In the wake of the economic crisis, companies should review the targets they share with financial markets in the future.
Written by: Rebecca Shelley, Brunswick, London Susan Stillings, Brunswick, New York
If recent trends continue, fewer than half of the publicly traded companies in the United States will be offering their investors earnings guidance on a regular basis by 2012. In 2009 another dozen or so stepped back from this practice, a retreat reflected in many other parts of the world. In many cases what was happening was not so much that companies provided less information but that they changed the mix, allowing investors a line of sight of their prospects where the guidance was less specific. Doing this creates an interesting new challenge for companies.
In large part the turbulent economic climate of the last 18 months – highlighting in particular the perils of publishing short-term earnings targets – precipitated the recent debate. But with the year coming to a close and hopes for economic recovery in the air, opinions on guidance around the world remain divided. While some business leaders insist that they have kicked the habit for good – and are glad that they have done so – the vast majority of companies continue to offer some insight into future performance at least qualitatively and, where possible, with hard numbers.
Among British-based companies Unilever’s CEO Paul Polman and Chief Financial Officer Jim Lawrence made the first move in February, quickly followed by GlaxoSmithKline (GSK) and Vodafone (which specifically dropped revenue guidance). Significantly, all three had new chief executives who determined that their management teams would be judged on delivering their strategy, not on how they deliver against headline targets over which they do not necessarily have control.
The share prices of Vodafone and Unilever fell 4 per cent and 8 per cent respectively on the days of their announcements, while GSK’s decision actually prompted a small rise (in all cases, it should be stressed, the actual results and overall market sentiment may have been responsible). The wider reaction of investors to Unilever’s move is probably more instructive. According to one leading investment bank, many (but by no means all) United Kingdom and continental European institutions were broadly supportive. Hedge funds, concerned by the removal of a potential trading catalyst, were predictably the most concerned. And in the United States, where companies have traditionally provided more detailed guidance than anywhere else in the world, views were mixed but less negative than one might have expected. In part this may have been because US-based mega-caps such as Gillette and Coca-Cola set a precedent as far back as 2001 and 2002, respectively, when they stopped giving quantitative guidance.
In the US in 2009, Microsoft attracted attention when it refrained from providing a quantitative outlook statement for the second and third fiscal quarters due to the uncertain economy and lack of insight into consumer spending.
Others, it seems, also bowed to the prevailing mood. The trend was illustrated by the National Investor Relations Institute’s (NIRI) May 2009 report aggregating the responses of more than 500 public companies. The survey revealed that only 60 per cent provided earnings guidance in 2009, compared with 64 per cent in 2008 and 77 per cent in 2007.
This said, several US-based bellwether companies in retail, technology and financial services continue to provide details of revenue percentage changes, forward looking EPS (quarterly and fiscal), and other financial line-items as well as more qualitative information.
German and French companies have also changed tack. In this year’s earnings season, with the exception of one company, none of the Dax 30 companies provided any financial guidance for the full year – a contrast to the former provision of guidance on a yearly basis, and even for two years in advance. Companies claimed that future earnings visibility had all but disappeared and avoided specific, quantitative guidance. Only issuers with business models independent of economic cycles or companies with highly predictable businesses such as utilities or telcos have continued along the established guidance paths.
In France, according to Brunswick analysis, the number of companies from the CAC 40 providing either specific forward looking guidance or more general quantitative statements for the full year 2009 dropped by nearly 20 per cent compared with 2008. Only 40 per cent gave specific quantitative guidance for revenues, margins or earnings (or all of these) for fiscal 2009, down from 70 per cent in 2008.
By contrast, Chinese companies traded on US markets have been adopting guidance practices that in some cases are actually more comprehensive than before the financial crisis, or at least as rigorous. Revenue target ranges tend to be wide, but the companies are providing more detail on the issues that will influence results. Chinese companies have spent the last ten years building the confidence of US investors and they are eager to maintain it. They nevertheless understand the perils of over-promising. Public companies in China, meanwhile, are increasingly a primary source of industry information, be it the timeline for widespread adoption of the 3G mobile platform, subsidies for mass migration to digital television, or amendments to the national college entrance exam. Leaders in these sectors are the first to know how business environments will be affected and recognize that sharing their insights can help reduce misunderstandings and boost investor confidence.
In other emerging markets where investor relations is still in its infancy, the picture is less uniform. Such markets are volatile, illiquid and immature and anything companies can do to instill investor confidence can potentially improve their rating, the quality of their shareholders and their reputation in international capital markets. In the Middle East, for instance, few of the larger-cap companies offered much in the way of guidance before the crisis, and further initiatives in this regard are likely to be postponed. But as economic confidence returns, the countries in this region will look to international capital markets for a lead on best practice.
WHAT WILL CHANGE IN 2010?
Brunswick has worked with many companies around the world on this vital communication issue. As the global economy recovers, we expect to see a majority continuing to provide qualitative guidance, though the level of detail and the metrics they choose will vary. Each geography and capital market presents its own set of challenges. But while market leaders and “bellwethers” can set their own pace, smaller and middle-market companies, and those not domiciled in the country where they are mainly traded, may need to consider providing more detail rather than less. The same goes for underperformers.
Specific targets can encourage both management and investors to be excessively short-termist. Detailed numbers please analysts at the time but the reputational cost of missing a target is out of proportion to its financial effect. Research by UBS in the UK shows no evidence that companies lacking published operational targets suffer lower valuations or that their share prices are more volatile.
The challenge is to strike a balance between establishing and maintaining management credibility by meeting targets without holding the company hostage to short-term targets. We would recommend that companies align their guidance practices, for example, with their three- to five-year strategy. Investors will judge managers on their ability to execute strategy, so guidance and targets need to be set to provide evidence of this.
Those contemplating a change of policy should make clear their intentions ahead of time and spell out the rationale for changing course, as well as the alternatives that will be provided in future. For example, when Coca-Cola withdrew guidance in 2002, it gave ample notice and to assuage concerns reaffirmed the then-current consensus expectations for 2003. It also clearly articulated both what it would no longer be providing and, most importantly, what it would be supplying to the marketplace in future (insights into the company’s value drivers, strategic initiatives and factors that influence the company’s business and operating environment).
The issue of whether to give guidance is likely to be debated in many boardrooms, audit committees and C-suites rather than accepted as a fait accompli. Companies are keener than ever to focus investors on the long-term value of the business, something that requires both increased transparency and more effective communication around what drives value. The decision to stop giving guidance will therefore be more acceptable and more effective if a company’s overall investor communications are of a high enough quality to provide the market with these insights.
What is Guidance?
The term “guidance” is generally taken to refer to those forward looking statements that accompany yearly, half-yearly and quarterly results announcements. Whether in the form of quantitative financial metrics or more qualitative background “color”, guidance is the lifeblood of equity analysis. Many analysts indeed lean heavily on the information they receive to build their models, calculate forecasts and decide on whether to recommend stocks to clients.
In an age of increased transparency – of the quality, quantity and frequency of reporting – analysts also expect companies continually to increase the amount of information they provide, including ever greater detail. But better guidance is not synonymous with increased disclosure.
From the company’s point of view the goal is to illuminate management thinking for shareholders and potential shareholders (as well as media and employees) rather than to make specific predictions about the future. Guidance metrics are determined on a case-by-case basis and will differ by company and industry. They may evolve over time, as the issues and industries change.
The challenge for companies wrestling with what to say is made worse by the lack of formal standards in many of the main financial markets. Regulators insist that companies disclose material events to all investors simultaneously but do not provide rules governing guidance.
Europe, Asia and the US all follow slightly different conventions, though international mega-cap companies set the tone and can generally provide as much or as little guidance as they like. Given their leadership positions, analysts will cover them by default and they are large enough that they have inherently more predictable revenue streams.
Views from the market
The hedge fund
“Removing guidance is annoying for hedge funds because it’s a good trading opportunity when companies miss their target. But there is no doubt that short-term guidance is not always conducive to building long-term value. Guidance is like a caffeine hit – it fulfills an immediate need but when the market has had a chance to digest the results later in the day and see how a company arrives at the number, the share price often falls.
Some of the best-understood companies are those that successfully talk about where they are trying to get to in the next three- to five-years. The problem is that this can be beyond the tenure of the existing management team – and a new team can come in and take the glory (or the rap!). What a company must not do is attempt through guidance to create a ‘floor’ for the share price: what happens on the day is often an amplification of how those shares have been trading in the market in the few weeks before the announcement – the market will tend to have factored in the various scenarios. It is not the removal of guidance which makes the share price fall, it is the surprise. Ironically, those companies which give guidance are generally the ones that don’t need to, and the ones that don’t are the ones that should.”
The (long only) fund manager
“Investors and analysts are inclined to like guidance – without it the market can get nervous and share prices unpredictable. The question is how companies can withdraw it least painfully. If they do so they should talk about the long-term characteristics of their industry, the drivers of it, and their place within that. The danger is that this disregards the short term – and however long-term an investor you are, the short term aggregates to become the long term. In a way, giving guidance is dangerous, and stopping giving it is dangerous, too.
Companies should at least acknowledge that the short term can affect the long term, and they should be clear about which metrics they believe can influence the short term. Increased financial disclosure can help achieve this, though this does start to encroach on ‘competitively sensitive’ information which companies are loath to give."
Rebecca Shelly is a Partner in Brunswick's London office. She was previously Group Communications Director at Prudential, the global life insurer.
Susan Stillings CFA is a Partner in Brunswick's New York office. She specializes in investor relations and transaction and crisis communications.
Brunswick's Jerome Biscay, Greg Faje, Jason Golz CFA, Philip Liso and Rupert Young contributed ideas to this article.
Guidance at Unilever
There were three reasons why Unilever decided to scrap guidance in early February 2009.
Written by: Jim Lawrence, Unilever
The first was that we genuinely did not know what was round the economic corner: it was the gloomiest and most uncertain of times. Second, our 15 per cent operating margin target for 2010 had been set five years previously, long before the unexpected rise in input costs in 2008 and the subsequent recession. Trying to hit this number might have required actions that were not in the long-term interest of the business. Finally, and perhaps most importantly, we believe that eschewing guidance is a good idea in principle (just as Coca-Cola and Berkshire Hathaway do). We should focus on communicating and executing our long-term strategy.
The most controversial aspect of our move, admittedly, was to drop targets for top-line revenue growth. Doing so certainly spooked the market – if Unilever cannot deliver three to five per cent, investors figured, the world must be coming apart! But lots of other companies told us that they would love to do the same: after all, it is a terrible mark of shame in the United Kingdom (less so in the United States) when you have to issue a profit warning. I’m delighted that we will no longer have to face this.
Many people say we should still give long-term guidance – an argument with which I have some sympathy. But you have to be careful that this does not become short-term guidance by the back door: analysts will inevitably seek to judge each set of results in the light of whether you are “on track” for the longer term. Everyone wants his share to be correctly priced, of course, but the best way to do this is to establish a track record over several quarters and allow investors to extrapolate the trend line. It is naturally tempting to give guidance if you think you are going to do better than trend, and you will certainly get a pop on your valuation – but the reverse is also true.
In Unilever’s case we may have abandoned guidance on top-line revenue and operating margins – but in 2009 we have actually provided more granular guidance on aspects of the business than we did in earlier years. We have openly discussed what we think is going to happen to commodity costs, for example, to the likely direction of operating margins quarter by quarter, and to Advertising and Promotion spending. We have also indicated in very general terms the extent to which a well-run company like Unilever ought to be able to outperform the consumer goods markets in the developed world, and what overall revenue trends are in emerging and developing markets.
Whatever the downside in the short term, our decision is costless from now on. Indeed, the market’s response to the 16 per cent fall in first-half earnings for 2009 – to mark the shares up five per cent – was pretty encouraging. My guess is that the only time we might revert to guidance is if we were to make a big acquisition (and there are no plans to do so!). If a company issues a large chunk of new shares, or gears up its balance sheet, I think its owners are entitled to ask for an explanation. In that event you have to spell out the likely financial returns, whether in improved top-line growth or better operating margins.
Jim Lawrence has been Chief Financial Officer of Unilever plc since September 1, 2007. Prior to joining Unilever he served as an Executive Vice President of International Operations of General Mills from 2000 to 2006 and Chief Financial Officer from October 1998 to 2007.