The State of ESG (Podcast)
December 6, 2019
Environmental, social and governance (ESG) factor consideration has grown substantially over the past decade as more managers seek to expand their investment lens to account for a growing number of issues. Epoch’s Head of Sustainable Investment, Richard Watt, joins Actively Speaking to discuss ESG’s growing influence on investing and the various hurdles it faces in achieving market standardization.
Autonomous Vehicles Podcast
July 22, 2019
Listen in as Epoch Analyst Jérôme Van Der Ghinst and Steven Bleiberg discuss the future of autonomous vehicles.
In the global context, transport contributes around 15% of total carbon emissions globally. For some, the widespread adoption of autonomous vehicles (AV’s) potentially offers not only significant reductions in emissions but also better safety, solutions to congestion problems, improved vehicle efficiency and lower costs for consumers. However, we point out that while the technology has advanced, it is not necessarily the case that emissions will decline given the possibility of increased use as driving conditions improve. We also discuss the industries likely to be most heavily impacted including the incumbent vehicle producers, software companies and insurance and real estate sectors. In addition, there will be implications for a variety of related sectors like the oil industry and the power generators, We conclude that while Epoch does not believe “you have bought your last car” quite yet, as we describe in this podcast, AV’s should be an important component of a future for transport that will look very different from today, with significant implications for investors in a range of industries.
Michael Jin’s Spotlight Note: “Utilities and Growth: Contradictory? We don’t think so”
January 15, 2019
Contrary to many investors’ perceptions, utilities have enjoyed consistent earnings and cash flow growth, often in the range of middle to high single digits. Capital spending on renewable energy as well as the transmission and distribution needed for these new sources of energy has been one driver of growth in the utilities’ rate bases. These trends are likely to continue, along with the mass adoption of electric vehicles. In well-regulated environments, companies and investors will be adequately compensated when management teams execute these projects efficiently.
Blitzscale and Hope: Unicorns, IPOs and the Fear of Repeating the Late 1990s
June 19, 2019
In this paper, we explore the sustainability of technology companies which have come to market in the recent surge of IPO listings often at stratospheric valuations. As we point out, the current hype about two-sided digital platforms, blitz scaling and winner-takes-most markets has meant it is difficult to reconcile valuations with free-cash-flow (FCF) fundamentals, and thus the big question is, are we repeating the excesses of the dot-com boom?
In addition, we note two features of the IPO boom: spending cash as fast as possible and operating with dual class share structures to allow control to remain with the founders.
We examine several of the pros and cons and conclude that the current situation is different from the dot com bubble. At the same time, we offer suggestions for assessing the likely sustainability of such companies including governance policies and being skeptical of those that lack transparency regarding key metrics.
Free Cash Flow Works
October 6, 2016
In this paper, we demonstrate that finding sustainable companies depends upon understanding that free cash flow is a sounder measure of a company’s performance than reported earnings. In addition, we show that companies with higher free cash flow yields outperform companies with lower free cash flow yields. This is the key insight into Epoch’s investment philosophy which can be summarized by saying that it is the ability to generate free cash flow that makes a company sustainable and worth something to begin with, and it is how management allocates that free cash flow that determines whether the value of the business rises or falls.
The Capital Reinvestment Strategy
June 30, 2016
This paper assesses the question of what the purpose of the Firm is, a topic which has become more commonplace following the global financial crisis, the perception that globalization has not benefited all equally, as well as the general increase in interest in “ESG” investing. At Epoch, we draw a crucial distinction between maximizing the value of a business for stockholders in terms of growth or size, and instead emphasize that value maximization is all about properly allocating capital. In this white paper, we focus on the application of this methodology within our Capital Reinvestment strategy which focuses on companies that use their free cash flow to reinvest and acquire, and in doing so have a consistently high level of ROIC well more than their weighted average cost of capital.
The Case for Active Management
March 23, 2015
In this paper and a subsequent part two, we illustrate how our methodology focusses on finance rather than accounting. Epoch believes this differentiating feature lies at the heart of identifying strong sustainable businesses, since accounting variables obscure rather than help clarify what really matters, which is whether management are allocating capital in a way that creates or destroys wealth. This in turn is a function of good governance and policy guidance as well as management incentivization arrangements.
China: a Long March to Imperial Renaissance
November 14, 2007
Imagine a country that at a certain point was a global leader with the most advanced technology in the world; now, take that same country and wonder how it was possible that for the next 650 years it had slipped into virtual obscurity and collapsed under revolution. That country is of course China, and what is remarkable as explained in this detailed paper by Epoch’s Thomas Hu, is that in less than three generations from that point of collapse, it has risen once again to become once again a global powerhouse based on unprecedented growth rates.
The paper describes the key drivers behind this growth – “capitalism with Chinese characteristics”: high levels of centrally planned investment, a willingness to subjugate and offer cheap labor, soft loans for business, and little accounting for bad debts nor environmental and other considerations facing competing nations and companies.
The sustainability of this has come under increasing scrutiny in recent years, in part due to domestic political pressures, but also a function of china’s engagement in The Paris Agreement on climate change – as noted in the paper, coal is a disproportionate component of energy which cannot be maintained if the world is to meet GHG emission targets. China cannot provide enough food for its population, even with declining rates of population growth. In addition, pressure has been building for fairer trade practices and inward investment is pulling back.
Today, under an increasingly autocratic leadership, China is once again aiming to establish global influence, through initiatives like the “Belt and Road” policy. Significant investment here is required, as is massive investment needed within China to repair the damage created by unsustainable economic growth.
The Canary in the Coal Mine: Subprime Mortgages, Mortgage-Backed Securities, and the US Housing Bust
April 23, 2007
This paper illustrates how the housing boom in the U.S. (and in many countries elsewhere) was a bubble of unreliable construction and unsustainable proportions. There was a massive failure of governance and a lack of diversity of thinking together with an alignment of perverse incentives. An aggressively easy monetary policy backdrop combined with the widespread abandonment of sensible lending practices plus an exponential increase in mortgage securitization which was largely unregulated. The period also illustrates the dangers of weak reporting standards and poor transparency stemming from the opaqueness of many of the underlying debt instruments and “mark to model” which proved no substitute for proper due diligence.
Is E-Commerce a Bubble?
September 13, 2018
Kevin Hebner asks the question whether e-commerce is a sustainable business model and if the valuations on such stocks are another bubble just waiting to be popped. He identifies a “growth over profits” mentality, featuring voracious spending to build scale and benefit from network effects. Thus, the time to produce positive free cash flow is being elongated just at the very moment technology advances are gaining speed, hence increasing the vulnerability of some of these companies to future disruption themselves. It is thus important to understand the basis and sustainability of cash flows: subscription models like Netflix, advertising revenues which lie behind Google, and transaction models such as Uber. The paper also identifies several warning signals to look for including weak transparency and governance policies. Ultimately, the ability to generate cash flows and allocate free cash flows sensibly is the best predictor of sustainable businesses.
Is Japan Investable Through a Cash Flow Prism?
October 6, 2016
In this paper, CEO and Co-CIO Bill Priest and Investment Strategist Kevin Hebner examine recent trends regarding Japanese corporate governance. As noted in the paper, Japan has historically scored poorly on corporate governance criteria. However, Prime Minister Abe has made improving corporate governance a priority and the initial indications are encouraging. The June 2015 reforms emphasized shareholders’ rights, increased disclosure and transparency, and required the appointment of at least two independent directors. In addition, both broad and narrow definitions of cross-shareholding ratios have declined to new record lows. This is an important development, as it allows for more arms-length transactions, better capital allocation and improved corporate governance. Finally, we would also note the decision of the world’s largest pension fund, the GPIF, to become a Signatory to the UNPRI. This has had enormous ripple effects across the financial services industry within Japan and across Asia.
Cash-Flow Opportunities in the Commercial Aerospace Industry
June 15, 2015
In this Insight, Epoch’s Rick Van Dale writes about the favorable backdrop for aircraft producers, while highlighting the importance of environmental considerations. Epoch expects commercial aircraft production will grow at a multiple of expected GDP growth due to two main factors: the continued increases in passenger travel demand especially from the developing economies of China and India, as well as the accelerated replacement of obsolete aircraft with next generation more fuel-efficient aircraft. Environmental considerations are important as in the last decade fuel cost has doubled as a percentage of total airline costs, representing up to 30% of total operating cost for single-aisle airplanes and up to 50% for wide-body airplanes. In addition, the UN agreed in 2016 to the Carbon Offsetting and Reduction Scheme for International Aviation (CORSIA) specifically geared to help mitigate CO2 emissions from international aviation. Implementation of the CORSIA will begin with a pilot phase from 2021 through 2023. Some believe this will help stimulate a global carbon market that in turn will drive new business opportunities via investment in low-carbon technologies.