Compass Minerals International Inc CMP (XNYS)

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1 Morningstar Equity Analyst Report Report as of 11:02, UTC Page 1 of Feb 2018 Morningstar Pillars Analyst Quantitative Economic Moat Wide Wide Valuation QQQQ Undervalued Uncertainty High High 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 Despite Near-Term Issues, Compass Minerals Offers Compelling Value Quantitative Valuation CMP Undervalued Fairly Valued Overvalued 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 OCompass holds a portfolio of cost-advantaged assets, including the Ontario rock salt mine and brine operations at the Great Salt Lake in Utah. OHighway deicing salt prices are relatively stable, and Compass' average selling prices in this area have increased year over year in each of the past 10 years. OWhile Compass' consumer and industrial salt assets are not as clearly advantaged as its rock salt mines, this business still has some attractive characteristics. Volume and prices tend to be relatively steady compared with other commodities. Bears Say OCompass' sulfate of potash selling prices should decline. The marginal costs of production for SOP have declined because of a drop in input prices for high-cost producers. OClimate change that lowers the number of snowfall days in Compass' key regions would have a negative long-term effect on the company's performance. OThe current high spread between SOP and MOP prices could encourage competitors to add SOP production capacity, leading to an oversupplied market. USA r Investment Thesis Seth Goldstein, CFA, Eq. Analyst, 26 July 2017 Compass Minerals holds an enviable portfolio of cost-advantaged assets. Its Goderich rock salt mine in Ontario benefits from unique geology, and with access to a deep-water port, it can deliver deicing salt to customers at a lower cost than competitors. Additionally, the company controls one of only three naturally occurring brine sources that produces sulfate of potash, or SOP, a specialty fertilizer priced at a premium to standard potash. These operations at the Great Salt Lake in Utah can produce SOP at a significantly lower cost than producers that use a chemical process. About 60% of Compass' salt sales are to highway deicing customers. Sales volume is determined during the winter months and is strongly linked to the number of snow days per season. As such, weather has a big impact on Compass' year-to-year results. The deicing salt business also exposes Compass to climate change risk. One effect of climate change is for climates to shift north, which brings warmer weather and fewer snow days to northern climates. As a result, we expect a small decline in normal deicing salt demand over time and limited prospects for sustained price increases. Pricing for deicing salt has historically been stable, especially compared with prices for other commodities. Deicing salt has a low value/weight ratio, and transportation costs make up a significant portion of total delivered costs to the customer. With mines close to waterways like the Great Lakes and the Mississippi River, Compass can typically deliver deicing salt at a lower cost than competitors. Compass is also a cost-advantaged producer of sulfate of potash, a specialty fertilizer used for high-value crops that are sensitive to the chloride in standard potash (muriate of potash, or MOP). While marginal producers of SOP use MOP and sulfuric acid to produce SOP, Compass makes SOP directly from salt brines at a considerably lower cost. SOP prices generally track MOP prices, but a wider-than-normal gap has opened up between the two more recently, with SOP prices remaining elevated despite a drop in MOP prices. We think this spread will tighten, leading to slimmer per-ton profits for the company's fertilizer business. Analyst Note Seth Goldstein, CFA, Eq. Analyst, 23 February 2018 Wide-moat Compass Minerals' share price has fallen nearly 10% since the company reported earnings on Feb. 14. Although the company s near-term outlook is likely to remain bleak due to operational challenges at the low-cost Goderich mine, we see no long-term issues and expect cost savings measures to boost profits over the next several years. Further, we expect the 2018 deicing salt bid season to bode well for Compass as the firm should benefit from slightly higher prices that generally follow a harsher winter. For investors who are willing to be patient, our $82 per share fair value estimate implies over 30% upside from the current price of $62.55 at the time of writing. As we wrote in our Feb. 14 note, the current patch of salt that Compass is extracting from Goderich has an increased level of impurities. To combat these challenges, Compass will install optical sorting equipment that will allow the firm the automatically separate most of the non-salt particles. The new equipment, expected to cost roughly $10 million, was included in the company s capital expenditure guidance for 2018, and as such, we have not materially changed our estimate that Compass 2018 capital expenditures will be toward the higher end of management s guidance of $100 million-$110 million. In our Feb. 14 update, we incorporated higher costs associated with additional processing into our forecast, slightly offsetting Compass cost savings measures at Goderich. We expect the full impact of both measures to materialize in 2020, one year later than we originally expected, as we do not expect the back-office cost savings program to be complete until the end of However, we expect Compass cost reduction to begin to improve profits in Economic Moat Seth Goldstein, CFA, Eq. Analyst, 23 February 2018 We think Compass possesses a wide economic moat. It holds unique assets with geological advantages that are nearly impossible to replicate, which gives the firm a

2 Morningstar Equity Analyst Report Page 2 of Feb 2018 Close Competitors Currency (Mil) Market Cap TTM Sales Operating Margin TTM/PE Nutrien Ltd NTR USD 30,648 4, K+S AG SDF EUR 4,483 3, sustainable cost advantage over other producers of both salt and sulfate of potash. The company's rock salt mine in Goderich, Ontario, is the world's largest active salt mine. At Goderich, Compass mines deposits that are 100 feet thick, compared with many competing mines whose seams are only feet thick. This allows Compass to use more efficient mining techniques and remove more salt for each foot advanced in the mine. Further, Goderich is located on a deep-water port on Lake Huron, giving Compass easy water-based access to the snowy markets near the Great Lakes. Because of its low value-to-weight ratio, salt can only be shipped economically by land over very short distances--roughly 150 miles. In its regions, Compass estimates that shipping by water is about half the cost of rail and one fifth the cost of trucking, leading to a shipping cost advantage for wintry markets from Minnesota to Western New York. In addition, Compass operates rock salt mines in Louisiana and the United Kingdom. The Cote Blanche, Louisiana, mine has a very thick deposit and access to markets in the Midwestern U.S. by shipping barge tons up the Mississippi River. The Winsford mine in northwest England has a thinner deposit, but is still the largest rock salt mine in the U.K. At current production rates, Compass estimates that its recoverable salt reserves will last at least several more decades. Compass also holds a cost advantage in the production of sulfate of potash. Sulfate of potash is primarily produced by two distinct methods. Producers at the high end of the global cost curve use the Mannheim process, which reacts muriate of potash and sulfuric acid at high temperatures to make SOP. About half of the world's SOP is produced using this method, and the marginal cost fluctuates with input costs. Compass and other SOP producers at the low end of the cost curve use naturally occurring salt brines to make sulfate of potash. The company's assets in Utah are one of only three naturally occurring brines used for SOP production. Compass estimates that it costs 40%-50% less to produce SOP using brines compared with the Mannheim process. Other SOP brines are in China and Chile, but Compass' Utah operations make the company the low-cost provider of SOP to its main markets in the Western and Southeastern U.S. Not all of Compass' SOP production is at the low end of the industry cost curve, however. The company also makes SOP in Wynyard, Saskatchewan, using a production process that sits in the middle of the cost curve. Compass must buy MOP from a third party in this process, but Wynyard accounts for only about 10% of companywide SOP production. The vast majority of Compass' SOP production is cost-advantaged. Compass' cost advantages have led to solid returns on invested capital. Over the past decade, returns on invested capital have averaged 20%. While we expect future returns to be pressured by lower deicing salt volumes and lower input costs, namely MOP, for high-cost SOP producers, we are still confident that Compass will continue to produce returns on invested capital that outpace the costs of capital for the next 20 years. Valuation Seth Goldstein, CFA, Eq. Analyst, 23 February 2018 Our fair value estimate is $82 per share. We expect salt volumes to recover from 2017's unusually low 10.6 million metric tons to over 12 million metric tons in the next several years as more typical weather conditions prevail across Compass' footprint. Thereafter, we expect flattish salt volumes as rising consumer and industrial demand offsets a long, slow decline in typical deicing salt demand due to the effects of climate change. While salt prices have historically outpaced inflation, we think the reduced deicing salt demand will result in sub-cpi price growth. That said, improvements to the Goderich mine should reduce unit costs over the next few years, which should drive salt segment operating earnings growth. On the fertilizer side, we think prices will decline as SOP prices eventually reflect marginal costs of production, which have declined recently with the drop in MOP prices. We project a nominal price per ton of around $620 in 2025, compared with $640 in We expect the company to continue to take advantage of its higher-priced Wolf Trax nutrients, which should offset some of the SOP price decline. We expect the acquisition of Brazilian specialty

3 Morningstar Equity Analyst Report Page 3 of Feb 2018 nutrition company Produquimica to contribute around $100 million of adjusted EBITDA by We use a cost of equity assumption of 9%. metric as it incentivizes management to pursue value accretive earnings growth. Risk Seth Goldstein, CFA, Eq. Analyst, 23 February 2018 We assign Compass a high uncertainty rating. In its salt operations, climate change could cause a permanent drop in deicing salt demand due to a reduction in snowfall from warmer winter temperatures as warmer climates shift north over time. Specialty fertilizer prices have experienced less volatility than commodity fertilizer prices historically, however, we still think the potential for big changes in SOP pricing presents both an upside and a downside risk. Additionally, a sustained reduction in the spread between muriate of potash (MOP) and SOP prices is a risk to the company s realized specialty fertilizer prices. Project execution risk is a factor whenever Compass undertakes a large asset expansion project. Management Seth Goldstein, CFA, Eq. Analyst, 26 July 2017 We award Compass Minerals management our stewardship rating. Current and past managers have a strong record of striking a good balance between returning cash to shareholders and investing in growth opportunities and cost-saving initiatives. Acquisitions have enhanced the strengths of existing salt and specialty fertilizer assets. These wise purchases include a document storage business in the U.K., Big Quill Resources, and Wolf Trax. We think the acquisition of Produquimica was made at a fair valuation. Growth investments have focused on the advantaged assets at Goderich and the Great Salt Lake. The current project to improve costs per ton at Goderich, which already sits at the bottom of the cost curve, is a prime example of management's solid capital-allocation strategy. CEO Fran Malecha joined Compass in January Malecha was COO of Viterra, a large Canada-based agribusiness firm, from 2007 to Malecha has continued the company's tradition of investing in high-return advantaged assets at a measured pace, so as not to harm pricing. Management s short-term compensation is based on adjusted EBITDA, while long-term compensation is based on return on invested capital and total shareholder return (including dividends and buybacks) versus the Russell 3000 index over a three-year period. We like the return on invested capital

4 Morningstar Equity Analyst Report Page 4 of Feb 2018 Analyst Notes Archive Although Compass Continues Chilly 2017; We Maintain Our $84 Fair Value Estimate Seth Goldstein, CFA, Eq. Analyst, 31 October 2017 Compass Minerals reported third-quarter results that were slightly below our expectations as continued weakness in the salt segment offset improved margins in the plant nutrition North America segment. With no changes to our long-term thesis that normal winter conditions and lower unit costs will boost the salt segment s operating profits, we maintain our $84 per share fair value estimate and wide-moat rating. Salt segment adjusted operating earnings fell 16% year on year to $25 million amid lower consumer and industrial volumes. Although the deicing salt bid season concluded with salt volumes and prices down 3% each, we note that deicing salt bids are often a reflection of the previous winter, instead of an indication for the upcoming winter. Additionally, salt bid volumes are typically for a midpoint, which means Compass will not necessarily sell 3% less salt in the upcoming winter. The actual volumes purchased can range between 80% to 120% of the midpoint. We forecast Compass to sell over 12 million metric tons of salt in 2018, versus less than 11 million in That assumes a return to normal winter weather conditions following two years of unusually light snowfall across Compass' largely Midwestern footprint. But a return to normal next year is hardly assured. As we've previously discussed, while the "typical" winter hasn't changed much over the past several decades, year-to-year snowfall variability has increased significantly. Even if a mild winter produces 2018 results similar to 2017, the dividend should remain safe. For 2017, we project over $150 million of free cash flow, versus an annual dividend of $100 million. All else equal, free cash flow should increase in 2018 as capital expenditures fall following the completion of expansion projects at Goderich and Ogden by the end of The Goderich project should further reduce Compass already-low salt unit production costs, bolstering the company's wide economic moat. Heavy December Snowfall Buoys Compass Shares and Supports Our Thesis Seth Goldstein, CFA, Eq. Analyst, 05 January 2018 Shares of Best Idea Compass Minerals have risen nearly 10% in the past two weeks as harsh winter weather seems to have improved market sentiment for the deicing salt producer. The winter has begun with an above-average number of snow days, which should bode well for Compass deicing salt profits in the near term. We calculate that 10 representative cities across Compass' Midwest and Great Lakes footprint saw 47 snow days in December 2017, the most for that month since This marked a significant rebound from the single-digit December snow days of 2015 and As discussed in our August 2017 report, Winter Is Coming: A Song of Ice and Salt, light snowfall in recent years had weighed heavily on Compass shares, which were trading near their lowest level since The market seemed to fret that climate change meant future winters would look much like 2015 and 2016: little snow, weak salt demand, and depressed profits for Compass. As we argued in that report, 120 years of weather data across Compass' key markets suggested climate change was, indeed, to blame for recent weakness, but only in the sense that it had increased snowfall volatility. In fact, we found that the "normal" winter brings just as much snow as it did decades ago, which made a bounce back in snowfall, salt demand, and profits more likely than not. Last month's heavy snowfall lends credence to that assessment. We maintain our $84 per share fair value estimate and now see moderate upside in Compass shares that trade just shy of $75 as we write. Our wide-moat rating is also intact. Compass Minerals Reports 4Q Snow Days and Salt Volume; We Maintain Our $84 FVE Seth Goldstein, CFA, Eq. Analyst, 10 January 2018 Compass Minerals reported fourth-quarter snow days and salt volume sales that were generally in line with our expectations. Compass sold roughly 3.6 million tons of salt during the fourth quarter of 2017, which is roughly 3% below the fourth quarter of As we noted in our Jan. 5 update, the winter has begun with an above-average number of snow days, which should bode well for Compass deicing salt profits in the near term. We expect the benefit of harsher late-december weather to show up in Compass 2018 first-quarter salt sales as governments replenish their deicing salt inventories. We continue to forecast over 12.3 million tons of total salt sales for Compass in 2018, which is roughly 16% higher

5 Morningstar Equity Analyst Report Page 5 of Feb 2018 than With no changes to our outlook, we maintain our $84 fair value estimate. Our wide moat rating is also unchanged. Compass reported 57 snow days during the fourth quarter of 2017 in the 11 representative cities that the company measures throughout the Midwest and Great Lakes regions in North America. This figure was 7 days above the fourth quarter of In our Jan. 5 update, we noted there were 47 snow days during December There are slight differences in our snow day count and Compass as Compass includes Toronto and Montreal, while we include Grand Rapids, Michigan, in our 10-city snow day count. Trimming Our Compass Minerals FVE to $82 as Goderich Geology Concerns Chill Cost Savings Seth Goldstein, CFA, Eq. Analyst, 14 February 2018 Compass Minerals reported fourth-quarter results roughly in line with our expectations as the company wrapped up a challenging 2017 that saw salt profits decline due to mild winter weather. Although the winter weather has begun with an above average number of snow days, we re lowering our fair value estimate to $82 per share from $84 on lower near-term profits than we previously anticipated. At the Goderich mine, the salt that Compass is currently extracting has an increased level of impurities. In order to meet product quality specifications, Compass will have to install new refining equipment. Because the vast majority of salt that Compass sells is a lower quality product used for deicing, we think the increased refining costs will only partially offset the firm s cost savings measures from the implementation of continuous miners. While we had projected the total company s unit production costs to fall roughly 15% from 2015 levels (in real terms), we now expect only a 10% reduction. As we still see an overall unit cost reduction, our wide-moat rating based on Compass cost advantage moat source is unchanged. We note that the winter of has continued to bode well for Compass near-term deicing salt sales. Through January, the number of snow days in Compass Midwest and Great Lakes footprint was around 10% higher than what we would expect in an average winter. While the two previous winters saw an unusually light amount of snowfall, this winter s solid start is likely to significantly increase near-term demand for deicing salt as municipalities and consumers will likely need to replenish inventories. As such, we forecast Compass total salt sales will grow to 12.4 million tons in 2018, versus 10.6 million in Despite Near-Term Issues, Compass Minerals Offers Compelling Value Seth Goldstein, CFA, Eq. Analyst, 23 February 2018 Wide-moat Compass Minerals' share price has fallen nearly 10% since the company reported earnings on Feb. 14. Although the company s near-term outlook is likely to remain bleak due to operational challenges at the low-cost Goderich mine, we see no long-term issues and expect cost savings measures to boost profits over the next several years. Further, we expect the 2018 deicing salt bid season to bode well for Compass as the firm should benefit from slightly higher prices that generally follow a harsher winter. For investors who are willing to be patient, our $82 per share fair value estimate implies over 30% upside from the current price of $62.55 at the time of writing. As we wrote in our Feb. 14 note, the current patch of salt that Compass is extracting from Goderich has an increased level of impurities. To combat these challenges, Compass will install optical sorting equipment that will allow the firm the automatically separate most of the non-salt particles. The new equipment, expected to cost roughly $10 million, was included in the company s capital expenditure guidance for 2018, and as such, we have not materially changed our estimate that Compass 2018 capital expenditures will be toward the higher end of management s guidance of $100 million-$110 million. In our Feb. 14 update, we incorporated higher costs associated with additional processing into our forecast, slightly offsetting Compass cost savings measures at Goderich. We expect the full impact of both measures to materialize in 2020, one year later than we originally expected, as we do not expect the back-office cost savings program to be complete until the end of However, we expect Compass cost reduction to begin to improve profits in 2019.

6 Quantitative Equity Report Release:, 18:02 UTC Reporting Currency: USD Trading Currency: USD Exchange:XNYS Page 1 of 1 Page 6 of 13 Q 02:00 UTC Compass Minerals International Inc CMP QQQQ Last Close Fair Value Q Market Cap Sector Industry Country of Domicile 02:00 UTC ,278.6 Mil r Basic Materials Industrial Metals & Minerals USA United States 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 Compass Minerals International Inc is associated with the mining industry. It produces minerals, including salt, sulfate of potash specialty fertilizer and magnesium chloride. Price vs. Quantitative Fair Value Quantitative Fair Value Estimate Total Return 110 Sales/Share Forecast Range Forcasted Price 88 Dividend 66 Split Momentum: Negative Standard Deviation: Liquidity: High Quantitative Scores Scores All Rel Sector Rel Country Quantitative Moat Wide Valuation Undervalued Quantitative Uncertainty High Financial Health Moderate CMP USA r Undervalued Fairly Valued Overvalued Source: Morningstar Equity Research 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 (K) Wk Yr Total Return % / Market (Morningstar US Index) Trailing Dividend Yield % Forward Dividend Yield % Price/Earnings Price/Revenue Morningstar Rating Q QQQQQ QQQQ QQQ QQ Q TTM Financials (Fiscal Year in Mil) 1,130 1,282 1,099 1,138 1,364 1,364 Revenue % Change Operating Income % Change Net Income Operating Cash Flow Capital Spending Free Cash Flow % Sales EPS % Change Free Cash Flow/Share Dividends/Share Book Value/Share 33,477 33,609 33,702 33,789 33,828 33,832 Shares Outstanding (K) 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 % ,195 1,330 1,330 Long-Term Debt 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 (Mil) Mar Jun Sep Dec Total , , , ,282.5 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

7 Morningstar Equity Analyst Report Page 7 of 13 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-

8 Morningstar Equity Analyst Report Page 8 of 13 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 *

9 Morningstar Equity Analyst Report Page 9 of 13 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:, 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-

10 Morningstar Equity Analyst Report Page 10 of 13 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

11 Morningstar Equity Analyst Report Page 11 of Feb 2018 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