) to decline (or rise) to its cost of capital. During the Stage II period, we use a formula to approximate cash flows in lieu of explicitly modeling the income statement, balance sheet, and cash flow statement as we do in Stage I. The length of the second stage depends on the strength of the company s economic moat. We forecast this period to last anywhere from one year (for companies with no economic moat) to years or more (for wide-moat companies). During this period, cash flows are forecast using four assumptions: an average growth rate for EBI over the period, a normalized investment rate, average return on new invested capital (RONIC), and the number of years until perpetuity, when excess returns cease. The investment rate and return on new invested capital decline until a perpetuity value is calculated. In the case of firms that do not earn their cost of capital, we assume marginal ROICs rise to the firm s cost of capital (usually attributable to less reinvestment), and we may truncate the second stage. Stage III: Perpetuity Once a company s marginal ROIC hits its cost of capital, we calculate a continuing value, using a standard perpetuity formula. At perpetuity, we assume that any growth or decline or investment in the business neither creates nor destroys value and that any new investment provides a return in line with estimated WACC. Because a dollar earned today is worth more than a dollar earned tomorrow, we discount our projections of cash flows in stages I, II, and III to arrive at a total pres-

9 Morningstar Equity Analyst Report Page 9 of 14 Research Methodology for Valuing Companies ent value of expected future cash flows. Because we are modeling free cash flow to the firm representing cash available to provide a return to all capital providers we discount future cash flows using the WACC, which is a weighted average of the costs of equity, debt, and preferred stock (and any other funding sources), using expected future proportionate long-term, marketvalue weights. 3. Uncertainty around that fair value estimate Morningstar s Uncertainty Rating captures a range of likely potential intrinsic values for a company and uses it to assign the margin of safety required before investing, which in turn explicitly drives our stock star rating system. The Uncertainty Rating represents the analysts ability to bound the estimated value of the shares in a company around the Fair Value Estimate, based on the characteristics of the business underlying the stock, including operating and financial leverage, sales sensitivity to the overall economy, product concentration, pricing power, and other company-specific factors. Analysts consider at least two scenarios in addition to their base case: a bull case and a bear case. Assumptions are chosen such that the analyst believes there is a 25% probability that the company will perform better than the bull case, and a 25% probability that the company will perform worse than the bear case. The distance between the bull and bear cases is an important indicator of the uncertainty underlying the fair value estimate. 3Medium: margin of safety for 5-star rating is a 30% discount and for 1-star rating is 35% premium. 3High: margin of safety for 5-star rating is a 40% discount and for 1-star rating is 55% premium. 3Very High: margin of safety for 5-star rating is a 50% discount and for 1-star rating is 75% premium. 3Extreme: Stock s uncertainty exceeds the parameters we have set for assigning the appropriate margin of safety. 4. Market Price The market prices used in this analysis and noted in the report come from exchange on which the stock is listed which we believe is a reliable source. For more detail information about our methodology, please go to Morningstar Star Rating for Stocks Once we determine the fair value estimate of a stock, we compare it with the stock s current market price on a daily basis, and the star rating is automatically re-calculated at the market close on every day the market on which the stock is listed is open. Our analysts keep close tabs on the companies they follow, and, based on thorough and ongoing analysis, raise or lower their fair value estimates as warranted. Please note, there is no predefined distribution of stars. That is, the percentage of stocks that earn 5 stars can fluctuate daily, so the star ratings, in the aggregate, can serve as a gauge of the broader market s valuation. When there are many 5-star stocks, the stock market as Morningstar Research Methodology for Valuing Companies a whole is more undervalued, in our opinion, than when very few companies garner our highest rating. We expect that if our base-case assumptions are true the market price will converge on our fair value estimate over time, generally within three years (although it is impossible to predict the exact time frame in which market prices may adjust). Our star ratings are guideposts to a broad audience and individuals must consider their own specific investment goals, risk tolerance, tax situation, time horizon, income needs, and complete investment portfolio, among other factors. The Morningstar Star Ratings for stocks are defined below: Five Stars QQQQQ We believe appreciation beyond a fair risk-adjusted return is highly likely over a multiyear time frame. Scenario analysis developed by our analysts indicates that the current market price represents an excessively pessimistic outlook, limiting downside risk and maximizing upside potential. Four Stars QQQQ We believe appreciation beyond a fair risk-adjusted return is likely. Three Stars QQQ Indicates our belief that investors are likely to receive a fair risk-adjusted return (approximately cost of equity). Our recommended margin of safety widens as our uncertainty of the estimated value of the equity increases. The more uncertain we are about the estimated value of the equity, the greater the discount we require relative to our estimate of the value of the firm before we would recommend the purchase of the shares. In addition, the uncertainty rating provides guidance in portfolio construction based on risk tolerance. Our uncertainty ratings for our qualitative analysis are low, medium, high, very high, and extreme. Price/Fair Value % 125% % 110% 95% 90% % 70% % 85% 115% 60% 175% 125% 80% 50% 1 Star 2 Star 3 Star 4 Star 5 Star 3Low: margin of safety for 5-star rating is a 20% discount and for 1-star rating is 25% premium. Low Medium High * Occasionally a stock s uncertainty will be too high for us to estimate, in which case we label it Extreme. Very High *

10 Morningstar Equity Analyst Report Page 10 of 14 Research Methodology for Valuing Companies Two Stars QQ We believe investors are likely to receive a less than fair risk-adjusted return. One Star Q Indicates a high probability of undesirable riskadjusted returns from the current market price over a multiyear time frame, based on our analysis. Scenario analysis by our analysts indicates that the market is pricing in an excessively optimistic outlook, limiting upside potential and leaving the investor exposed to Capital loss. Other Definitions: Last Price: Price of the stock as of the close of the market of the last trading day before date of the report. Stewardship Rating: Represents our assessment of management s stewardship of shareholder capital, with particular emphasis on capital allocation decisions. Analysts consider companies investment strategy and valuation, financial leverage, dividend and share buyback policies, execution, compensation, related party transactions, and accounting practices. Corporate governance practices are only considered if they ve had a demonstrated impact on shareholder value. Analysts assign one of three ratings: Exemplary, Standard, and Poor. Analysts judge stewardship from an equity holder s perspective. Ratings are determined on an absolute basis. Most companies will receive a Standard rating, and this is the default rating in the absence of evidence that managers have made exceptionally strong or poor capital allocation decisions. Quantitative Valuation: Using the below terms, intended to denote the relationship between the security s Last Price and Morningstar s quantitative fair value estimate for that security. 3Undervalued: Last Price is below Morningstar s quantitative fair value estimate. 3Farily Valued: Last Price is in line with Morningstar s quantitative fair value estimate. 3Overvalued: Last Price is above Morningstar s quantitative fair value estimate. Risk Warning Please note that investments in securities are subject to market and other risks and there is no assurance or guarantee that the intended investment objectives will be achieved. Past performance of a security may or may not be sustained in future and is no indication of future performance. A security investment return and an investor s principal value will fluctuate so that, when redeemed, an investor s shares may be worth more or less than their original cost. A security s current investment performance may be lower or higher than the investment performance noted within the report. Morningstar s Uncertainty Rating serves as a useful data point with respect to sensitivity analysis of the assumptions used in our determining a fair value price. Quantitative Equity Reports Overview The quantitative report on equities consists of data, statistics and quantitative equity ratings on equity securities. Morningstar, Inc. s quantitative equity ratings are forward looking and are generated by a statistical model that is based on Morningstar Inc. s analyst-driven equity ratings and quantitative statistics. Given the nature of the quantitative report and the quantitative ratings, there is no one analyst in which a given report is attributed to; however, Mr. Lee Davidson, Head of Quantitative Research for Morningstar, Inc., is responsible for overseeing the methodology that supports the quantitative equity ratings used in this report. As an employee of Morningstar, Inc., Mr. Davidson is guided by Morningstar, Inc. s Code of Ethics and Personal Securities Trading Policy in carrying out his responsibilities. Quantitative Equity Ratings Morningstar s quantitative equity ratings consist of: (i) Quantitative Fair Value Estimate, (ii) Quantitative Star Rating, (iii) Quantitative Uncertainty, (iv) Quantitative Economic Moat, and (v) Quantitative Financial Health (collectively the Quantitative Ratings). The Quantitative Ratings are calculated daily and derived from the analyst-driven ratings of a company s peers as determined by statistical algorithms. Morningstar, Inc. ( Morningstar, we, our ) calculates Quantitative Ratings for companies whether or not it already provides analyst ratings and qualitative coverage. In some cases, the Quantitative Ratings may differ from the analyst ratings because a company s analyst-driven ratings can significantly differ from other companies in its peer group. Quantitative Fair Value Estimate: Intended to represent Morningstar s estimate of the per share dollar amount that a company s equity is worth today. Morningstar calculates the Quantitative Fair Value Estimate using a statistical model derived from the Fair Value Estimate Morningstar s equity analysts assign to companies. Please go to for information about Fair Value Estimate Morningstar s equity analysts assign to companies. Quantitative Economic Moat: Intended to describe the strength of a firm s competitive position. It is calculated using an algorithm designed to predict the Economic Moat rating a Morningstar analyst would assign to the stock. The rating is expressed as Narrow, Wide, or None. 3Narrow: assigned when the probability of a stock receiving a Wide Moat rating by an analyst is greater than 70% but less than 99%. 3Wide: assigned when the probability of a stock receiving a Wide Moat rating by an analyst is greater than 99%. 3None: assigned when the probability of an analyst receiving a Wide Moat rating by an analyst is less than 70%. Quantitative Star Rating: Intended to be the summary rating based on the combination of our Quantitative Fair Value Estimate, current market price, and the Quantitative Uncertainty Rating. The rating is expressed as One- Star, Two-Star, Three-Star, Four-Star, and Five-Star. 3One-Star: the stock is overvalued with a reasonable margin of safety. Log (Quant FVE/Price) < -1*Quantitative Uncertainty 3Two-Star: the stock is somewhat overvalued. Log (Quant FVE/Price) between (-1*Quantitative Uncertainty, -0.5*Quantitative Uncertainty) 3Three-Star: the stock is approximately fairly valued. Log (Quant FVE/Price) between (-0.5*Quantitative Uncertainty, 0.5*Quantitative Uncertainty) 3Four-Star: the stock is somewhat undervalued. Log (Quant FVE/Price) between (0.5*Quantitative Uncertainty, 1*Quantitative Uncertainty) 3Five-Star: the stock is undervalued with a reasonable margin of safety. Log (Quant FVE/Price) > 1*Quantitative Uncertainty Quantitative Uncertainty: Intended to represent Morningstar s level of uncertainty about the accuracy of the Quantitative Fair Value Estimate. Generally, the lower the Quantitative Uncertainty, the narrower the potential range of outcomes for that particular company. The rat-

11 Morningstar Equity Analyst Report Page 11 of 14 Research Methodology for Valuing Companies ing is expressed as Low, Medium, High, Very High, and Extreme. 3Low: the interquartile range for possible fair values is less than 10%. 3Medium: the interquartile range for possible fair values is less than 15% but greater than 10%. 3High: the interquartile range for possible fair values is less than 35% but greater than 15%. 3Very High: the interquartile range for possible fair values is less than 80% but greater than 35%. 3Extreme: the interquartile range for possible fair values is greater than 80%. Quantitative Financial Health: Intended to reflect the probability that a firm will face financial distress in the near future. The calculation uses a predictive model designed to anticipate when a company may default on its financial obligations. The rating is expressed as Weak, Moderate, and Strong. 3Weak: assigned when Quantitative Financial Health < 0.2 3Moderate: assigned when Quantitative Financial Health is between 0.2 and 0.7 3Strong: assigned when Quantitative Financial Health > 0.7 Other Definitions: Last Close: Price of the stock as of the close of the market of the last trading day before date of the report. Quantitative Valuation: Using the below terms, intended to denote the relationship between the security s Last Price and Morningstar s quantitative fair value estimate for that security. 3Undervalued: Last Price is below Morningstar s quantitative fair value estimate. 3Farily Valued: Last Price is in line with Morningstar s quantitative fair value estimate. 3Overvalued: Last Price is above Morningstar s quantitative fair value estimate. This Report has not been made available to the issuer of the security prior to publication. Risk Warning Please note that investments in securities are subject to market and other risks and there is no assurance or guarantee that the intended investment objectives will be achieved. Past performance of a security may or may not be sustained in future and is no indication of future performance. A security investment return and an investor s principal value will fluctuate so that, when redeemed, an investor s shares may be worth more or less than their original cost. A security s current investment performance may be lower or higher than the investment performance noted within the report. The quantitative equity ratings are not statements of fact. Morningstar does not guarantee the completeness or accuracy of the assumptions or models used in determining the quantitative equity ratings. In addition, there is the risk that the price target will not be met due to such things as unforeseen changes in demand for the company s products, changes in management, technology, economic development, interest rate development, operating and/or material costs, competitive pressure, supervisory law, exchange rate, and tax rate. For investments in foreign markets there are further risks, generally based on exchange rate changes or changes in political and social conditions. A change in the fundamental factors underlying the quantitative equity ratings can mean that the valuation is subsequently no longer accurate. For more information about Morningstar s quantitative methodology, please visit

12 Morningstar Equity Analyst Report Page 12 of 14 General Disclosure The analysis within this report is prepared by the person (s) noted in their capacity as an analyst for Morningstar s equity research group. The equity research group consists of various Morningstar, Inc. subsidiaries ( Equity Research Group). In the United States, that subsidiary is Morningstar Research Services LLC, which is registered with and governed by the U.S. Securities and Exchange Commission. The opinions expressed within the report are given in good faith, are as of the date of the report and are subject to change without notice. Neither the analyst nor Equity Research Group commits themselves in advance to whether and in which intervals updates to the report are expected to be made. The written analysis and Morningstar Star Rating for stocks are statements of opinions; they are not statements of fact. The Equity Research Group believes its analysts make a reasonable effort to carefully research information contained in the analysis. The information on which the analysis is based has been obtained from sources believed to be reliable such as, for example, the company s financial statements filed with a regulator, company website, Bloomberg and any other the relevant press sources. Only the information obtained from such sources is made available to the issuer who is the subject of the analysis, which is necessary to properly reconcile with the facts. Should this sharing of information result in considerable changes, a statement of that fact will be noted within the report. While the Equity Research Group has obtained data, statistics and information from sources it believes to be reliable, neither the Equity Research Group nor Morningstar, Inc. performs an audit or seeks independent verification of any of the data, statistics, and information it receives. General Quantitative Disclosure The Quantitative Equity Report ( Report ) is derived from data, statistics and information within Morningstar, Inc. s database as of the date of the Report and is subject to change without notice. The Report is for informational purposes only, intended for financial professionals and/or sophisticated investors ( Users ) and should not be the sole piece of information used by such Users or their clients in making an investment decision. The quantitative equity ratings noted the Report are provided in good faith, are as of the date of the Report and are subject to change. While Morningstar has obtained data, statistics and information from sources it believes to be reliable, Morningstar does not perform an audit or seeks independent verification of any of the data, statistics, and information it receives. The quantitative equity ratings are not a market call, and do not replace the User or User s clients from conducting their own due-diligence on the security. The quantitative equity rating is not a suitability assessment; such assessments take into account may factors including a person s investment objective, personal and financial situation, and risk tolerance all of which are factors the quantitative equity rating statistical model does not and did not consider. Prices noted with the Report are the closing prices on the last stock-market trading day before the publication date stated, unless another point in time is explicitly stated. General Disclosure (applicable to both Quantitative and Qualitative Research) Unless otherwise provided in a separate agreement, recipients accessing this report may only use it in the country in which the Morningstar distributor is based. Unless stated otherwise, the original distributor of the report is Morningstar Research Services LLC, a U.S.A. domiciled financial institution. This report is for informational purposes only and has no regard to the specific investment objectives, financial situation or particular needs of any specific recipient. This publication is intended to provide information to assist institutional investors in making their own investment decisions, not to provide investment advice to any specific investor. Therefore, investments discussed and recommendations made herein may not be suitable for all investors: recipients must exercise their own independent judgment as to the suitability of such investments and recommendations in the light of their own investment objectives, experience, taxation status and financial position. The information, data, analyses and opinions presented herein are not warranted to be accurate, correct, complete or timely. Unless otherwise provided in a separate agreement, neither Morningstar, Inc. or the Equity Research Group represents that the report contents meet all of the presentation and/or disclosure standards applicable in the jurisdiction the recipient is located. Except as otherwise required by law or provided for in a separate agreement, the analyst, Morningstar, Inc. and the Equity Research Group and their officers, directors and employees shall not be responsible or liable for any trading decisions, damages or other losses resulting from, or related to, the information, data, analyses or opinions within the report. The Equity Research Group encourages recipients of this report to read all relevant issue documents (e.g., prospectus) pertaining to the security concerned, including without limitation, information relevant to its investment objectives, risks, and costs before making an reprints, call To license the research, call