Wealth = Quality x Quantity

Transcription

1 Wealth = Quality x Quantity

2 Wealth = Quality x Quantity April 2013 By Justin Bown Managing Director Juno Partners The production of wealth, as 19th century philosopher John Stuart Mill observed, has its necessary conditions. New research by Juno Partners, summarised in this briefing paper, reveals that for companies, the two necessary conditions can succinctly be described as quality and quantity. Most senior managers today would agree that the job of a corporation is to create wealth. In our capitalist, democratic society, we create different institutions for different purposes. We create charities to fund good causes, governments to set and enforce laws and businesses to create wealth. When they focus on the creation of sustained gains in wealth, businesses provide the lifeblood of our economy. When businesses forget about wealth creation or the importance of the long term, the economy and all our institutions suffer. For senior executives therefore, and directors in particular, few things could be more important to understand than the necessary conditions for the production of wealth. The basis of our research So what are the necessary conditions for creating wealth? We set out to answer this question by looking at a group of Australia s largest listed companies and asking who has created (or destroyed) wealth and then digging deeper to find the root causes 1. We used a simple definition of wealth creation being the difference between how much has been invested in a company and how much it is worth as at 30 June. This measure has the advantage of being a dollar measure of wealth, as opposed to a percentage measure, like Total Shareholder Return or TSR and hence shows the true impact the business has had on the economy. The Wealth Created results are summarised in the table following, ranking the two hundred businesses in our set by Wealth Created as at 30 June and show, for example that BHP Billiton (ranked #1 in the table) at 30 June had taken $113 billion of capital from shareholders and lenders and turned it into a business worth $198 billion, creating a staggering $85 billion of wealth 2. By contrast, BlueScope Steel (#200) had taken $7.2 billion and turned it into $2 billion, destroying $5.2 billion. 1 For the purposes of this study, our database comprised the 200 largest Australian domiciled public companies as at 30 June, excluding investment businesses, such as listed investment companies, insurance and real estate businesses, those with less than five years of publicly available financial reports and those who made losses in three or more of the past five years. 2 Note that in the table of data we list the average balance, being the average of the year-end results for 2011 and. The year-end values cited in the main text of this article and used to calculate Wealth Created, will usually be a little larger. page [1]

3 Juno Partners Wealth Creators Report 30 June Ticker Wealth Creators Rank Company Wealth created: How much the company's Enterprise Value exceeds at 30 June $m Wealth Created Quartile $m What rate of return is the business generating on the funds entrusted to it? Return on What could investors expect to earn elsewhere at similar levels of risk? Average Weighted of Cost Quality: How much does this business beat (or fall behind) other investments of similar risk? Spread Profit Quartile 5 year median EP Spread Quantity: The total funds invested in the business; debt & equity. - = x = $m 5 year average Average Quantity x Quality: The dollar amount of profits in excess of what investors could have expected, at similar risk Profit $m 5 year cumulative BHP 1 BHP Billiton Limited 85, % 21.8% 11.1% 10.4% 11.4% 11.4% 73, , , ,430.4 CBA 2 Commonwealth Bank of Australia 38, % 15.6% 10.8% 9.0% 6.6% 6.6% 33, , , ,864.9 TLS 3 Telstra Corporation Limited 28, % 14.1% 6.9% 4.6% 6.0% 9.6% 33, , , ,211.3 RIO 4 Rio Tinto Limited 26, % 19.0% 12.1% 12.8% 4.8% 6.1% 81, , , ,270.7 WOW 5 Woolworths Limited 23, % 14.3% 7.5% 5.6% 6.8% 8.7% 19, , , ,987.0 WBC 6 Westpac Banking Corporation 16, % 13.6% 10.9% 9.7% 3.9% 3.8% 35, , , ,824.6 CSL 7 CSL Limited 16, % 22.4% 8.8% 6.6% 12.8% 15.9% 4, , , ANZ 8 ANZ Group Ltd 12, % 12.5% 10.6% 9.9% 3.7% 2.6% 35, , , ,172.3 WPL 9 Woodside Petroleum Limited 11, % 10.1% 11.4% 11.1% -1.0% -1.0% 14, , FMG 10 Fortescue Metals Group Ltd. 11, % 18.0% 13.3% 12.6% 5.4% 5.4% 5, , , WES 11 Wesfarmers Limited 9, % 7.9% 8.7% 7.1% -1.6% 0.9% 34, , , CCL 12 Coca-Cola Amatil Limited 8, % 19.7% 7.1% 5.4% 12.7% 14.3% 3, , , BXB 13 Brambles Limited 7, % 14.0% 8.9% 8.0% 6.0% 6.0% 3, , , ORG 14 Origin Energy Limited 6, % 7.9% 8.6% 7.7% -0.6% 0.2% 11, , OSH 15 Oil Search Limited 6, % 4.2% 10.1% 11.2% -4.8% -6.9% 2, , ORI 16 Orica Limited 5, % 14.9% 10.9% 9.6% 3.7% 5.2% 5, , CWN 17 Crown Limited 5, % 26.8% 8.6% 8.6% 7.5% 18.2% 3, , TCL 18 Transurban Group 4, % 3.7% 7.8% 6.7% -3.3% -2.9% 7, , , WOR 19 WorleyParsons Limited 4, % 13.6% 13.3% 12.7% 0.9% 0.9% 2, , SYD 20 Sydney Airport 3, % 1.1% 8.1% 7.5% -4.6% -6.4% 12, , , RHC 21 Ramsay Health Care Limited 3, % 10.4% 6.8% 5.4% 1.7% 4.9% 3, , COH 22 Cochlear Limited 3, % 21.8% 8.5% 7.6% 14.2% 14.2% AMC 23 Amcor Limited 2, % 9.0% 8.0% 7.2% -0.4% 1.8% 8, , ILU 24 Iluka Resources Limited 2, % 26.0% 9.6% 9.7% -6.0% 16.2% 1, , ,833 ALQ 25 ALS Limited 2, % 18.8% 13.2% 13.2% 2.2% 5.6% , STO 26 Santos Limited 2, % 5.1% 10.0% 9.1% -4.0% -4.0% 7, , , CPU 27 Computershare Limited 2, % 8.8% 9.7% 8.3% 4.5% 0.5% 2, , AGK 28 AGL Energy Limited 2, % 4.2% 7.7% 6.1% -1.6% -1.9% 6, , ASX 29 ASX Limited 2, % 13.4% 10.6% 8.2% 5.2% 5.2% 2, , APA 30 APA Group 2, % 7.7% 7.0% 6.4% -0.4% 1.3% 4, , SHL 31 Sonic Healthcare Limited 1, % 7.8% 7.8% 6.5% -0.1% 1.3% 4, , PTM 32 Platinum Asset Management Limited 1, % 44.0% 10.1% 8.6% 43.9% 35.4% SVW 33 Seven Group Holdings Limited 1, % 17.0% 13.3% 9.5% 1.9% 7.6% 1, , SEK 34 SEEK Limited 1, % 17.9% 14.2% 12.8% 6.2% 5.1% MND 35 Monadelphous Group Limited 1, % 40.7% 15.2% 14.4% 28.4% 26.3% REA 36 REA Group Ltd. 1, % 37.9% 12.3% 11.0% 26.9% 26.9% RRL 37 Regis Resources Limited 1, % 26.8% 14.9% 14.1% -18.1% 12.7% NVT 38 Navitas Limited 1, % 18.4% 10.5% 7.3% 16.4% 11.1% REH 39 Reece Australia Limited 1, % 15.1% 11.5% 11.0% 5.5% 4.2% NAB 40 National Australia Bank Limited 1, % 10.8% 10.9% 9.6% 1.2% 1.2% 40, , , WHC 41 Whitehaven Coal Limited 1, % 3.9% 14.2% 13.7% -5.0% -9.8% , FLT 42 Flight Centre Limited % 19.4% 11.0% 10.2% 5.9% 9.3% 1, , NCM 43 Newcrest Mining Limited % 6.5% 10.2% 9.4% -0.1% -2.9% 8, , SPN 44 SP AusNet % 7.2% 6.6% 5.3% -0.2% 1.9% 6, , PNA 45 PanAust Limited % 15.3% 14.3% 14.8% -8.6% 0.4% TPM 46 TPG Telecom Limited % 13.7% 7.5% 5.1% 3.6% 8.7% MIN 47 Mineral Resources Limited % 23.6% 13.6% 13.6% 12.4% 10.0% UGL 48 UGL Limited % 10.8% 12.1% 11.0% -1.2% -0.2% 1, , ABC 49 Adelaide Brighton Limited % 11.7% 11.5% 11.8% 0.4% -0.2% 1, , WTF 50 Wotif.com Holdings Limited % 61.4% 11.0% 9.2% 52.2% 52.2% % Note: The calculation of EP Spread and Profit in this table works for the figures, but not for the 5 year data, due to the averaging of annual results. page [2]

4 Juno Partners Wealth Creators Report 30 June Ticker Wealth Creators Rank Company Wealth created: How much the company's Enterprise Value exceeds at 30 June $m Wealth Created Quartile $m What rate of return is the business generating on the funds entrusted to it? Return on What could investors expect to earn elsewhere at similar levels of risk? Average Weighted of Cost Quality: How much does this business beat (or fall behind) other investments of similar risk? Spread Profit Quartile 5 year median EP Spread Quantity: The total funds invested in the business; debt & equity. - = x = $m 5 year average Average Quantity x Quality: The dollar amount of profits in excess of what investors could have expected, at similar risk Profit $m 5 year cumulative ENV 51 Envestra Limited % 7.9% 6.8% 5.6% 0.2% 2.3% 2, , TTS 52 Tatts Group Limited % 10.2% 8.2% 6.6% 0.7% 3.5% 3, , PPT 53 Perpetual Limited % 15.3% 11.4% 11.0% 1.2% 4.3% IVC 54 InvoCare Limited % 11.5% 8.3% 7.0% 8.0% 4.5% MMS 55 McMillan Shakespeare Limited % 21.4% 10.8% 8.9% 12.5% 12.5% SUL 56 Super Retail Group Limited % 11.2% 9.7% 8.2% 2.6% 3.0% , MTS 57 Metcash Limited % 10.7% 7.2% 5.5% 3.6% 5.1% 3, , SKI 58 Spark Infrastructure Group % 8.8% 6.8% 5.6% 2.1% 3.1% 2, , IRE 59 IRESS Limited % 24.6% 11.9% 10.3% 17.0% 14.3% JBH 60 JB Hi-Fi Limited % 20.2% 11.3% 9.3% 11.8% 10.9% ALL 61 Aristocrat Leisure Limited % 2.4% 10.6% 8.6% 2.0% -6.2% 1, , ACR 62 Acrux Limited % 13.4% 10.1% 7.5% 5.8% 5.8% MML 63 Medusa Mining Ltd % 17.0% 12.0% 12.0% 26.2% 4.9% DMP 64 Domino's Pizza Enterprises Limited % 17.9% 8.9% 8.9% 5.4% 9.1% SAI 65 SAI Global Limited % 9.2% 9.6% 8.3% 0.2% 1.0% DJS 66 David Jones Limited % 9.8% 11.7% 11.0% 1.8% -1.2% 1, , ARP 67 ARB Corporation Limited % 25.9% 10.5% 9.1% 16.8% 16.8% AGI 68 Ainsworth Game Technology Limited % 42.9% 8.3% 9.1% -4.1% 33.8% NWH 69 NRW Holdings Limited % 22.4% 16.0% 16.0% 6.4% 6.4% CDD 70 Cardno Limited % 12.4% 11.3% 9.5% -0.1% 2.9% GNC 71 Graincorp Limited % 11.1% 8.1% 6.4% 2.2% 4.7% 1, , FWD 72 Fleetwood Corporation Limited % 22.0% 12.3% 12.1% 10.4% 10.0% FXL 73 FlexiGroup Limited % 10.8% 8.2% 7.7% 2.9% 3.1% DUE 74 DUET Group % 5.7% 6.5% 5.3% -0.1% 0.4% 6, , ,964 SLR 75 Silver Lake Resources Limited % 22.5% 10.5% 9.7% 9.3% 12.8% QUB 76 Qube Holdings Limited % 7.4% 11.8% 9.8% -8.2% -2.4% , WSA 77 Western Areas Limited % 10.1% 13.2% 12.3% -6.4% -2.3% BRG 78 Breville Group Limited % 21.5% 12.9% 13.6% 2.1% 7.9% BKL 79 Blackmores Limited % 26.1% 9.0% 7.7% 15.3% 18.5% CDU 80 CuDeco Limited % 0.4% 15.4% 15.4% -16.1% -15.0% MTU 81 M2 Telecommunications Group Ltd % 14.3% 7.8% 5.1% 12.4% 9.2% GUD 82 GUD Holdings Limited % 12.5% 11.7% 12.0% 2.3% 0.5% ASL 83 Ausdrill Limited % 13.0% 11.7% 12.1% -0.6% 0.8% , LWB 84 Little World Beverages Limited % 19.1% 8.4% 6.9% 6.2% 12.2% CGX 85 CGA Mining Limited % 1.8% 9.7% 9.3% -7.5% -7.5% MRM 86 Mermaid Marine Australia Limited % 12.3% 11.3% 8.6% 1.3% 3.7% KRM 87 Kingsrose Mining Limited % 27.9% 13.1% 13.1% -14.4% 14.8% SRX 88 Sirtex Medical Limited % 26.3% 10.5% 7.5% 18.8% 18.8% BKW 89 Brickworks Limited % 6.5% 8.7% 7.8% -0.1% -1.3% 1, , CAB 90 Cabcharge Australia Limited % 14.8% 9.4% 8.3% 6.6% 6.6% TNE 91 Technology One Limited % 7.9% 10.5% 7.7% 10.0% 0.2% ORL 92 OrotonGroup Limited % 28.7% 10.6% 10.6% 17.7% 18.1% GDO 93 Gold One International Limited % 21.3% 11.9% 11.5% -29.1% 9.8% CLO 94 Clough Limited % 11.2% 11.3% 11.8% 1.3% -0.7% DCG 95 Decmil Group Limited % 21.6% 13.7% 17.2% 2.8% 4.4% RKN 96 Reckon Limited % 24.1% 9.6% 8.3% 14.3% 15.8% NST 97 Northern Star Resources Ltd % 33.1% 15.1% 15.2% -24.1% 17.9% FGE 98 Forge Group Limited % 30.6% 17.1% 17.9% 14.9% 12.7% APE 99 AP Eagers Limited % 7.9% 8.6% 8.1% -0.7% -0.2% AHD 100 Amalgamated Holdings Limited % 8.8% 8.2% 8.8% 2.3% 0.0% 1, , % Note: The calculation of EP Spread and Profit in this table works for the figures, but not for the 5 year data, due to the averaging of annual results. page [3]

5 Juno Partners Wealth Creators Report 30 June Ticker Wealth Creators Rank Company Wealth created: How much the company's Enterprise Value exceeds at 30 June $m Wealth Created Quartile $m What rate of return is the business generating on the funds entrusted to it? Return on What could investors expect to earn elsewhere at similar levels of risk? Average Weighted of Cost Quality: How much does this business beat (or fall behind) other investments of similar risk? Spread Profit Quartile 5 year median EP Spread Quantity: The total funds invested in the business; debt & equity. - = x = $m 5 year average Average Quantity x Quality: The dollar amount of profits in excess of what investors could have expected, at similar risk Profit $m 5 year cumulative TRY 101 Troy Resources Limited % 22.7% 12.4% 11.0% -2.6% 11.7% MFG 102 Magellan Financial Group Limited % 11.3% 15.1% 12.2% -11.1% -0.9% LYL 103 Lycopodium Limited % 29.0% 14.2% 14.3% 17.3% 14.7% HZN 104 Horizon Oil Limited % 4.4% 13.1% 12.5% -8.1% -8.1% ANG 105 Austin Engineering Limited % 17.4% 14.7% 13.9% 3.5% 3.5% IIN 106 iinet Limited % 9.7% 7.5% 5.0% 4.0% 4.7% AAX 107 Ausenco Limited % 8.8% 15.9% 14.0% -5.2% -5.2% GWA 108 GWA Group Limited % 7.5% 10.2% 9.7% -0.9% -2.1% TRS 109 The Reject Shop Limited % 12.6% 9.0% 7.2% 6.8% 5.4% IMD 110 Imdex Limited % 20.8% 13.8% 13.8% 3.3% 6.9% IDL 111 Industrea Limited % 4.8% 14.2% 14.1% -0.3% -9.3% AHE 112 Automotive Holdings Group Limited % 8.0% 9.6% 8.8% -1.1% -0.8% 1, , IGR 113 Integra Mining Limited % 7.0% 12.6% 11.3% -22.1% -4.3% BKN 114 Bradken Limited % 11.2% 14.9% 14.6% -2.2% -3.4% , AMM 115 Amcom Telecommunications Limited % 10.2% 7.7% 5.1% 3.2% 5.1% BCI 116 BC Iron Limited % 44.0% 14.9% 14.7% -18.9% 29.3% TOX 117 Tox Free Solutions Limited % 10.2% 12.0% 8.6% 1.7% 1.7% FAN 118 Fantastic Holdings Limited % 12.9% 11.4% 9.7% 3.2% 3.2% CDA 119 Codan Limited % 22.4% 9.2% 8.3% 9.9% 14.1% ALK 120 Alkane Resources Ltd % -4.8% 15.4% 15.4% -16.2% -20.2% RFG 121 Retail Food Group Limited % 12.7% 9.0% 7.4% 5.2% 5.2% SAR 122 Saracen Mineral Holdings Limited % 13.4% 11.9% 11.9% -9.8% 1.4% PMV 123 Premier Investments Limited % 9.4% 9.8% 9.5% -0.1% -0.1% , NFE 124 Northern Iron Limited % 2.1% 13.4% 13.0% -13.9% -10.9% ,610 SDM 125 Sedgman Limited % 19.7% 16.7% 16.8% 1.3% 2.9% PFL 126 Patties Foods Limited % 11.8% 7.7% 6.5% 3.1% 5.3% SLM 127 Salmat Limited % 8.5% 8.6% 7.3% 0.1% 1.2% CTY 128 Country Road Limited % 8.3% 8.4% 7.1% 0.5% 1.2% SGH 129 Slater & Gordon Limited % 11.4% 8.3% 6.8% 4.7% 4.7% SKE 130 Skilled Group Limited % 11.1% 9.1% 10.1% 1.0% 1.0% SRV 131 Servcorp Limited % 7.0% 9.7% 10.0% -3.0% -3.0% HVN 132 Harvey Norman Holdings Ltd % 8.3% 12.6% 9.8% -1.5% -1.5% 2, , CTX 133 Caltex Australia Limited % 23.0% 10.2% 8.9% 1.9% 14.0% 3, , ASB 134 Austal Limited % 2.8% 14.6% 9.1% -1.8% -6.2% EWC 135 Energy World Corporation Ltd % 4.7% 9.3% 7.7% -5.5% -3.0% RHL 136 Ruralco Holdings Limited % 7.7% 8.4% 7.3% 0.0% 0.4% SGN 137 STW Communications Group Limited % 11.3% 11.2% 10.7% 0.6% 0.6% CMG 138 Chandler Macleod Group Limited % 9.4% 8.1% 7.7% -0.9% 1.7% CCV 139 Cash Converters International % 11.6% 9.9% 8.5% 1.9% 3.1% KCN 140 Kingsgate Consolidated Limited % 10.5% 11.5% 11.2% -0.8% -0.8% IRN 141 Indophil Resources NL % 0.6% 15.2% 14.7% -14.4% -14.0% AAC 142 Australian Agricultural Company Ltd % 4.7% 8.0% 6.0% -7.0% -1.3% RIC 143 Ridley Corporation Limited % 6.0% 8.0% 5.9% -0.2% 0.0% OGC 144 OceanaGold Corporation % 6.6% 9.4% 8.4% -5.6% -1.7% PRT 145 Prime Media Group Limited % 9.1% 8.4% 8.0% -1.1% 1.1% OMH 146 OM Holdings Limited % -2.1% 14.8% 13.3% -0.1% -15.4% WHG 147 WHK Group Limited % 4.3% 8.6% 7.5% -2.6% -3.2% MAH 148 Macmahon Holdings Limited % 10.2% 14.4% 13.9% -7.5% -3.7% TGR 149 Tassal Group Limited % 9.2% 9.3% 5.6% 2.4% 3.6% BTT 150 BT Investment Management Limited % 7.1% 13.8% 10.5% -3.9% -3.4% % Note: The calculation of EP Spread and Profit in this table works for the figures, but not for the 5 year data, due to the averaging of annual results. page [4]

6 Juno Partners Wealth Creators Report 30 June Ticker Wealth Creators Rank Company Wealth created: How much the company's Enterprise Value exceeds at 30 June $m Wealth Created Quartile $m What rate of return is the business generating on the funds entrusted to it? Return on What could investors expect to earn elsewhere at similar levels of risk? Average Weighted of Cost Quality: How much does this business beat (or fall behind) other investments of similar risk? Spread Profit Quartile 5 year median EP Spread Quantity: The total funds invested in the business; debt & equity. - = x = $m 5 year average Average Quantity x Quality: The dollar amount of profits in excess of what investors could have expected, at similar risk Profit $m 5 year cumulative PRG 151 Programmed Maint. Services Ltd % 7.8% 9.7% 8.4% -0.6% -0.6% PAG 152 PrimeAg Australia % 2.3% 9.8% 7.1% -8.7% -4.9% CSV 153 CSG Limited % 17.2% 11.5% 9.0% 8.2% 8.2% SBM 154 St Barbara Limited % 21.0% 9.7% 9.6% -7.0% 11.3% AAD 155 Ardent Leisure Group % 7.0% 8.8% 7.7% -2.5% -0.6% SMX 156 SMS Management and Tech. Ltd % 6.3% 12.7% 11.5% -6.9% -5.3% ENE 157 Energy Developments Limited % 6.9% 7.7% 6.1% -2.3% 0.9% HIL 158 Hills Holdings Limited % 5.6% 9.7% 8.9% -3.1% -3.3% VAH 159 Virgin Australia Holdings Limited % 5.6% 7.1% 6.0% -3.4% -0.4% 3, , RSG 160 Resolute Mining Limited % 16.0% 13.5% 14.3% -7.5% 1.6% , IPL 161 Incitec Pivot Limited % 9.0% 11.5% 11.0% -2.1% -2.1% 4, , VRL 162 Village Roadshow Limited % 6.9% 6.8% 6.4% 1.0% 0.5% 1, , TAH 163 Tabcorp Holdings Limited % 12.1% 8.0% 7.2% 2.4% 4.9% 5, , EHL 164 Emeco Holdings Limited % 7.5% 11.0% 10.0% -4.8% -2.5% 1, , BPT 165 Beach Energy Limited % 8.1% 9.9% 9.1% -5.2% -0.9% 1, , TEN 166 Ten Network Holdings Limited % 3.6% 10.6% 9.1% -3.0% -5.5% 1, , TOL 167 Toll Holdings Limited % 6.6% 8.2% 8.1% -1.2% -1.5% 4, , IGO 168 Independence Group NL % 17.2% 15.3% 15.3% -3.5% 1.9% , MGX 169 Mount Gibson Iron Limited % 14.0% 14.7% 14.8% -0.8% -0.8% , CSR 170 CSR Limited % 10.0% 11.0% 11.5% -1.4% -1.4% 2, , IFN 171 Infigen Energy % 1.8% 6.8% 5.0% -4.1% -3.2% 3, , TSE 172 Transfield Services Limited % 5.8% 11.9% 11.2% -3.8% -5.5% 1, , ALS 173 Alesco Corporation Limited % 1.8% 11.6% 11.6% -7.1% -9.7% NUF 174 Nufarm Limited % 6.0% 9.2% 7.8% -1.8% -1.8% 2, , ,909 AQP 175 Aquarius Platinum Limited % -10.7% 14.5% 12.7% -7.6% -23.4% 1, , API 176 Aust. Pharmaceutical Industries Ltd % 4.6% 7.4% 5.7% -1.3% -1.0% SIP 177 Sigma Pharmaceuticals Limited % 3.4% 7.2% 5.5% -2.1% -2.1% 1, , ERA 178 Energy Resources of Australia Limited % -2.4% 12.5% 11.0% 1.3% -13.4% , AWE 179 AWE Limited % -0.7% 10.2% 11.5% -8.0% -12.2% 1, , SXL 180 Southern Cross Media Group Limited % 6.7% 9.5% 9.7% -3.0% -3.0% 1, , APN 181 APN News and Media Limited % 6.4% 9.2% 8.2% -1.8% -1.8% 2, , DOW 182 Downer EDI Limited % 8.3% 10.1% 8.8% -0.5% -0.5% 2, , PRY 183 Primary Health Care Limited -1, % 5.1% 7.8% 6.4% -2.5% -1.3% 3, , ANN 184 Ansell Limited -1, % 4.6% 8.0% 6.5% -3.5% -1.9% 3, , BBG 185 Billabong International Limited -1, % 12.9% 10.8% 10.8% 1.7% 2.2% 1, , BOQ 186 Bank of Queensland Limited -1, % 6.2% 11.3% 11.3% -0.7% -5.1% 2, , AWC 187 Alumina Limited -1, % 3.8% 13.8% 11.4% -7.6% -7.6% 3, , , GFF 188 Goodman Fielder Limited -1, % 5.4% 7.4% 6.1% -0.4% -0.7% 2, , BLD 189 Boral Limited -1, % 3.1% 10.1% 9.9% -5.0% -6.7% 4, , , SGM 190 Sims Metal Management Limited -1, % 2.8% 13.3% 13.9% -9.0% -11.1% 3, , , TPI 191 Transpacific Industries Group Ltd -1, % 5.4% 8.7% 8.6% -3.2% -3.2% 3, , PBG 192 Pacific Brands Limited -1, % 4.4% 10.9% 9.8% -5.4% -5.4% 2, , SWM 193 Seven West Media Limited -1, % 7.1% 10.5% 9.6% 10.4% -2.6% 4, BEN 194 Bendigo and Adelaide Bank Limited -1, % 9.4% 10.5% 8.9% -2.0% 0.5% 3, , MQG 195 Macquarie Group Limited -2, % 6.9% 12.6% 10.6% -3.5% -3.7% 9, , OZL 196 OZ Minerals Limited -3, % 5.9% 14.5% 15.3% -9.4% -9.4% 5, , , QAN 197 Qantas Airways Limited -3, % 4.2% 8.8% 6.7% -3.5% -2.5% 14, , , ARI 198 Arrium Limited -4, % 6.8% 12.0% 10.4% -6.9% -3.6% 6, , , FXJ 199 Fairfax Media Limited -4, % 4.1% 11.1% 9.5% -6.0% -5.4% 7, , , BSL 200 BlueScope Steel Limited -5, % -1.7% 11.9% 9.4% -9.6% -11.0% 7, , , % Note: The calculation of EP Spread and Profit in this table works for the figures, but not for the 5 year data, due to the averaging of annual results. page [5]

7 How do businesses create wealth? How does a business like BHP Billiton create $85 billion of wealth? If you were to believe the prospectuses, annual reports and investor briefings issued by many of our listed companies, you would be left with the firm impression that what matters in creating wealth is EPS growth and EBITDA. But our research shows that is not the case. In fact, these metrics are unreliable at best and dangerously misleading at worst. Managers that navigate with these measures risk running their businesses off course and destroying wealth. Our analysis shows that wealth creation is also not a function of sector. For example, some miners performed well, but some destroyed billions. Wealth is also not just a matter of size. BHP Billiton is a very large company and created the most wealth, but Qantas (#197) is also a very large business, but its size did not save it from destroying billions. Even growth per se does not matter. Both Arrium (#198) and Westpac (#6) have grown their balance sheets at 23% compound over the five years to 30 June but by the end of it, Westpac had turned $49 billion of investors funds into a business worth $65 billion, creating $16 billion, while Arrium, turned $7.9 billion into $3.8 billion, destroying $4.1 billion. Instead, our research shows that the two most important conditions necessary for the creation of wealth can be characterized as quality and quantity. The importance of quality Let s look at the first condition: quality. The quality of a business is captured by the returns the business is expected to generate above what investors could expect to enjoy elsewhere at similar risk. We call this the company s Profit spread, or EP spread for short (for further detail on our calculations, see Terminology on page 11). In assessing quality, we tend to give most emphasis to the EP spread the business has made over five years. This five year timeframe helps iron out year-to-year fluctuations and gives a picture of sustained performance. It shows, for example, the highest quality business in our set is Wotif.com Holdings Ltd (#50), which over the past five years has enjoyed an average return on capital employed of 61%, 52% above the rate investors could have expected to earn elsewhere at similar risk. Intuitively, generating 52% more than the return required for risk is good performance, but when you consider three quarters of the businesses covered in our research failed to generate more than 5% above what investors could expect for risk, then you begin to appreciate what are rare jewel Wotif.com is. page [6]

8 Quantity: the great accelerator of wealth creation The second condition necessary for the creation of wealth is quantity, in this case the quantity of funds that can be invested at high rates of return. The more capital that can be put to work at high rates of return, the more wealth will be created. This is best exemplified by BHP Billiton (#1) who not only enjoyed a median return on capital employed 11% above the return required for risk over the past five years, but also was able to employ an average of $74 billion a year at those rates, creating nearly $45 billion more profits than investors would require for the risk associated with their investment. Quantity is the great accelerator of wealth creation. As good as Wotif.com s returns are, the service nature of its business means that it does not organically generate large capital investment opportunities. It is hard to see how Wotif.com could ever employ $74 billion of capital in their business. Ultimately this restricts the wealth the business is able to generate. But quantity without quality is a recipe for wealth destruction But while the ability to put capital to work is important, we found quality must always come first. Investing large amounts of capital in low return, low quality businesses is a recipe for wealth destruction. Arrium Limited (formerly OneSteel Limited) is a good example of this. Over the past five years Arrium suffered returns on average 7% below what investors required for risk. At the same time, it expanded its capital base, investing billions at low rates of return. The result was a valuation $4 billion less than what investors had poured into the business as at 30 June. Warren Buffett put it this way in his 1992 letter to fellow Berkshire Hathaway investors, Leaving the question of price aside, the best business to own is one that over an extended period can employ large amounts of incremental capital at very high rates of return. The worst business to own is one that must, or will, do the opposite that is, consistently employ ever-greater amounts of capital at very low rates of return. The final ingredient: expectations But to complete the analysis of what creates wealth, we need to bring in expectations. Ultimately it is expectations of quality and quantity that drive the creation of wealth. If a company is expected to generate high returns on capital and employ large amounts of money doing so, the value of the company will be bid up well above the amount originally contributed by investors and wealth will be created. But the reverse is also true. If a company is expected to invest at low rates of return its value will fall and, absent of a takeover premium, it will trade at a discount to the book value of capital employed. page [7]

9 Our research found that the valuation that companies trade at is a function of expectations of the quality of future returns and the quantity of funds likely to be employed at those rates. But because the future is unknowable, with a few exceptions (like oil and gas exploration and development business Woodside Limited (#9)), in forecasting the future quality of a business and the quantity of funds it will be able to put to work, investors tend to put great store in historical performance, meaning wealth often reflects historical performance, particularly for established businesses. For example, Cochlear (#22) had created $3.1 billion of wealth as at 30 June and an average return above that required for risk over the five years to 30 June of 14%. Unpacking Cochlear s valuation into quality and quantity expectations shows that investors were expecting the Group to continue to enjoy returns significantly above the cost of capital even as it grows invested capital well into the future. Contrast this with Qantas (#197), who by 30 June had destroyed $3.9 billion with an average return 3.5% below that required for risk over the past five years. Unpacking Qantas 30 June valuation shows that investors were expecting returns to stay well below the cost of capital no matter what growth scenario is envisaged. The macro picture Grouping the two hundred businesses in our set into four quartiles further reinforces the importance of quality and quantity to wealth creation. Cumulative Wealth Created by Quartile Quality Median 5 year EP spread Quantity Total 30 June Profit Cumulative 5 year EP Q1 $384 B 3.6% $631 B $118 B Q2 $22 B 2.3% $42 B $3 B Q3 $4 B -0.5% $28 B -$1B Q4 -$51B -3.2% $153 B -$22 B The total wealth created by the top 25% of businesses we analysed was $384 billion, more than 17 times as much as the next quadrant. These businesses fit the description given by Warren Buffett as the best to own, as quoted above: they invest large amounts of capital at high rates of return. page [8]

10 Indeed by 30 June, the top quartile, including the likes of BHP Billiton, Commonwealth Bank, Telstra, Rio and Woolworths, had invested $631 billion nearly three times as much as the other quadrants put together at the highest average returns, 3.6% above what investors could expect to earn elsewhere at comparable risk. The second quartile created a very credible $22 billion of wealth. Their average returns were close to those in the first quartile (2.3% above the cost of capital, versus 3.6% enjoyed by the first quadrant), but these businesses, including the likes of software developed IRESS Limited and retailer, Oroton Group, were not able to put large amounts of capital to work at those rates (just $42 billion in total at 30 June ). With the accelerator of wealth creation missing, the second quadrant created a fraction of the wealth of the first. The third quartile created $3.6 billion of wealth. This group has averaged returns over the past five years just below what investors could expect to earn elsewhere (their median EP spread being -0.5%). invested at 30 June is the lowest of the four quartiles at just $28 billion. With quality just below average and low quantity, this quadrant has done well to amass even $3.6 billion of wealth. The bottom quartile has destroyed $51 billion of wealth by putting large amounts of capital to work ($153 billion by 30 June ) at low rates of return, averaging 3.2% below what investors could expect to earn elsewhere. Little wonder Buffett described these kind of businesses as the worst to own. This quartile analysis shows the strong link between quality, quantity and wealth. The top 25% of wealth creators were also the businesses with the highest quality or EP spreads and the highest quantity of capital invested. The next 25% had good EP spreads, but less invested. The third quartile had breakeven EP spreads and the smallest amounts invested and the bottom 25% destroyed $51 billion of wealth by investing the second highest amount of capital at the lowest rates of return. But where does accounting profit sit in all this? Given the emphasis placed on accounting profits by investment banks, the media and stock brokers, many managers would be forgiven for assuming measures like EPS, Net Profit and EBITDA are reliable indicators of wealth creation: more profit is always good for shareholders. This is not borne out by our analysis. In fact accounting profit was shown to be a very misleading measure: while the top 25% of wealth creators also made more Net Profit After Tax (NPAT) than any other quartile, the bottom quartile, who destroyed $51 billion of wealth, came second in terms of cumulative NPAT over the five years to 30 June. The problem is accounting profit measures like EPS, Net Profit and EBITDA say nothing about the quality of the business. They do not take into account the return investors could earn elsewhere on their funds and so businesses that employ large amounts of money at low rates of return can grow their accounting profits handsomely, all the while destroying wealth for investors. For anyone interested in wealth creation, the evidence is compelling: wealth is not a function of accounting profitability. Wealth = Quality x Quantity. page [9]

11 Competition can be hazardous to wealth How do businesses achieve and sustain high returns on the funds entrusted to them and therefore create so much wealth? It is a rare achievement just 25 of the 200 businesses we studied enjoyed average returns 10% or more above the cost of capital over the five years to 30 June. Like most of the businesses in our set, these businesses are professionally managed, offer compelling value propositions to their customers and play their part in the communities in which they operate. The difference is the competition that they face. For most businesses, the competition for sales, supplies or employees forces returns down to a level that just compensates investors for the risk that they take on. A short period of high returns attracts the attention of competitors and in the absence of a hard to replicate product or cost advantage, returns fall away as new players enter the market. But a small group of businesses has been able to avoid these pressures and maintain high returns. Some, like Cochlear invest hundreds of millions in research and development and enjoy the protection of patents, allowing them to reduce competition over the life of the patent. Others, like BHP Billiton enjoy cost advantages over their competitors and pricing power in some of their businesses, while others like Reece Australia (#39) leverage brand recognition and distribution networks. In each of these instances, the advantages have proven durable, giving investors confidence that high returns can be maintained well into the future, even in the face of competitive pressures. When these advantages can be maintained, wealth will be created, limited only by the size of the capital investment opportunity. Key takeaway The production of wealth has its necessary conditions. Boards and senior managers play a critical role in guiding that production, but only if they understand the importance of quality and quantity and ensure every aspect of their business is managed with them in mind. page [10]

12 Terminology Net Operating Profit After Tax (NOPAT) The underlying operating profits of the business. Adjustments are made to statutory results to calculate NOPAT, including adding back interest and significant items, converting tax expense to cash, capitalizing research & development expenditure and reversing goodwill amortisation. The total funds invested in the business by lenders and shareholders as at the most recent balance date. Adjustments as detailed above are made to the statutory results to achieve a better picture of the underlying performance of the business. Return on Calculated as the adjusted profits of the business divided by the two year average, Return on (ROCE) is a good measure of the unlevered return the business generates on the funds entrusted to it. Weighted Average Cost of (WACC) The weighted average cost of debt and equity capital. This is equivalent to what investors could expect to earn elsewhere over the long term at similar levels of risk. Profit Spread Calculated as ROCE WACC, the EP Spread tells us about the quality of the business. A high quality business is one that can consistently put investor funds to work at a rate greater than what investors can earn elsewhere at similar risk (the WACC). Businesses with positive EP Spread are generating returns in excess of the WACC. Enterprise Value The market value of the company s debt and equity as at 30 June. Where debt is not publicly quoted, the book value of debt is used. Profit (EP) The profits made by the company after charging for the expected return on all invested debt & equity. A number of adjustments are made to reported profits and to see through to the underlying performance of the business. Formulaically, EP = (ROCE WACC) x Average, or Quality x Quantity. page [11]

13 Juno Partners Pty Ltd Level 27, 101 Collins Street Melbourne Victoria 3000 Telephone contact@junopartners.com.au JunoPartners.com.au