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Is Management in Your Corner?

Jeremy Glaser
Heather Brilliant, CFA

Jeremy Glaser: For Morningstar, I am Jeremy Glaser. Today, we're launching the new Morningstar Stewardship Rating for stocks. I am here today with Heather Brilliant, the vice president of global equity and credit research, who will explain the new rating and give some examples of how investors can use it. Heather, thanks for joining me.

Heather Brilliant: Thanks for having me, Jeremy.

Glaser: So, let's talk a little bit about why you decided to launch this new rating and how it differs from the existing Stewardship Grade?

Brilliant: In mid-2011, we decided to take a fresh look at our stewardship methodology, and what we found is that we had been using a series of kind of check boxes to really evaluate whether we thought companies would be in the right position to think about the best interest of shareholder capital. And in fact, we didn't need to use a proxy because our analysts are looking at these companies every day and analyzing their capital-allocation decisions. So, we thought it would make more sense to just focus on the actual output. What are the capital-allocation decisions that companies are making, and are they in the best interest of shareholders?

We really think this is a huge upgrade to our stewardship methodology, and in order to reflect the more holistic nature of the rating, we are going with three buckets instead of the five letter grades we were using before. So, the new stewardship methodology will result in ratings of: Exemplary, for those companies that are doing a fantastic job looking after shareholder interests; Standard, for really the vast majority of companies that are doing just fine on that regard; and Poor, for companies where we really feel like it's important to call out companies that are not looking after shareholders' best interests.

Glaser: Now, in the move to this new methodology, are there any companies that kind of surprised you, that used to have kind of a low Stewardship Grade, but under the new rating look a lot better?

Brilliant: Yes. Ford is an example that jumps to mind. So, we were giving Ford a Stewardship Grade of D in our old system, and the reason for that is because the firm has a dual share-class structure that we felt hampered the interest of minority shareholders.

However, when you look at what Ford has done really during the last six years, it's amazing. Ever since Alan Mulally became CEO, the company has really been focused on buttoning down the offerings it has. It never needed capital from the government, unlike many of its peers, and we really feel like Alan Mulally and Ford have been acting in the best interest of shareholders. So, under our new system, Ford will have a Standard rating, which is much better than what you would assume from the former D grade that we were giving it.

Glaser: What are some companies that you think really have Exemplary stewardship?

Brilliant: Actually, one that comes to mind is Eldorado Gold. Within gold mining, it's very important that managers really look after the interests of shareholder capital and capital allocation because it's a very commoditized business by its very nature. The great thing about Eldorado is that we really feel like it has a management team that is making great investments, buying companies and mines when they are really cheap, and taking advantage of the opportunity to put shareholder capital to work in a very efficient way. That really contrasts with Kinross, which is another gold company in that same sector, where we feel like the acquisitions Kinross has done have been at tremendously high prices and have really destroyed shareholder value.

Glaser: Are there any that really stood out as having a particularly Poor stewardship rating?

Brilliant: Yes. Cablevision is a company that we consider to be very poor. Its controlling interest is held by the Dolan family. They control about 70% of the company, even though they own about 30%. They have done things like take out a huge loan in order to pay a special dividend, which disproportionately benefited them at the expense of minority shareholders. So, we're really looking out for things like that.

Another example would be Vulcan Materials. Vulcan Materials bought one of its largest competitors at the peak of the market and put a ton of capital and took on a huge amount of leverage to the point where we were really worried whether the firm was going to make it through this financial crisis. So, that is something we consider: a disproportionate amount of risk and a poor capital-allocation decision. All of that results in a Poor rating, as well.

Glaser: How should investors use these ratings? At what point of the investment process do they really come in? Are they a veto, in that if you see something as Poor, does that mean you should never buy it? How are these ratings meant to be used?

Brilliant: I think there are two ways. I think if you see a Poor stewardship rating, you really do have to consider whether you are comfortable investing alongside this management team it you know that they are not necessarily looking out for the interest of shareholder return. At the end of the day, that's why we're all investing, and so, that's really the most important consideration.

On the upside though, if you're looking for a business that you can hold for the long term and you want to feel confident that a company and a management team is really looking out for your best interests, then I would purposely look for companies that have an Exemplary rating as a good starting place.

Glaser: Heather, thanks so much for your thoughts on this new rating today.

Brilliant: Thanks for having me, Jeremy.

Glaser: For Morningstar, I am Jeremy Glaser.