Setting An Enterprise Compass, Executing Insightful Strategies And Deploying A Dynamic WACC Peter Hanlon FTA 29 th Annual Conference November 17, 2016 1 Benefit from Our Experience Financial Institutions & Management Advisory Pty Ltd Suite 108, 430 Little Collins Street, Melbourne, VIC, 3000 Telephone +61 3 9614 5000, Facsimile +61 3 9614 0734, Email: info@fima.com.au
Global Financial Stability Risks High & Rising Source : IMF, Financial Stability Report, Oct 2016, Page 2 2
Global Financial Stability Risks High & Rising Source : IMF, Financial Stability Report, Oct 2016, Page 3 3
Scenario Planning for An Uncertain World Always expect the unexpected 4
Setting the Enterprise Compass Scenarios provide perspectives on the future to exercise insightful strategies today Empowers Board and management conviction to authenticate strategies that deliver long term enterprise value Embraces the unthinkable via setting the enterprise compass beyond current boundaries Promotes organisational foresight, agility and adaptiveness as key attributes for ongoing success and sustainability The future is too important to be left to your competitors 5
WACC Not the only game in town Equity Capital, Economic Capital, Regulatory Capital RORAC Net income/allocated Economic Capital RAROC Expected return/economic Capital RARORAC Expected return/economic Capital - Diversification benefits ROREG Net income / Regulatory Capital Capital is first and foremost driven by risk McKinsey 6
Key WACC Drivers for Scenarios Future landscape Political, Economic, Social, Technological, Legislative and Environmental Customer Ownership Relationship Risk Appetite Profile Mitigation Barriers To Entry Legislation Regulation Licencing Business Model Marketing Experience Change catalysts Speed to Market Performance Growth Trajectory Leverage Innovation Disruptive Tech Automation/ Robotisation Energy Storage Investment Capital Intensive Brand Valuations Franking Credits 7 Competitor Activity Cartel Exclusivity Locked in Income v Income Risk Reinvent revenue annually Loyalty/Churn Direct v Intermediaries
WACC Dynamic Strategic Benchmarks & Metrics Static Financial Metrics Dynamic Strategic Benchmarks Dynamic Metrics Income/ Cashflow Statements RAROC/ ROE ROA Cost to Income Margin Spread Dividend Cover P/E ratios Customer Demographics: The propensity of a current and future customer base to consume and reward for services and products Service: The quality of the customer experience offered Inspiration Innovation: The capacity to front run technological, product and business advances Delivery: The ability to implement insightful, accretive business strategies Enterprise Execution: The competence, confidence and culture to take decisions and provide direction Efficiency: The capacity to invest and effectively harness capital Management Leadership Management credentials to motivate and deploy the team Reputation Influence and presence on engaging with internal / external stakeholders Share of wallet /x sells/ lifecycle Customer surveys /Complaints/ Brand recognition Feedback from software/ hardware vendors/ systems architecture/ website Speed to market/ project management credentials/ Business Led Succession planning/ Career Path policies/ Strategic Vision Investment audits/ Capital Regeneration policies/ Cashflow profiles Good news fast/ bad news faster / whistle blower programme/ behavioural surveys/ competence v loyalty Culture of transparency and openness/ media commentary/ community/ environmental agenda 8
Capital As a Scarce Commodity 50-70% 40-60% 35-50% 25-35% Seed Capital Venture Capital Acquisition and VCs IPO Seed Stage Early Stage Later Stage End Stage Features of capital claims v Internal Market Competitive Bidding Incremental subscription Pure Equity Buyside agenda Dynamic perspective Terminal Value Illiquidity Premia Risk basis Transparent Management Execution Speed to Market Simulation modelling Source:- NYU Stern Business School 9
WACC Challenges in the Current Environment Uncertainty v Risk Management Rigged Markets V Free Enterprise Negative risk free yield curves v Real Rates Dysfunctional political landscape New normal Risk bias Public Good 10
Australian WACCs Too High & Sticky 11
Risk-free Rates for Valuation Impact & Alternatives DCF Assumptions Country Risk-free rate - 10yrs % Dec 2014 Change in 2014 - % Impact on DCF - % of Valuation Germany 0.5-1.4 46 Italy 1.9-2.2 38 Spain 1.6-2.5 45 UK 1.8-1.3 13 Alternatives: Average historical yield over long run Another benchmark country or debt instrument Adjust ERP to compensate for volatility increase the beta Adjust the discount rate Source: E&Y, Estimating risk free rates for valuation, 2015 12
Sector WACC rates -2015 RFR ERP Banks 5.50% 6.00% Building Materials 3.40% 6.00% Chemicals 6.00% 4.00% Energy n/a (use a 11%nominal WACC) Engineers & Contractors 6.00% 6.30% Gaming 6.00% 4.00% Healthcare 5.00% 6.00% Insurance & Div Fins 5.30% 6.00% Media 5.00% 6.00% Paper & Packaging 6.00% 4.00% REITS 5.00% 5.00% Resources (Bulk) 3.00% 6.00% Resources(Non-Bulk) n/a (use a 12%nominal WACC) Retail 5.30% 6.00% Small Caps 5.20% 6.00% Steel 3.10% 6.00% Telco 5.50% 6.00% Transport 6.00% 5.00% Infrastructure 6.00% 4.50% Utilities 6.00% 6.30% Average 5.18% 5.51% Major ASX 100 company received 20% target price upgrade via a revision to Risk Free Rate Risk Free Rate embraced current for 3 years and composite weighted average after One starting point for WACC leverage is to target a ratings agency benchmark e.g. BBB 13
WACC - A Way Forward All standalone metrics are only as good as their provenance credentials Scenario planning future landscape, risk/ reward assessment, optimal enterprise strategies authenticates an informed WACC Organisational keys to deploying WACC conviction, adaptability, nimbleness, decisiveness, opportunism- lead to successful outcomes WACC needs company and support in challenging times- terminal values, mean reversion, risk free restatement Capital to be hungry not lazy internal market, reinvestment options, due diligence Capital allocation is a dynamic process...intelligent capital allocation requires understanding the long-term value of an array of opportunities and spending money accordingly Warren Buffett Capital Allocation Evidence, Analytical Methods and Assessment Guidance Credit Suisse August, 2014 14