Deutsche Bank Global Transaction Banking. What DR investors are buying: An analysis of investment drivers for depositary receipts

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1 What DR investors are buying: An analysis of investment drivers for depositary receipts

2 What DR investors are buying: An analysis of investment drivers for depositary receipts Conventional methods of trying to determine what DR investors are buying have focused on looking at shareholder analysis data or by building up a picture of investor sentiment through verbatim comments made by institutional investors through conducting a perception study. Whilst both of these methods are still important in assessing who is investing and why, there is an alternative way of gaining a wider understanding by the analysis of fundamental financial data. Deutsche Bank has partnered with Thomson Reuters to focus specifically on the DR market by looking at 3, mutual funds around the world. The model looks at which stocks each fund bought over the previous 3-6 months and the fundamental characteristics of those stocks to uncover what matters to each fund. For example, are funds buying stocks with low EV/EBITDA multiples or those with good dividend yields? All of the fundamental metrics can be categorised into groups: value, growth, profitability, momentum and leverage. Within these groups, 4 fundamental characteristics were screened. See Table 1 below. Of the 4 fundamental characteristics, we discovered that on average there are only around 8-1 that really matter to investors and after this point the significance of each factor tailed off sharply. The key fundamental characteristics we discovered for DR investors were stock liquidity, leverage (interest coverage), profitability (net margin), return on assets, return on equity, dividend yield, relative valuation and long-term growth. Table 1: Fundamental metrics Value Profitability Momentum Leverage Forward Price / Earnings Forward 1Y EPS Trailing net income/ revenue 18 day price return Long-term debt/ assets Intrinsic Value/Price Forward 1Y Rev Trailing Return on Assets StarMine Analyst Revision Model score Long-term debt/ book value Relative Value Forward Y EPS CAGR Trailing Return on Equity Long term price momentum EBITDA/Interest Expense Trailing Price to Book Value Long Term Earnings quality 3 day average volume Trailing Cash Flow/ Price Year Trailing EPS CAGR Trailing Dividend Yield Forward Dividend Yield EV/EBITDA 1

3 Figure 1: Threshold for EBITDA / interest expense DR Investors Figure : Threshold for return on equity Return on Equity (%) DR Investors Interest Coverage (x Cover) Figure 4: Threshold for long term growth estimates Figure3: Threshold for the earnings quality score Earnings Quality Score (1 1 Score). Stock Liquidity By looking at average stock volumes, it appears that investors regard the ability to get in and of a stock without disturbing the price as critical. In current market conditions, characterised by low equity volumes, this is of growing importance. Leverage Interest cover, as defined as EBITDA/ Interest Expense, is an important consideration in decision making but the data suggests that DR investors are more comfortable with lower rates of interest cover than investors in the market as a whole. See Figure 1 opposite Profitability The analysis showed that the profitability criteria came out quite strongly with a key metric being Return on Equity (ROE). For DR investors, they seem to be looking for companies with.7% ROE and above compared to the market as a whole where the figure is.1%. See Figure. Thomson Reuters also screened using an earnings quality model, with a 1-1 ranking (1 being the best). See Figure 3. In terms of assessing earnings quality, those companies who have superior cash earnings obtain a higher ranking. As with ROE, DR investors are willing to apply a lower hurdle when they buy a DR compared to the market. DR investors tend to look for companies with long-term growth based upon estimates from the sellside of approximately 6.6% compared to.% for the market as a whole. See Figure 4. Long-term growth rate is defined as the average of analyst estimates of a security s long-term annualized earnings growth rate. By long-term, it usually implies years. Therefore we can conclude that DR investors are more concerned with longer term growth and less concerned with near term predictability of earnings. Analyst long term growth estimates (%) (Typically years)

4 Value When looking at some of the value factors there doesn t seem to be one valuation metric that investors look at, for example, P/E ratio comes quite far down the list. Investors seem to be screening for attractive companies on a range of valuation metrics. It is surprising that some of the traditional valuation metrics are not higher in the order of preferences. If we look at Relative Valuation (RV) scores, where all companies are ranked on a scale of 1 1, 1 being the most expensive and 1 being the cheapest, we find some interesting results. Looking at Figure 6 below, DR Investors seem to be looking for stocks ranked 3 and above. In other words, if you rank in the cheapest 7% of stocks then DR investors are more likely to buy. Figure : Threshold for Price / Book 3.8 However those companies who are in the most expensive quartile of stocks are likely to find it a barrier for new DR investment. We can also take a look at the benchmark for all investors, not just those buying DRs. What you can see is that they have a higher threshold at 36%. In other words, they are looking for cheaper stocks compared to DR investors who are willing to pay more. This finding is also observed when looking at price/book ratios, in Figure below. Dividend yield Dividend yield is key factor for investment decisions but results show that there are no significant differences between DR investors and the market Figure 6: Threshold for Starmine relative value 4 Interestingly, there is significant marginal increase in the amount of investment companies can attract when moving up from no dividend to around 1.%. However once companies are at.% dividend yield, there is still an impact in terms of potential investors, particularly with income and yield investors, but the marginal propensity to attract new investors is less profound. ADRs vs GDRs As part of our analysis, we investigated if there were any significant findings from looking at ADRs compared to GDRs. The table in Figure 7 below illustrates the results and our conclusion is that there are negligible differences. This is line with our expectations due to the fact that US institutions are the largest holders of both ADRs and GDRs Price/(Trailing) Book Ratio Relative Value Score (1 1 Score) DR Investors Figure 7 Fundamentals that are most important to Top DR holders Category Median ADR Investors Median GDR Investors Median in 3 day avg stock volume Value.%.1%.3% Interest coverage Leverage Net margin Profitability 1.3% 1.4%.8% Operating income / assets (ROA) Profitability.3%.6%.% Net income book value (ROE) Profitability.7% 3.%.1% Starmine relative valuation (RV) model score Value Forward 1m dividend yield Value.3%.% 1.% Analyst mean long term growth est 6.6% 6.%.% Starmine price momentum long term component score Momentum Starmine analyst revision model (ARM) score Momentum

5 Conclusion Stock liquidity: important due to the fact that equity volumes are incredibly low at the moment. Getting in and out of the stock without disturbing the price is a key factor for DR investors. Value: DR investors do look for good buying opportunities but are willing to pay higher multiples than the market as a whole for quality companies. : looking for companies with high long-term growth rates are important for DR investors compared to the market. Leverage: investors tend to look at interest cover when making investment decisions and DR investors are comfortable with comparatively lower levels of interest cover. Profitability: whilst an important metric, DR investors tend to apply a lower hurdle when buying DRs. Dividend yield: a key metric for investment decisions, with no material differences between DR investors and the rest of the market. Significant investment inflows when yield increases from to 1.% but once over.%, marginal increase flattens out. ADRs vs GDRs: no significant differences when compared to looking at DR investors in aggregate. Fundamental analysis provides another tool for companies to evaluate institutional investor behaviour. In relation to the DR industry, it can be a useful method for companies to determine who are going to be the likely theoretical buyers of DRs. By looking at potential target investors from this angle, targeting methods can be refined and the data used in combination with the company s usual strategies. 4

6 Please do not hesitate to contact the DR Market Solutions team: Zafar Aziz Head of DR Market Solutions Manan Desai +91() Harish Kriplani +91() in the event that you have any questions regarding the matters discussed here About Deutsche Bank Trust & Securities Services Deutsche Bank s Trust & Securities Services business, part of, is one of the leading providers of trustee, agent, depositary, registrar, SPV management and related services for a wide range of financial structures and transactions. It is a leading depositary for American and Global Depositary Receipts, providing value-added services to companies raising capital in international markets or listing on the New York, NASDAQ, London, Luxembourg, Singapore or NASDAQ Dubai stock exchanges by means of depositary receipts. It also offers both mutual and alternative fund administration and provides securities custody, clearing and agency lending services from a global network spanning more than 3 markets. Additional details are available on or Disclaimer: The information contained herein does not constitute and shall not be construed to constitute legal and/or tax advice by Deutsche Bank AG or any of its affiliates. Individuals should consult with their advisors regarding their particular situation. This bulletin is provided for informational purposes only. The information and opinions in this bulletin were prepared by Deutsche Bank Trust Company Americas or one of its affiliates (collectively Deutsche Bank). The information herein is believed by Deutsche Bank to be reliable and has been obtained from public sources believed to be reliable, but Deutsche Bank makes no representation as to the accuracy or completeness of such information. Deutsche Bank has no obligation to update, modify or amend this bulletin or to otherwise notify a reader thereof in the event that any matter stated herein, or any opinion, projection, forecast or estimate set forth herein, changes or subsequently becomes inaccurate, or if research on the subject company is withdrawn. It is not o be construed as an offer to buy or sell or a solicitation of an offer to buy or sell any financial instruments or to participate in any particular trading strategy in any jurisdiction. Past results are not indicative of future performance. This communication has been approved and/or communicated by Deutsche Bank AG London. No part of this bulletin may be copied or reproduced in any way without the prior written consent of Deutsche Bank AG. Copyright November 1 Deutsche Bank AG. All rights reserved.