The Relevance of Annual Reports

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1 Deutsche Bank AG The Relevance of Annual Reports for Analysts in Recession Times September 2009 All prices are those current at the end of the previous trading session unless otherwise indicated. Prices are sourced from local exchanges via Reuters, Bloomberg and other vendors. Data is sourced from Deutsche Bank and subject companies. Deutsche Bank does and seeks to do business with companies covered in its research reports. Thus, investors should be aware that the firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision. DISCLOSURES AND ANALYST CERTIFICATIONS ARE LOCATED IN APPENDIX 1. MICA(P) 106/05/2009 D A d N b Dr. Andreas Neubauer Head of Research Germany / Austria Andreas.Neubauer@db.com -(49)

2 Introduction Earnings Guidance in Recession Times

3 Earnings Guidance Global l recession in 2009E but recovery in 2010E G7 GDP growth GDP growth, CPI inflation (in %) by region GDP growth, % CPI inflation, % F 2010F 2008F 2009F 2010F US % qoq ann. G7 GDP growth Japan Euroland Germany Asia (ex Japan) China EMEA Russia Latam Brasil G EM countries Global Source: Global Insight, Deutsche Bank Global Markets Research Forward data are estimates Source: Deutsche Bank Global Markets Research Forward data are estimates Dr. Andreas Neubauer September 2009 page 3

4 Earnings Guidance Global l GDP decline 2009E by 1.5% for 2009E means earnings should decline by 30-40% Global GDP outlook 2009E suggests earnings to decline by 30-40% whereas bottom up estimates are showing only a small decline US earnings growth (%) (LHS) European earnings growth (%) (LHS) World GDP growth (%) (RHS) Source: Thomson Financial, IBES, Deutsche Bank Forward data are Deutsche Bank estimates Dr. Andreas Neubauer September 2009 page 4

5 Earnings Guidance Earnings guidance widely suspended d in recession Ongoing g recession, volatility in financial markets has caused an increasing number of public companies to suspend earnings guidance as operations become increasingly difficult to predict Recession has accelerated an existing trend in which many public companies have moved from annual to quarterly guidance Hence, analyst expectations, ti earnings uncertainty t start t to fluctuate t much more widely Dr. Andreas Neubauer September 2009 page 5

6 Earnings Guidance Strong downgrade d momentum and high h volatility of macro variables have pushed up earnings uncertainty 25% Standard deviation as % of earnings 20% 15% 10% 5% 0% US Europe Note: Earnings uncertainty is measured as the standard deviation of the estimates of the individual analysts around the average consensus estimates. For Europe, the average of the MSCI Europe is used and for the US, all S&P500 companies are taken into account. Source: I/B/E/S, Deutsche Bank Global Markets Research Dr. Andreas Neubauer September 2009 page 6

7 Earnings Guidance Earnings growth, uncertainty t by country 2009E and 2010E growth of country earnings (%) Earnings uncertainty by country (%) Switzerland: SMI MSCI Asia ex Japan 2010E earnings growth (%) 2009E earnings growth (%) 8.2 TOPIX UK: FTSE S&P Euro Stoxx 19.6 Germany: Dax MSCI EMEA 19.5 MSCI Latin America FTSE Italy 19.1 Euro Stoxx MSCI Latin America Stoxx Germany: Dax MSCI EMEA Stoxx Euro Stoxx France: CAC France: CAC Spain: IBEX Spain: IBEX 35 UK: FTSE Euro Stoxx 50 MSCI Asia ex Japan year average standard deviation of 12M fwd. earnings relative to earnings FTSE Italy TOPIX nm Switzerland: SMI S&P Current standard deviation of 12M fwd. earnings relative to earnings Source: Thomson Financial, IBES and Deutsche Bank estimates Forward data are estimates Source: Thomson Financial, IBES and Deutsche Bank estimates Forward data are estimates Dr. Andreas Neubauer September 2009 page 7

8 Earnings Guidance Q2 09 Reporting Overview So far, 416 companies of the Stoxx 600 universe have reported their results* On the earnings front, 57% of the companies beat their estimates while 42% missed them 49% of the companies exceeded d their revenue expectations, ti while 51% missed them Cost cutting programs adopted by the companies appear to be more successful than expected and hence contributing to the divergence between the revenues and earnings beats However, we believe that sales is a purer reflection of what is going on than EPS and cannot be engineered as easily Looking at the stock performance relative to the performance of the Stoxx 600 index, 24 European companies have shown a significant positive surprise, whereas 16 companies had negatively surprised (time period of measurement: from 2 days before and 1 day after the reporting day) * As of 24 August 2009 Dr. Andreas Neubauer September 2009 page 8

9 Earnings Guidance European EPS and Revenues vs. Consensus Estimates t * Of the 154 companies DB covers, for 36 companies our analysts have improved the outlook, while for 15 companies our analysts have reduced their outlook. * 416 companies of the Stoxx 600 universe have reported their results according to Bloomberg. The statistics includes only those DJ STOXX companies where EPS numbers (both actual and consensus) were available Dr. Andreas Neubauer September 2009 page 9

10 Earnings Guidance Main risks we see for corporate earnings in 2009 Lower sales growth Margins falling to at least mild recession levels (2002/2003) Higher cost of debt, especially for small companies with no access to the bond market and/or poor ratings Consequently, yield gap between high quality and low quality corporate bonds has reached unprecedented levels Goodwill impairment tests could lead to strong goodwill write-downs Risk of pension funding gaps as pension assets may have strongly suffered in 2008 Dr. Andreas Neubauer September 2009 page 10

11 Key Prerequisites

12 Key Prerequisites What do analysts and investors expect from companies? Contemporary publication of statements (information efficiency) Lean and meaningful financial reporting in order to provide investors with unambiguous information (limiting creative interpretation ) Analysts and investors call for transparent, t credible and reliable information Hence, Value Reporting based upon untransparent assumptions to convince investors of strong gperformance is of no relevance Furthermore, both analysts and investors demand structured reference work, therefore a standardization of annual reports (such as US 10K fillings) would reduce time exposure to research enhance comparability among industry and peer groups limit creative interpretation of earnings and balance sheet figures Dr. Andreas Neubauer September 2009 page 12

13 Key Prerequisites Analysts and investors demand d execution of general norm German principles p of proper p accounting ( 243 I HGB) / Grundsätze ordnungsmäßiger Buchführung (GoB) Merchants ( 238 I S.1 HGB i.c.w. 243 I HGB): Jeder Kaufmann ist verpflichtet, Bücher zu führen und in diesen seine Handelsgeschäfte und die Lage seines Vermögens nach den Grundsätzen ordnungsmäßiger Buchführung ersichtlich zu machen. Corporations ( 264 II S.1 HGB i.c.w. 243 I HGB): Der Jahresabschluß der Kapitalgesellschaft hat unter Beachtung der Grundsätze ordnungsmäßiger Buchführung ein den tatsächlichen Verhältnissen entsprechendes Bild der Vermögens-, Finanz- und Ertragslage der Kapitalgesellschaft zu vermitteln. Dr. Andreas Neubauer September 2009 page 13

14 Key Prerequisites Hence, annual accounts are to satisfy Profit assessment (primary function) Focus on GoB codified in 252 I S.1 No. 4 HGB: - German HGB demands cautious ( Vorsichtsprinzip ), revenue related ( Realisationsprinzip ), loss anticipating ( Imparitätsprinzip ) and objective ( Objektivierungsprinzip ) determination of earnings Documentation and Accountability Besides providing clear, complete, unambiguous and comprehensible documentation for third parties, the Annual Report shall comprise the disclosure of usage of entrusted capital and intermediation of a complete, reasonable, appropriate insight. Information function protecting the interests of third parties Analysts focus on appendix (HGB) / management commentary (IFRS) Dr. Andreas Neubauer September 2009 page 14

15 Earnings revisions among pooled markets

16 Earnings Revisions What are earnings revisions i good for? Consensus analyst estimates are widely used to represent market expectations of earnings Efficient market theory states that all the information about the value of a stock is already priced in. Hence, stock prices should only change due to unpredictable information. In reality, however, markets could be inefficient due to information asymmetries and changes in earnings expectations ti are highly hl correlated to stock price movements In late 2008 and early 2009, many analysts got caught up in the atmosphere of doom and gloom, and overreacted Adverse selection issues arise due to products with heterogeneous quality ( pooled markets) information quality can (at least partially) explain the biases in expected returns (D. Hong and M. Warachka, 2005) Dr. Andreas Neubauer September 2009 page 16

17 Earnings Revisions Earnings guidance among pooled markets Information Asymmetry y due to quality uncertainty about earnings guidance: Analyst faces increased earnings uncertainty due to companies vague guidance behavior in recession times Dilemma: Analyst weighs up a costs associated with information (screening process) against b expected benefit disadvantages at imperfect information Looming market failure due to adverse selection issues (Akerlof, 1970) Quality of earnings guidance varies among companies as they are better informed than analysts Pooled markets: Market comprises products with heterogeneous quality and an uniform price (Spremann, 1990) Solution: Market separation through signaling good quality (credible, honest guidance) at reasonable cost provided that signaling costs exceed a low quality company s willingness to pay for signaling at all Dr. Andreas Neubauer September 2009 page 17

18 Earnings Revisions Country earnings revisions i Revisions of 2009E country earnings (%) Revisions of 2010E country earnings (%) MSCI Asia ex Japan MSCI Asia ex Japan S&P 500 S&P 500 MSCI EMEA UK: FTSE 100 TOPIX TOPIX MSCI Latin America MSCI EMEA Switzerland: SMI Switzerland: SMI Euro Stoxx 50 MSCI Latin America UK: FTSE 100 Stoxx 600 Stoxx 600 FTSE Italy Spain: IBEX 35 Germany: Dax 30 Germany: Dax 30 Spain: IBEX 35 France: CAC 40 revision of 2009E earnings Euro Stoxx 50 revision of 2010E earnings FTSE Italy revision previous two months France: CAC 40 revision previous two months Euro Stoxx revision last month Euro Stoxx revision last month Source: Thomson Financial, IBES and Deutsche Bank estimates Forward data are estimates Source: Thomson Financial, IBES and Deutsche Bank estimates Forward data are estimates Dr. Andreas Neubauer September 2009 page 18

19 Earnings Revisions IBES Index Earnings trends: Europe (Stoxx 600) Earnings estimates trend Earnings revision ratio month forward earnings Jan Apr Jul Oct Jan Apr Jul Oct Jan Apr Jul Oct Jan Apr Jul Oct Jan Apr Jul Earnings revisions: Companies with 12-month-forward earnings (ups-downs) / total Average 3-month moving average Source: Thomson Financial, IBES and Deutsche Bank estimates Source: Thomson Financial, IBES and Deutsche Bank estimates Forward data are Deutsche Bank estimates Dr. Andreas Neubauer September 2009 page 19

20 Earnings Revisions IBES Index Earnings trends: Germany (DAX30) Earnings estimates trend Earnings revision ratio month forward earnings Jan Apr Jul Oct Jan Apr Jul Oct Jan Apr Jul Oct Jan Apr Jul Oct Jan Apr Jul Earnings revisions: Companies with 12-month-forward earnings (ups-downs) / total Average 3-month moving average Source: Thomson Financial, IBES and Deutsche Bank estimates Forward data are Deutsche Bank estimates Source: Thomson Financial, IBES and Deutsche Bank estimates Dr. Andreas Neubauer September 2009 page 20

21 Earnings Revisions How long will European earnings continue to decline and is there a chance to recover to the longer trend? 32 Development of forward earings based on current consensus estimates The constant growth rate of the trend earnings equals 6.1% month rolling earnings forecast (LHS) Normalised earnings forecast (LHS) Source: I/B/E/S, Datastream, Deutsche Bank Forward data are Deutsche Bank estimates Dr. Andreas Neubauer September 2009 page 21

22 Earnings Revisions Focus on earnings revisions i in recession times Even in recession times, when earnings uncertainty is above usual levels, firms should stay committed to reporting policy due to sustainable credibility A company that has decided to suspend earnings guidance should take into account a number of issues, including: Announcement of suspension or discontinuation of guidance Metrics that will be provided in lieu of EPS Regulatory considerations However, the current financial crisis has raised questions that have not been addressed sufficiently in Annual Reports / Quarterly Reports Refinancing issues (< 1 year, 1 5 years, > 5 years) Contractant risk (both suppliers and customers) Risk reporting often only re-active but pro-active Dr. Andreas Neubauer September 2009 page 22

23 Conclusion

24 Conclusion Earnings guidance became widely suspended in recession and, hence, earnings uncertainty started to fluctuate much more widely Especially in recession times analysts, investors demand contemporary publication of statements as well as transparent, credible, reliable information However, quality of earnings guidance varies among companies and pooled markets for information make it increasingly i difficult for analysts, investors to generate investment ideas out of corporate statements Even in recession times, when earnings uncertainty is above usual levels, firms should stay committed to reporting policy due to sustainable credibility Dr. Andreas Neubauer September 2009 page 24

25 Dr. Andreas Neubauer September 2009 page 25 Thank you for your attention

26 Deutsche Bank Appendix 1 Important Disclosures Additional Information Available upon Request For disclosures pertaining to recommendations or estimates made on a security mentioned in this report, please see the most recently published company report or visit our global disclosure look-up page on our website at Dr. Andreas Neubauer September 2009 page 26

27 Analyst Certification This report covers more than one security and was prepared by more than one analyst. The views expressed in this report accurately reflect the personal views of each undersigned lead analyst about the subject issuers covered by each, and the securities of those issuers. In addition, the undersigned lead analysts have not and will not receive any compensation for providing a specific recommendation or view in this report. Andreas Neubauer, Ingo Schmitz, Stefan Bielmeier. Dr. Andreas Neubauer September 2009 page 27

28 Deutsche Bank Regulatory Disclosures 1. Important Additional Conflict Disclosures Aside from within this report, important conflict disclosures can also be found at under the "Disclosures Lookup" and "Legal" tabs. Investors are strongly encouraged to review this information before investing. 2. Short-Term Trade Ideas Deutsche Bank equity research analysts sometimes have shorter-term trade ideas (known as SOLAR ideas) that are consistent or inconsistent with Deutsche Bank's existing longer term ratings. These trade ideas can be found at the SOLAR link at 3. Country-Specific Disclosures Australia: This research, and any access to it, is intended only for "wholesale clients" within the meaning of the Australian Corporations Act. EU countries: Disclosures relating to our obligations under MiFiD can be found at Japan: Disclosures under the Financial Instruments and Exchange Law: Company name Deutsche Securities Inc. Registration number Registered as a financial instruments dealer by the Head of the Kanto Local Finance Bureau (Kinsho) No Member of associations: JSDA, The Financial Futures Association of Japan. This report is not meant to solicit the purchase of specific financial instruments or related services. We may charge commissions and fees for certain categories of investment advice, products and services. Recommended investment strategies, products and services carry the risk of losses to principal and other losses as a result of changes in market and/or economic trends, and/or fluctuations in market value. Before deciding on the purchase of financial products and/or services, customers should carefully read the relevant disclosures, prospectuses and other documentation. New Zealand: This research is not intended for, and should not be given to, "members of the public" within the meaning of the New Zealand Securities Market Act Russia: This information, interpretation and opinions submitted herein are not in the context of, and do not constitute, any appraisal or evaluation activity requiring a license in the Russian Federation. Dr. Andreas Neubauer September 2009 page 28

29 Deutsche Bank Global Disclaimer The information and opinions in this report were prepared by Deutsche Bank AG or one of its affiliates (collectively "Deutsche Bank"). The information herein is believed to be reliable and has been obtained from public sources believed to be reliable. Deutsche Bank makes no representation as to the accuracy or completeness of such information. Deutsche Bank may (1) engage in securities transactions in a manner inconsistent with this research report, (2) with respect to securities covered by this report, sell to or buy from customers on a principal basis, and (3) consider this report in deciding to trade on a proprietary basis. Opinions, estimates and projections in this report constitute the current judgment of the author as of the date of this report. They do not necessarily reflect the opinions of Deutsche Bank and are subject to change without notice. Deutsche Bank has no obligation to update, modify or amend this report or to otherwise notify a recipient thereof in the event that any opinion, forecast or estimate set forth herein, changes or subsequently becomes inaccurate. Prices and availability of financial instruments are subject to change without notice. This report is provided for informational purposes only. It is not an offer or a solicitation of an offer to buy or sell any financial instruments or to participate in any particular trading strategy. Deutsche Bank has instituted a new policy whereby analysts may choose not to set or maintain a target price of certain issuers under coverage with a Hold rating. In particular, this will typically occur for "Hold" rated stocks having a market cap smaller than most other companies in its sector or region. We believe that such policy will allow us to make best use of our resources. Please visit our website at to determine the target price of any stock The financial instruments discussed in this report may not be suitable for all investors and investors must make their own informed investment decisions. Stock transactions can lead to losses as a result of price fluctuations and other factors. If a financial instrument is denominated in a currency other than an investor's currency, a change in exchange rates may adversely affect the investment. Past performance is not necessarily indicative of future results. Unless governing law provides otherwise, all transactions should be executed through the Deutsche Bank entity in the investor's home jurisdiction. In the U.S. this report is approved and/or distributed by Deutsche Bank Securities Inc., a member of the NYSE, the NASD, NFA and SIPC. In Germany this report is approved and/or communicated by Deutsche Bank AG Frankfurt authorized by the BaFin. In the United Kingdom this report is approved and/or communicated by Deutsche Bank AG London, a member of the London Stock Exchange and regulated by the Financial Services Authority for the conduct of investment business in the UK and authorized by the BaFin. This report is distributed in Hong Kong by Deutsche Bank AG, Hong Kong Branch, in Korea by Deutsche Securities Korea Co. This report is distributed in Singapore by Deutsche Bank AG, Singapore Branch, and recipients in Singapore of this report are to contact Deutsche Bank AG, Singapore Branch in respect of any matters arising from, or in connection with, this report. Where this report is issued or promulgated in Singapore to a person who is not an accredited investor, expert investor or institutional investor (as defined in the applicable Singapore laws and regulations), Deutsche Bank AG, Singapore Branch accepts legal responsibility to such person for the contents of this report. In Japan this report is approved and/or distributed by Deutsche Securities Inc. The information contained in this report does not constitute the provision of investment advice. In Australia, retail clients should obtain a copy of a Product Disclosure Statement (PDS) relating to any financial product referred to in this report and consider the PDS before making any decision about whether to acquire the product. Deutsche Bank AG Johannesburg is incorporated in the Federal Republic of Germany (Branch Register Number in South Africa: 1998/003298/10). Additional information relative to securities, other financial products or issuers discussed in this report is available upon request. This report may not be reproduced, distributed or published by any person for any purpose without Deutsche Bank's prior written consent. Please cite source when quoting. Copyright 2009 Deutsche Bank AG Dr. Andreas Neubauer September 2009 page 29

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