1 Quest UK themes update – Operation Style Twist 17th January 2012 Nigel Sedgley +44 (0)20 7523 8497 [email protected] Quest helpline +44 (0)20.

1

Quest™ UK themes update – Operation Style Twist17th January 2012

Nigel Sedgley+44 (0)20 7523 [email protected]

Quest™ helpline+44 (0)20 7523 [email protected]

2

Quest™ framework and tools

M&A

LBO valuation

LBO Superscreen

Quest™ market-to-book (replacement cost of assets)

Deal Watch and analysis

Stocks & Products

Companies in the News

triAngle Escalator

Newsletter

Performance

Style matrix

Quest™ themes

Screening

Screen for stocks

triAngle

Wealth creation

Cash flow returns

Capital deployment

Growth

Value tools

Quest™ valuation

Quest™ market-to-book

LBO FCF yield

triAngle Value (Quest™ + conventional)

Risk management tools

Quest™ Risk Rater

Aggressive/Defensive Indicator

Quest™ triAngle

Momentum

3

2008-2009 all over again?

Operation style twist

The run to safe stocks over the summer was more extreme than in 07/08

Value has seen its longest stretch of UK weakness

How much bad news is priced in?

Value approach in Nov 08 Quest Newsletter delivered strong performance

Value started working before the trough in 08/09

Which Value tools to use? (Stable measures)

Stock screens to find value opportunities and overextended (expensive) situations

4

Q-files

*New* *New*

5

60

70

80

90

100

110

Dec-09 Mar-10 Jun-10 Sep-10 Dec-10 Mar-11 Jun-11 Sep-11 Dec-11

80

90

100

110

120

130

140

150

160

170

Dec-09 Mar-10 Jun-10 Sep-10 Dec-10 Mar-11 Jun-11 Sep-11 Dec-11

Q-files performance highlight the exponential shift to quality

High Q-score companies outperforming

Volatile companies underperforming

Quest™ Risk Rater

Aggressive defensive indicator

UK large caps (to 3 Jan)

Aggressive Defensive indicator

■ Identifies the most/ least cyclical and volatile companies

■ Based on three measures: EBITDA stabilityCFROA stabilityShare price volatility

■ Measured over 12 years (including forecasts)

■ High deciles (10) indicate defensive, more stable stock

6

Factors and triAngle composition

Quest™ valuation

Quest™ market-to-book

EV/sales rel. LRA

Dividend yield rel. LRA

P/E rel. LRA

CFROC spread

Capital growth

Equilibrium growth

Fixed charge cover

CFROC change

9m-relative trend

100/200-day switch

12m-relative range

30/90 day switch

Earnings momentum

triAngleValue Quality

Momentum

33% 33%

33%

Quest triAngle

Excellent 12- year track record

3-pronged approach improves consistency

UK Large – 42/52 +ve quarters, +4.3% average

Pan-Euro – 36/47 +ve quarters, +3.1% average

UK small – 34/41 +ve quarters, +6.4% average

■ Value, Quality and Momentum ‘ baskets’ are dynamic – driven by current rankings

UK large caps

100

1000

10000

No

v-9

8

Ma

y-9

9N

ov-

99

Ma

y-0

0N

ov-

00

Ma

y-0

1N

ov-

01

Ma

y-0

2N

ov-

02

Ma

y-0

3N

ov-

03

Ma

y-0

4N

ov-

04

Ma

y-0

5N

ov-

05

Ma

y-0

6N

ov-

06

Ma

y-0

7

No

v-0

7M

ay-

08

No

v-0

8M

ay-

09

No

v-0

9M

ay-

10

No

v-1

0M

ay-

11

No

v-1

1

triAngle™

Value

Quality

Momentum

7

2008 all over again? ■ 11 years of live triAngle history

■ Value works in short sharp burst – normally when valuation dispersion is high.

■ During the credit crunch, and now ….Quality and Momentum are the main drivers

Top quintile minus bottom quintile on each factor on an equally weighted basis. Non-financials.

8

-15% -10% -5% 0% 5% 10% 15%

triAngle

Value

Quality

Momentum

Quest™ Valn

Quest™ Mkt to Book

EV/Sales rel LRA

Div Yield rel LRA

PE Rel LRA

CFROC Spread*

Capital Growth

Equilibrium growth

Fixed charge Cover

CFROC change

9m relative trend

100/200 day switch

12m relative range

ST Indicator

EPS momentum 3m

-15% -10% -5% 0% 5% 10% 15%

triAngle

Value

Quality

Momentum

Quest™ Valn

Quest™ Mkt to Book

EV/Sales rel LRA

Div Yield rel LRA

PE Rel LRA

CFROC Spread*

Capital Growth

Equilibrium growth

Fixed charge Cover

CFROC change

9m relative trend

100/200 day switch

12m relative range

ST Indicator

EPS momentum 3m

9 negative Q in a row2nd best in a decade

3rd best in a decade

2nd best in a decade

Yield holding up

UK Large

Factor by factor in H2 2011 – Quality and Momentum strong

May-Aug 2011 Aug-Nov 2011

best for over 3 years

More mixed

9

Fixed Charge Cover

-30%

-20%

-10%

0%

10%

20%

30%

Feb 99

Nov 99

Aug 00

May 01

Feb 02

Nov 02

Aug 03

May 04

Feb 05

Nov 05

Aug 06

May 07

Feb 08

Nov 08

Aug 09

May 10

Feb 11

Nov 11

0

500

1000

1500

2000

2500

3000

3500

4000

Fixed charge Cover* FTSE350

Three months ending at date show n*Live triAngle factor since Feb 04. Previously Ex post backtest. 3m to Feb 04 N/A.

Quality

-30%

-20%

-10%

0%

10%

20%

30%

Feb 99

Nov 99

Aug 00

May 01

Feb 02

Nov 02

Aug 03

May 04

Feb 05

Nov 05

Aug 06

May 07

Feb 08

Nov 08

Aug 09

May 10

Feb 11

Nov 11

0

500

1000

1500

2000

2500

3000

3500

4000

Quality FTSE350

Three months ending at date show n

Value

-30%

-20%

-10%

0%

10%

20%

30%

Feb 99

Nov 99

Aug 00

May 01

Feb 02

Nov 02

Aug 03

May 04

Feb 05

Nov 05

Aug 06

May 07

Feb 08

Nov 08

Aug 09

May 10

Feb 11

Nov 11

0

500

1000

1500

2000

2500

3000

3500

4000

Value FTSE350

Three months ending at date show n

Earnings Momentum

-30%

-20%

-10%

0%

10%

20%

30%

Feb 99

Nov 99

Aug 00

May 01

Feb 02

Nov 02

Aug 03

May 04

Feb 05

Nov 05

Aug 06

May 07

Feb 08

Nov 08

Aug 09

May 10

Feb 11

Nov 11

0

500

1000

1500

2000

2500

3000

3500

4000

EPS momentum 3m FTSE350

Three months ending at date show n

D

triAngle

-30%

-20%

-10%

0%

10%

20%

30%

Feb 99

Nov 99

Aug 00

May 01

Feb 02

Nov 02

Aug 03

May 04

Feb 05

Nov 05

Aug 06

May 07

Feb 08

Nov 08

Aug 09

May 10

Feb 11

Nov 11

0

500

1000

1500

2000

2500

3000

3500

4000

triAngle FTSE350

Three months ending at date show n

CFROC Spread

-30%

-20%

-10%

0%

10%

20%

30%

Feb 99

Nov 99

Aug 00

May 01

Feb 02

Nov 02

Aug 03

May 04

Feb 05

Nov 05

Aug 06

May 07

Feb 08

Nov 08

Aug 09

May 10

Feb 11

Nov 11

0

500

1000

1500

2000

2500

3000

3500

4000

CFROC Spread* FTSE350

Three months ending at date show n*Pre Feb 04 Avg over 5 historic yrs. Post Feb 04 Avg over 4 Historic, 1 Forecast yr.

triAngle H2 2011 in historic context: Highlights

Best for 3 yrs

3rd Best in a decade

9 neg quarters in a row

In Europe: May-Aug 2011: Value, 2nd worst everFixed charge cover, best since 2003

Quality 2nd best everEarnings Momentum: best for 3 yrs

9 out of 10positive

quarters

2nd best in a decade

10

The troughV,Q neutral,Mmtm -ve

Crisis developingValue –ve, Qual +ve,

Mmtm +ve

History rhymes – where are we now?UK Large

Now(2010-2012)

to 13 Jan 2012

Then(2007-2009)

Market rallyingValue +ve, Qual neutral,

Mmtm -ve

Top quintile minus bottom quintile on each factor on an equally weighted basis. Non-financials.

60

70

80

90

100

110

120

130

140

150

160

170

180

J an-07

Mar-07

May-07

J ul-07

Aug-07

Oct-07

Dec-07

Feb-08

Apr-08

J un-08

Aug-08

Oct-08

Dec-08

Feb-09

Apr-09

J un-09

Aug-09

Oct-09

Value

Quality

Momentum

Value made an absolute low in

Nov 2008

60

70

80

90

100

110

120

130

140

Jan-10

Mar-10

May-10

Jun-10

Aug-10

Oct-10

Dec-10

Feb-11

Apr-11

Jun-11

Aug-11

Oct-11

Dec-11

Feb-12

Apr-12

Jun-12

Aug-12

Oct-12

Value

Quality

Momentum

11

-40% -30% -20% -10% 0% 10% 20% 30%

triAngle

Value

Quality

Momentum

Quest™ Valn

Quest™ Mkt to Book

EV/Sales rel LRA

Div Yield rel LRA

PE Rel LRA

CFROC Spread*

Capital Growth

Equilibrium growth

Fixed charge Cover

CFROC change

9m relative trend

100/200 day switch

12m relative range

ST Indicator

EPS momentum 3m

UK end Nov 08-end Feb 09: Value rallied before the market

More stable value measures leading the way

Fixed charge cover: Feb-May 2009 -13%, May-Aug 2009 -7%

A sign of rotation

Quality held up

12

Style matrix

Data to 13th January 2012Source: Top quintile minus bottom quintile on each factor on an equally weighted basis. Non-financials.

13

But how much is now priced in?….. market valuation charts ■ Markets as cheap as Oct 2008-May 2009

■ Corporate action, policy response less likely to be as helpful this time, but less solvency risk.

Prices as at 5 Jan 2012

Quest Mkt-to-book (ex goodwill)

0.0

0.5

1.0

1.5

2.0

2.5

3.0

May

-01

Nov

-01

May

-02

Nov

-02

May

-03

Nov

-03

May

-04

Nov

-04

May

-05

Nov

-05

May

-06

Nov

-06

May

-07

Nov

-07

May

-08

Nov

-08

May

-09

Nov

-09

May

-10

Nov

-10

May

-11

Nov

-11

Upper qtlMedianLower qtl

Equities Expensive

Equities Cheap

EV/Sales rel. to trailing 10yr avg

0.00

0.50

1.00

1.50

2.00

May-

01

Nov-

01

May-

02

Nov-

02

May-

03

Nov-

03

May-

04

Nov-

04

May-

05

Nov-

05

May-

06

Nov-

06

May-

07

Nov-

07

May-

08

Nov-

08

May-

09

Nov-

09

May-

10

Nov-

10

May-

11

Nov-

11

Upper qtlMedianLower qtl

Equities Expensive

Equities Cheap

Quest default valuation

-75%

-50%

-25%

0%

25%

50%

75%

Mar-

09

May-

09

Jul-09

Sep-0

9

Nov-

09

Jan-1

0

Mar-

10

May-

10

Jul-10

Sep-1

0

Nov-

10

Jan-1

1

Mar-

11

May-

11

Jul-11

Sep-1

1

Nov-

11

Upper qtlMedianLower qtl

Equities Expensive

Equities Cheap

Earnings yield rel. to trailing 10 yr avg

0.0

1.0

2.0

3.0

4.0

May

-01

Nov

-01

May

-02

Nov

-02

May

-03

Nov

-03

May

-04

Nov

-04

May

-05

Nov

-05

May

-06

Nov

-06

May

-07

Nov

-07

May

-08

Nov

-08

May

-09

Nov

-09

May

-10

Nov

-10

May

-11

Nov

-11

Upper qtlMedianLower qtl

Equities Cheap

Equities Expensive

14

Finding value I: Cheap on Quest for the first time in a long time

Rank by market

cap (>$250m)

Criteria >4>0>3

16 Jan 2012

Warning signals

15

Finding Value II: Time to rejoin the Q

Quest™ market-to-book

A variation on Tobin’s Q which compares market value of a company to the replacement cost of assets

Profits, sales, cash flows and dividends are all unpredictable at present.

Valuation relative to the asset base is more stable.

Excellent track record at market turning points.(Time to get into the Q note – November 2008)

Total market capitalisation (equity + debt + quasi debt)

Quest™ mkt-to-book = --------------------------------------------------------------------------------

Estimated replacement cost of assets

16

80

100

120

140

160

Mar

09

Apr

09

May

09

Jun

09Ju

l 09

Aug

09

Sep

09

Oct

09

Nov

09

Dec

09

Jan

10F

eb 1

0M

ar 1

0A

pr 1

0M

ay 1

0Ju

n 10

Jul 1

0A

ug 1

0S

ep 1

0O

ct 1

0N

ov 1

0D

ec 1

0Ja

n 11

Feb

11

Mar

11

Apr

11

May

11

Jun

11Ju

l 11

Aug

11

Sep

11

Quest valuation Quest market-to-book Revenue multipleDividend yield P/E ratio

UK Value

60

80

100

120

140

160

180

200

Jan 9

0

Apr

90

Jul 9

0

Oct 90

Jan 9

1

Apr

91

Jul 9

1

Oct 91

Jan 9

2

Apr

92

Jul 92

Oc

t 92

Jan 9

3

Apr

93

Jul 9

3

Oct 93

Jan 9

4

Apr

94

Jul 9

4

Oc

t 9

4 60

70

80

90

100

110

120

130

140

150

160Value (Composite)

P/E

Price/Book

DY

DJSTOXX (RH)

Kept outperforming after the other value measures waned.M&A, just –in-time capexsupport a sustained rally

Quest™ market-to-book: the market recovery and beyond

2003-6

1992-4Price to book worked well (Pan Euro)

2009-11Market to book headed the Value charge

and sustained performance

Mkt troughMarch ‘09

Mkt peakFeb ‘11

80

100

120

140

160

180

Mar

03

Apr

03

May

03

Jun

03Ju

l 03

Aug

03

Sep

03

Oct

03

Nov

03

Dec

03

Jan

04F

eb 0

4M

ar 0

4A

pr 0

4M

ay 0

4Ju

n 04

Jul 0

4A

ug 0

4S

ep 0

4O

ct 0

4N

ov 0

4D

ec 0

4Ja

n 05

Feb

05

Mar

05

Apr

05

May

05

Jun

05Ju

l 05

Aug

05

Sep

05

Oct

05

Nov

05

Dec

05

Jan

06F

eb 0

6M

ar 0

6

Quest valuation Quest market-to-book Revenue multipleDividend yield P/E ratio

UK Value

17

Quest™ market-to-book: What is the opportunity? level + dispersion

“Time to rejoin the Q”

“Who is still left in the Q?”

Market level

Dispersion

Europe ex UK smallUses avg mkt cap for yrUK Large cap

“Slowly moving up the Q”

As at Jan 16

Quest market to book (yr avg)

0.4

0.5

0.6

0.7

0.8

0.9

1.0

1.1

1.2

1.3

1987

1988

1989

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

+12

Current 0.83LRA 0.90

Quest market to book (yr avg)

0.4

0.5

0.6

0.7

0.8

0.9

1.0

1.1

1.2

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

+12

m

Current 0.69LRA 0.80

CITN/ Newsletter articles“Time to get into the Q”

18

UK companies within 10% of 5-year trough Quest™ market-to-book – by size

Rank by market

cap

9 January

19

Pan-Euro market to book performance

Quality filters don’t help when the market takes

off

To 5 Dec 2011

Trough?

20

Quest™ market-to-book strategies

■ Cheapest companies on market to book

■ Current pricing relative to a long-term view of asset’s productive capacity over their lifetime (Nov 08 note)

Quest™ mkt-to-book

Q-discount (10yr) = ------------------------------------------------------

Cyclical average CFROC / WACC

■ Avoid value traps: Solvency, historic average may overestimate future potential, asset write downs/ badwill

■ What if no mean reversion? – need to consider valuation relative to the ‘new normal’

Quest™ mkt-to-book

Q-discount (+12m) = ------------------------------------------------------ +12m CFROC / WACC

21

Finding Value II: UK Quest market-to-book: Time to rejoin the Q?

22

Value Superscreen – using Quest screening - Criteria

Cheap on Quest for 1st time in a long time

Mkt to book below LRA

Quality filters (optional)

23

Value Superscreen – using Quest screening – Stocks

Ranked by mkt cap

<0.8>5>1>3

Quality filters.1) Lots of debt/quasi

debt .2) Negative EPS

momentum. Signal of risk of

a profit warning?

Criteria

16 Jan 2012

Companies which meet the ‘quality filters’

?

24

Overextended valuations – the other side of the value trade

Outperformed

Mkt to book above LRA

Mkt to book/returns analysis

Lacks value support

Other value metrics

Other risks

25

Overextended valuations – the other side of the value trade<5>15 >1

Rank by market

cap

16 Jan 2012

26

Margins bite, leverage hurts – Reporting season poses risks

23 June CITN

■ Designed to explore the risks associated with over-optimism in analysts forecasts

■ March/June articles: GDP slowing, commodity prices rising. Peak margins screen combined full valuation.

■ Forecasts and valuations have fallen but consensus forecasts show forecasts remain high. Consensus forecasts down c3% for 2011, 3% for 2012 (3m, median), but…33% of companies still forecast to be at peak margin.

■ Output: Q-File. Excel spreadsheet (searchable + Filters) + CITN articles

■ Original articles March/June: 79 names. CITN article highlighted Siemens , Volvo, Aker, Daimler, WH Smith, Philips, PPR, Fiat, Ferrovial, Clariant, Cookson, Lanxess, Sandvik, Pernod Ricard, ABB.

■ Margin stability definition: average historical EBITDA margin (10 years) divided by standard deviation of EBITDA margin over the same period (minimum 5 years required for calculation).

27

Margins plus other risk factors

UK Screen as at 9th Jan

28

Performance of the Q-discount screen from Nov 08-

Pan-euro

Source:Datastream

Rel to WIEROP$

29

Appendices

30

What is Cash Flow Return On Capital?

■ Cash Flow Return On Capital (CFROC)

■ Real

■ Post-tax

■ Return On Gross Invested Capital

■ Shifts from accrual accounting towards cash

■ Better insight into corporate performance and valuation(takes into account all the capital used, asset life, asset mix)

31

CFROC: Step 1 – Accounting to cash

EBIT + Investment & non-operating income + Interest income – Current tax ≈ NOPAT + Dep’n & Amort’n + Rental expense – Tax shield on interest & rent + Monetary working capital adjustment

Non-depreciating assets Land & investment property Fixed asset investments Stock Monetary working capital

+ Depreciating assets Fixed assets at gross cost Fixed assets current cost (adjusted) Capitalised operating leases Intangible assets Cumulative goodwill w/off

€ Gross cash flow

€ Gross investment

Cash in

Cash out

=€ Operating income

€ Operating assets

32

Quest™ valuation

Cash Flow Return On Capital in a DCF model

■ Use Consensus forecasts — 2-years forward

■ Forecast Cash Flow Return On Capital — existing assets

■ Forecast growth rate — reversion to mean

■ Forecast Cash Flow Return On Assets — future investment returns (reversion to mean)

■ Forecast net cash flows — implicit

■ Discount back using WACC for Enterprise Value

33

-2.0%

-1.0%

0.0%

1.0%

2.0%

3.0%

4.0%

Decile10

Decile9

Decile8

Decile7

Decile6

Decile5

Decile4

Decile3

Decile2

Decile1

UK large capSummary - avg Q rel perf by decile

0

25

50

75

100

Decile10

Decile 9 Decile 8 Decile 7 Decile 6 Decile 5 Decile 4 Decile 3 Decile 2 Decile 1

UK large capPositive quarters (%) by decile

Quarterly relative performance % of positive quarters by decile

UK Large cap non financials.Quarterly rebalancing.

Performance relative to FT All share

Performance summary by decile (Nov 2001-Aug 2011)