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18ºEncontro nacional de Relações com Investidores e Mercado de Capitais

São Paulo, June 28, 2016

Perspectives on Best Practices in Investor Relations

18º Encontro nacional de Relações com Investidores e Mercado de CapitaisPerspectives on Best Practices in Investor Relations

São Paulo, June 28, 2016

McKinsey & Company 3|

Objectives of investor relations more than increasing share price

Investor relations objectives Why is this important?

▪ If market value above intrinsic value: high risk of future decline, management loses credibility, and employees lose motivation

Align market value and intrinsic value in light of overall industry valuation

▪ During challenging periods, critical to have strong shareholder support that enables decision making for long-term health of company

Develop a core group of supportive investors

▪ You will hear conflicting demands from investors, focus on those who matter

Gather feedback from investors who matter

▪ Too much time takes away from running the business

Use management time effectively

Prepare for potential activist activities

▪ Awareness of issues can ward off events or help you respond effectively


Four issues for investor relations

What should the company be worth?

Who to talk to?

What to talk about?

What channels?


Two companies can create same value with different combinations of growth and ROIC

ROIC

Value creationValue of $1 invested in 1985

$14

$14 16%

29%3xGeneralMills

22xWalgreens

GrowthRevenues, 2012/Revenues, 1985

GROWTH AND ROIC DRIVE VALUE1


Growth and return on invested capital drive value

7 9 13

8 11 143

6 11 166 21

4 11 199 27

25

ROIC Percent

GrowthPercent

S&P 500

Fix ROIC

Unlevered price-earnings ratioCost of capital = 9%

16

SOURCE: McKinsey’ Strategy & Corporate Finance practice

WHAT SHOULD THE COMPANY BE WORTH?1

Apresentador

Notas de apresentação

Se here we have it. There is a lot going on here, so we take it one by one.


Growth creates more value for high return on capital companies

High Return on Capital Moderate Return on Capital

5%

15%1% higher returnon capital

1% highergrowth 10%

6%

SOURCE: McKinsey analysis

Percent change in value



Different types of growth create different amounts of value

-0.1-0.20

Competing for share in a stable market -.25-0.40

Growing share in a growing market

Acquisition

0.1-0.5

Expanding an existing market 0.3-0.8

New-product 2.0

Shareholder value created for incremental $1 of revenue

Consumer products example



The IR group needs to clearly understand the value gap between the market and the Company’s internal view

SOURCE: Company reports; analyst reports; McKinsey analysis

1 Differing views on growth, market potential, achievable margins, risk, and other

Example: Disaggregating equity value for a leading resources Company

Market valuation

Capital invest

MarginLongterm

Shortterm

Internal valuation

Drivers of the value gap

Growth expectations ROIC expectations Unknown

Equity valueCdn $ Billions

WHAT SHOULD THE COMPANY BE WORTH?1

Identifying significant unknown figure will necessitate further investigation into the value gap




Who to talk to?

What to talk about?

What channels?


A practical approach

Mechanical Or

▪ Uses pre-determined criteria that neither consider nor require ongoingcommunications from company

▪ Is a de facto mimic of index fund portfolio with minor deviations (“closet indexer”)

Trading

▪ Tries to anticipate major events or sentiment changes that result in short-term share price movements

▪ Has a deep understanding of potential economic performance based upon intensive reviewIntrinsic

WHO TO TALK TO?2


Typical investor characteristics

Closet indexers 20-80

Quants 100-300

Indexers <20

Traders 200+

Intrinsic 20-50

150-200

1,000+

500+

400+

40-60

50-300

50-100

200-500

20-100+

5-10

SOURCE: McKinsey Corporate Performance Center estimates

TurnoverPercent

Number of positions

Positions perprofessional

WHO TO TALK TO?2


Start at $30 – All intrinsic investors buy

25

30

35

40

45

50

55

60

65

70

0 2 4 6 8 10 12 14 16 18 20 22 24 26 28 30 32 34

Upper level value for intrinsic investors

Lower level value for intrinsic investors

Share price model$ per share

Time

Share price goes up

WHO TO TALK TO?2


Step 2 – in intrinsic range

25

30

35

40

45

50

55

60

65

70

0 2 4 6 8 10 12 14 16 18 20 22 24 26 28 30 32 34

Some intrinsic investors buy, some sell Momentum investors buy


Time

WHO TO TALK TO?2


Step 3 – Momentum drives overvaluation

25

30

35

40

45

50

55

60

65

70

0 2 4 6 8 10 12 14 16 18 20 22 24 26 28 30 32 34


Time

All intrinsic investors start to sell Momentum investors still buy but will slow down

WHO TO TALK TO?2


In the end, share price fluctuates around an average expected value even if no new information is available

25

30

35

40

45

50

55

60

65

70

0 2 4 6 8 10 12 14 16 18 20 22 24 26 28 30 32 34


Time

WHO TO TALK TO?2


New information changes Share price band

25303540455055606570758085

0 2 4 6 8 10 12 14 16 18 20 22 24 26 28 30 32 34


Time

WHO TO TALK TO?2


U.S. equity assets under management

100% = $19,500 billion

Proportion of intrinsic investors is similar in Brazil and U.S.

1 Volumes calculated as AuM * Turnover (based on quarterly 13F). Since this methodology significantly understates the most frequent traders (ST, News, Quants), we adjust the trading volumes based on estimated average holding period for each segment. The results are supported by another approach (adjusting Thomson turnover data for frequent traders) and also by academic research

SOURCE: Thomson; McKinsey

Institutional investorsIntrinsic

42%

Closet Index

27%

Index

31%

Top 150 investors

100

Leading Brazilian top 150 institutional investors

100% = shares held by the top 150 institutional ivnestors

Intrinsic investors hold ~40% of shares held by top 150 investors in leading Brazilian company

0.35% ST Intrinsic,Event

9% LT Intrinsic

8%

Retail

41%

Corporations

18%

Quantitative6%

News

2%

Activists

2%Insiders6%

Index Funds 8%

Closet Index Funds

WHO TO TALK TO?2


Intrinsic investors can be systematically identifiedChemicals example

SOURCE: Thomson One; Mckinsey Investor database; McKinsey analysis

▪ Excluded investors that already invest in the company (103)

▪ Of these excluded– Index investors (23)– Closet index (46)– Traders (21)– Other (1)

Top investors in Chemicals

(300)

Investors that do not invest in

client(197)

Investors overweight

on chemicals(148)

Select intrinsic investors (57)

1 Less than ~2.6% of equity assets invested in chemicals

▪ Excluded sovereign wealth funds/ government related (2)

▪ Excluded investors underweight on chemicals1 (47)

HIGHLY PRELIMINARYWHO TO TALK TO?2


Example: Initial view on top intrinsic investors

Sector overweight

Chemicals as % of World ~2.6%

Client as % of Chemicals ~1.2%

Company overweight in Sector

Funds overweight in both Chemicals industry and client

Client investment as a % of AUM

SOURCE: Thomson One; McKinsey investor database; Team analysis

Investment in client as a % of investment in Chemicals

Investment in Chemicals as a % of AUM

TOP 10

02468

10121416182022242628303234363840424446

0 5 10 15 20 25 30 35 40

RS Global Natural Resources Fund

DWS Invest Global Agribusiness (USD)

American Funds American Balanced Fund

Shapiro Capital Management LLC

American Funds Washington Mutual Investors Fund

American Funds American Mutual Fund

American Funds Fundamental Investors Fund, Inc.

American Funds Growth Fund of America

Franklin Income Fund - US

HIGHLY PRELIMINARYWHO TO TALK TO?2




Who to talk to?

What to talk about?

What channels?


How to talk to intrinsic investors3 WHAT TO TALK ABOUT?

▪ Demonstrate that your strategy and aspirations are grounded in a deep understanding of your competitive strengths and your market dynamics

▪ Be open about both successes and failures, they don’t expect perfection and are suspicious of companies where everything goes right

▪ Use concrete examples to demonstrate value added as a corporate owner

▪ Assure them that you won’t invest in low payoff capital projects or M&A transactions

▪ Don’t try to convince them to that they aren’t looking at your company the right way

▪ Treat them like sophisticated thought partners


How important are the following factors when assessing a company as a potential investment?

For intrinsic investors willingness to take risks and management credibility are the most important factors

SOURCE: Long Term Voices Survey 2015

100 96

2513 13

42 6350

3325

38

4

Willingness to take LT risks (+3Y)

Low Earnings Volatility

Neutral

Not Important1

00

Consistently beat consensus for revenues

0

Management Credibility

Important2

Consistently beat consensus for EPS

Percent

1 Includes categories not important and not important at all 2 Includes categories very important and important


Meeting short term estimates is not a cause of concern for long term investors


25 63

42

33

13

54

634

4

Neutral Negative1Positive

Situation

▪ Company A, a US-based branded consumer goods company, earns 70% of its revenues and profits from outside the US. The US dollar unexpectedly strengthens by 10% in the middle of 2014, which will reduce consolidated US dollar revenues and profits in 2014 below investment analyst expectations for net income (though margins will remain roughly the same). Company A is deciding among the following actions. Taking each separately, how might you interpret the Company's possible reactions to this scenario?

Actions and investor views

▪ Action 1: Makes no changes and reports lower than expected profits at the end of 2014.

▪ Action 2: Finds pockets of cost reduction opportunities that are easiest to implement in the short time available

▪ Action 3: Issues an order for all its non-US businesses to find cost reductions to offset the currency effect.

Percent

1 Includes categories “Red Flag” and “Yellow Flag” combined


What would be the importance of the company pre-announcing it will stop providing quarterly EPS guidance a year from now?

Percent

EPS guidance is not important for long term investors


1 Not Important: Not concerned, Important: This news makes you much less likely to continue to hold your current investment in this company, Neutral: news has been noted, you will watch the situation and ask in-depth questions next time you are engaged with the company

Neutral 0

79

21

Not Important

Important ▪ “EPS is not important, as it is not a metric even to be used when you think of building value over time, though 95% of Wall Street would disagree in general”

▪ “Companies should consistently give you the metrics that they believe matter for their business”


Whether a company meets consensus EPS estimates is not important to LT investors


1 Includes categories not important and not important at all 2 Includes categories very important and important

How important is it to meet/beat consensus EPS estimates?

13

38

50Neutral

Important Not Important

Percent

▪ “In general, we think that running a business with a goal of meeting consensus expectations for revenue or EPS creates temptations for sub-optimal choices. We prefer to invest in businesses with fewer, simpler long term goals and no near-term guidance”


Get comfortable with more transparency

SOURCE: McKinsey

Financial transparency

Operational transparency

Performance Assessment

Short term operational guidance

Long term strategy

1

2

34

5

▪ Does the company lay out key performance metrics by BU?

▪ Is this consistent over time?

▪ Does management address how they will make key strategic choices?

▪ Do they follow up?

▪ Does management give useful financial and operational guidance (i.e., not only EPS)?

▪ Does management give guidance on operating parameters that are independent of financials (e.g., # of subscribers for a telecom operator)?

▪ Does management assess success and failures honestly?

▪ Is there transparency about success of announced initiatives?

▪ Can intrinsic investors asses the performance by key business units?

▪ Are the schedules clearly presented, including reconciliations and intra-company items?

Performance and assessment

Guidance

3 WHAT TO TALK ABOUT?


Investors want to be educated by companies


▪ “Help me understand your business and strategy. If I disagree, I don’t have to invest. But I don’t necessarily think I know better than management”

▪ “Don’t pander to what Wall Street wants: educate as to what’s important for management and consistently give you the metrics that they believe matter for their business and explain why you should care about those metrics if you care about maximizing LT”

▪ “I want companies to help me understand their business, I want them to teach me”

▪ “We want to understand: how does a business makes money? Why do people pay for our product or service?. Based on this we can form an opinion about what level of profitability is sustainable.”


In general, separate the issues

What you cannot influence

What you can influence

Historical Future

▪ Underlying performance

▪ Volume growth

▪ M&A value creation

▪ Strategy

▪ Segment-level (or below) clarity on performance vs. target

▪ Segment-level long term targets based on constant currency, Fx, etc

▪ Exchange rates

▪ Commodity prices

▪ Mechanics of M&A

▪ Tax regimes

▪ Segment-level (or below) clarity on Influence of these factors

▪ If material, sensitivity vs. driver


Many large companies are starting to report return on capital

SOURCE: McKinsey, Company Reports

Depth

Segmentlevel

Corporate



ROIC: Maersk gives great detail on Business unit performance

SOURCE: Source


McKinsey & Company 32|SOURCE: Company annual reports; quarterly reports, and investor presentations

1 Applicable to gold production only

Gold company disclosure examples

Consumables/other

Free cash flow

All-In Sustaining Costs/oz1

Labor

Costs applicable to sales

Regional onlyRevenue

Regional onlyTotal assets

GoldcorpBarrickPer mine reportingYamana Gold

Ore grade

Recovery rate

Capex

Reserves

Depreciation

Production

Regional onlyExploration

Regional onlyPre-tax income

Average mill head grade

Total cash costs per ounce

In some businesses, even more granularity expected3 WHAT TO TALK ABOUT?


What you cannot influence: Alcoa bridges for each BU

SOURCE: Alcoa investor relations



What you cannot influence: Example currency exposure (Alcoa)

SOURCE: Alcoa





Who to talk to?

What to talk about?

What channels?


One on one meetings and investor day conferences are the preferred method of communication for investors


86 79

26 18

1413

43

23

8

30

59

Quarterly CallsOne on One/ Small group meetings with investors

Industry Conference / Corporate Days

organized by banks

0

Neutral

Important2

Not Important 1

Investor Day/ Strategy Conference

Percent

Please rank the importance of how CEOs and CFOs should spend their time with investors

1 Categories not important and not very important combined2 Categories very important and important were combined

WHAT CHANNELS?4


Investors prefer less scripted and more Q&A based calls(1/2)


Yes5347No

Publish results and management write-up in advance of quarterly call so investors can absorb the information beforehand

Eliminate scripted reading of results; go right to Q&A (assuming management write-up made available beforehand)

68

32

Yes

No

Ask investors to submit questions in advance, so management can focus on questions most broadly relevant to all investors

17

83Yes

No

Of the following, which experiments would you like to see more of from companies?1

1 Sample of 25 responses for each question, no opinion answers were 6,6 and 7 respectively

Percent


Some thoughts on the current context

Do investors understand, in detail, your exposure to the future growth outlook of the country?

Is your strategy and operations aligned to weather the storm?

Do you talk about liquidity, cash position, debt refinancing, cash flow etc. in a way that investors can assess risk?

Is there a way to create investor confidence by more transparency on planned actions?


Call to action

Lead the change in your company towards developing, communicating, and measuring a compelling strategy

Educate management about the importance of focusing on long-term intrinsic investors and what they are looking for

Change the paradigm – not EPS and short term guidance, but long term return on capital and growth

Ensure that CEO/CFO spend most of their time with intrinsic investors (so that they hear their questions)




Who to talk to?

What to talk about?

What channels?

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