Top Honours for AB InBev & Novo Nordisk

Morningstar's new stewardship rating singles out companies where management is acting in the best interests of shareholders

Elizabeth Collins, CFA 22 November, 2012 | 11:25AM
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In May 2012, Morningstar's equity research department launched a revised stewardship rating methodology, which identifies companies that make capital allocation decisions in the best interests of shareholders. To date, analysts have assigned ratings to nearly 1,000 companies.

The new methodology is globally applicable, allowing for apples-to-apples comparisons among companies even if corporate governance standards vary by location. Our methodology places a heavy emphasis on management's stewardship of capital and only incorporates corporate governance practices to the extent that they have a demonstrated impact on shareholder value creation or destruction.

In Europe, government ownership or employee representation on the board are familiar or even common. Morningstar's stewardship rating methodology doesn't automatically penalise companies where minority shareholders' interests are subordinate to the government or employees. However, when these corporate governance structures have led to behaviours that result in the significant creation or destruction of shareholder value, then our ratings reflect such stewardship.

New Methodology

A history of value-accretive acquisitions, optimal financial leverage, ideal dividend and share-buyback policies, and investments that enhance competitive advantages--these are the marks of exemplary stewards of shareholder capital.

In practice, Morningstar analysts assign companies one of three stewardship ratings: exemplary, standard, or poor. Analysts judge stewardship from an equity holder's perspective, not a debt holder's. Ratings are determined on an absolute basis, as companies are judged not against peers within their industry, but against ideal stewardship of shareholder capital. Most companies receive a standard rating, and this should be considered the default rating in the absence of evidence that a management team has been exceptionally strong or weak in its capital allocation decisions.

Morningstar analysts evaluate management teams based on the following factors:

1. Investment Strategy and Valuation. Do investments and acquisitions support the company's competitive advantages and core businesses? What is the cost of acquisitions and major investments?

2. Financial Leverage. Is the company's debt load appropriate given its cyclicality, capital intensity, and growth trajectory?

3. Dividend and Share-Buyback Policies. Has the company struck the right balance between internal investment opportunities and returning cash to shareholders?

4. Execution. Does the company avoid accidents and problems? Does the company manage its operations well?

5. Compensation. Is a material amount of value being directed to managers at the expense of owners?

6. Related-Party Transactions. Do related party transactions indicate a material redirection of value to managers and their friends and family at the expense of a company's owners?

7. Accounting Practices. Does the company engage in deceitful accounting practices?

8. Management Backgrounds. Do the company's managers have the right backgrounds for their positions?

9. Health, Safety, and the Environment; and Stakeholder Focus. Has a company's health, safety, and environment (HSE) track record had a demonstrated impact on operational performance or shareholder value? Has a stakeholder focus led to actions for or against the interest of shareholders?  (For example, BP's (BP.) bad track record on safety contributes to our poor stewardship rating for the company.)

10. Ownership Structure. Has the ownership structure impacted capital allocation decisions?  Morningstar analysts take note of a company's ownership structure: Is it family owned and controlled? Does the government have a controlling stake or a golden share? Is it majority owned by another company? When the ownership structure has led to value-destructive capital allocation decisions, we certainly take this into consideration when assigning stewardship ratings. (For example, although Novo Nordisk's (NOVO B) minority shareholders have little control given the board and voting structures, we give the company an exemplary stewardship rating given stellar execution.)

Exemplary Standout: Anheuser-Busch InBev (ABI) 
We believe that AB InBev's management team has been exemplary stewards of shareholders' capital. Through a series of acquisitions and a focus on cost control, the global brewer has built a wide economic moat (aka a large competitive advantage). The firm's culture instills the responsibility for the company's performance and the creation of shareholder value into each of its managers. Compensation is determined on the basis of a "stretched but achievable target," which requires detailed, quantitative performance goals throughout the organisation.

A significant portion of AB InBev's senior management consists of the Brazilian team that bought Brazil-based Brahma in 1989, merged the company with Antarctica in 1999 to form AmBev, and then merged with Interbrew in 2004 to create InBev. The team has significant experience dealing with the nuances of integrating acquired firms with differing corporate cultures. CEO Carlos Brtio joined AB InBev's predecessor AmBev in 1989 holding various roles in finance, operations, and sales before becoming AmBev CEO in 2004 and AB InBev CEO in 2006.

Exemplary Standout: Novo Nordisk (NOVO B)
We believe Novo has been an exemplary steward of shareholder capital. Stellar execution by Novo's management has helped the company's stock outperform its peer group by a huge margin during the last decade. CEO Lars Rebien Sorensen has led the firm since 2000 and boasts nearly 30 years of experience at the company. We believe executive compensation to be very reasonable, especially when compared to the often excessive compensation packages at competing firms such as Eli Lilly (LLY).

We are wary, however, of the firm's board independence--or relative lack thereof. Only five of the firm's 12 board members are considered independent: Three members are elected by the Novo Nordisk Foundation, and four are chosen by the company's employees, in accordance with Danish law. Furthermore, the company's A shares, which are controlled exclusively by the foundation, carry 10 times the voting power of the publicly traded B shares. Although this control structure could conceivably compromise the interests of minority shareholders, we are reassured by Novo's impressive record of protecting shareholder value.

Poor Standout: BP (BP.)
In the wake of the Macondo oil spill, Robert Dudley took over BP with the job of stabilising the firm and rebuilding its very tarnished reputation. To date, Dudley has run BP well enough, although his hardest tests lie ahead when he has to determine how to shape the company after Macondo and TNK-BP. Macondo is the second time BP has had to shore up its safety record in recent years, the first being the Texas City refinery explosion of 2005. Other notable incidents of the past decade include 6,500 barrels of oil leaking from the Trans-Alaska pipeline in 2007 and a record $303 million fine levied by the US Commodities Futures Trading Commission for BP traders trying to corner the propane market in 2003-04. Even after Texas City, BP continued to notch up a great deal more safety violations than its peers in its US refining operations, which along with Macondo, makes us believe that BP was fundamentally flawed in how it was running its operations.

It's impossible to say if BP is finally going to change its ways in terms of safety performance; after all, Texas City clearly did not usher in a safety-first culture in the way the Valdez oil spill did for ExxonMobil (XOM). But Macondo is an event of such monumental value destruction that if it can't shake BP to the core and instill change, nothing can. Putting together its poor safety record and execution issues, we consider BP management to be a poor steward of shareholder capital.

Poor Standout: Credit Agricole (ACA)
We think Credit Agricole's stewardship of shareholder value has been poor. We were glad to see the last of empire-building CEO Georges Pauget in March 2010 when he retired. Since his appointment in 2005, he oversaw the bulking up, and later the scaling back, of Credit Agricole's investment bank, as well as a spate of international acquisitions, including the overpriced purchase of Emporiki in Greece. Pauget was replaced by Jean-Paul Chifflet, formerly head of one of the group's most important regional banks, and he seems to be steering the bank well so far.

This change will not resolve our biggest complaint about Credit Agricole's management: its corporate structure. Credit Agricole is controlled by its regional bank subsidiaries, which together own 55% of outstanding shares. This means that when outside shareholders' interests conflict with those of regional managers--as they may over matters such as compensation and strategy--outside shareholders may be given short shrift. We note, however, that the regional banks also help to keep group managers in check. Regional heads were vehemently opposed to increasing investment banking risk, for example, and their fears were realised in 2008 when losses forced a rights issue. Under the new management, we expect Credit Agricole to continue its quest for growth but to be more focused on traditional banking.

The information contained within is for educational and informational purposes ONLY. It is not intended nor should it be considered an invitation or inducement to buy or sell a security or securities noted within nor should it be viewed as a communication intended to persuade or incite you to buy or sell security or securities noted within. Any commentary provided is the opinion of the author and should not be considered a personalised recommendation. The information contained within should not be a person's sole basis for making an investment decision. Please contact your financial professional before making an investment decision.

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Securities Mentioned in Article

Security NamePriceChange (%)Morningstar
Anheuser-Busch InBev SA/NV55.68 EUR0.04Rating
BP PLC455.35 GBX1.04Rating
Credit Agricole SA13.96 EUR-0.29Rating
Eli Lilly and Co878.29 USD1.42Rating
Exxon Mobil Corp113.41 USD-1.61Rating
Novo Nordisk A/S Class B911.30 DKK-1.19Rating

About Author

Elizabeth Collins, CFA  is an associate director of equity research with Morningstar.

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