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Corporate Strategy Weekly Radar Update

Week ending Friday 16 November 2012 (snapshot: 2052 - a debrief of Jrgen Randers' vistit)

Highlights and Insights Financial Services QBE downgraded their FY12 profit forecast to US$1B (down ~35%; ITR from 12% to 8%) and announced a $500M sub-debt raising. The insurer highlighted retained losses of $350M-$450M from Hurricane Sandy and expected drought losses from its crop business as key contributors. o A combination of recent bad news and questionable announcements has led to analysts to question QBEs underlying business: 1) how could QBE reaffirm its $1.75B FY12 profit projection only 4 weeks ago given further provisions in its US-run-off portfolio? 2) S&P described QBEs capital position as deficient and, along with Moodys, put it on negative outlook; 3) Speculation continues it will have to write off up to $1B of its $2.5B US goodwill; 4) The appropriateness of reinsurance arrangements entered into in 2010, which increased retention to $589M whilst saving $300M. QBEs messy underlying business is in contrast to the relative clarity and boring nature of Suncorps business model and story, which analysts are growing increasingly comfortable with. NAB split the CIO role with prev CIO Adam Bennett moving to EGM Enterprise Transformation and Denis McGee to Chief Technology Officer (incl day-to-day IT BAU). Both roles report to the Business Services Group Exec Gavin Slater (effectively COO). o NAB must deliver its core system replacement started with NextGen in 2008, and must also maintain stable BAU during this period of change (as acutely reminded by some recent outages) o In fact digital platforms and system renewal in financial services remain a key issue: KPMG estimates +20% IT spent by the Big 4 in 2012. The acceleration of Technologies also puts pressure on banks to handle the balancing act of adapting strategically vs running stable operations like clockwork: NAB has chosen to split strategic IT transformation from running the day-to-day. NAB also confirmed its push into Online Broking through low price (cutting its fee by $5 becoming the cheapest of the Big4), seeking to emulate its recent home loan discounting strategy. BOQ raised $1B in Residential Mortgage-Backed Securities (RMBS) subscription, more than doubling its initial issue of $500M, representing the banks first move into RMBS securitisation in 2 years. It also included tranches in , a first for an Australian bank since 2007 on the RMBS market. o Interesting because RMBS notoriously dried out after the GFC because of their link with Sub-prime, but effectively causing smaller lenders who don't have big deposits or high ratings on wholesale market to scale down (when not disappearing): so this means that RMBS are picking up again. Westpac opened their first branch in India, the last of the majors to expand their footprint to the sub-continent. (fact: India is Australias 5th-largest trading partner and 4th-largest export market with bilateral trade expected to double to $40B by 2015) o WBC has been clear to differentiate their Asian strategy organic growth to support existing customer base from ANZs superregional strategy, driven by inorganic growth and aggressive expansion. Berkshire Hathaway was granted an underwriting licence by the RBNZ, and is expected to begin writing construction and engineering cover within the Canterbury region in NZ. Increased regulation, higher reinsurance costs and industry consolidation have driven higher barriers to entry within NZ GI. However, offshore insurers with parental backing (such as Berkshire Hathaway) remain threats to incumbents such as Suncorp, as they are able to cherry pick prime market segments (such as construction & engineering). APRA released the final package of Basel III counterparty risk prudential standards and final suite of prudential standards for super: all APRA regulated industries are now subject to prudential requirements, with the majority to take effect on 1 July 2013. . Other industries Myer announced 1% rise in 1Q sales (+0.8% on a like-for-like basis), representing its 1st Qtr of sales growth since July 2010. o This announcement followed a higher Westpac-Melbourne Institute of Consumer Confidence index of 104.1 (highest since Apr 2011) driven by lower interest rates, no new news (is good news) out of EU + US, and stable employment figures. However, the Sword of Damocles is still hanging over Australian retailers who haven't resolved the digital mutations affecting their sector Executive Remuneration: Paperlinx and Lend Lease were each delivered a first strike (more than 25% of shareholders voting against their remuneration reports) whilst MZI Resources and Ask Funding have become the first companies to receive a second strike, triggering a spill of their Boards. o Directors are dissatisfied with the two strikes rule is growing, with claims the rule is being used for ulterior motives, but it also shows shareholder activism is a reality boards must deal with QANTAS announced early repayment of $650M of debt and a $100M on-market share buy-back, to be funded from selling the freight business StarTrack and a settlement from Boeing. It also announced an underlying pre-tax profit outlook of $180M$230M for 1H13, at the upper end of analyst expectations. o The announcement continues management's attempt to bolster the struggling airline: offloading non-core businesses, proposed alliance with Emirates, further debt reduction (total of $1B anticipated in FY13) and 'turnaround strategy' for QANTAS International that will try to manage the inherent volatility within the air-travel market, driven by fuel prices and international exchange rate movement. Macro Economy, Politics and Regulation It's now official, the EU dipped into recession: with 3Q12 GDP 0.1% following 2Q12 of -0.2%: adding continued pressure on politicians to stimulate growth whilst cutting debt. This coincides with widespread strikes over the failure of austerity AU Sovereign Credit Rating: S&P speculated that Australia could lose its AAA credit rating if it is unable to budget surplus by 2014, highlighting parallels between Australias indebted banking system and Spains position pre-crisis. o Whilst S&P noted cataclysmic events would be required to drive such an Australian downgrade in the near-term, the comments highlight the ongoing clash between stimulating growth and run a deficit vs austerity to get budget surplus and satisfy rating agencies. It also continues to question their role China's Communist Party appointed Xi Jinping as party generalsecretary and ex officio National President. He was seen as a consensus nominee within the party, and is known for a cautious, uncontroversial style after the Bo Xilai's disgrace. o A notable feature of this transition is that contrary to Jiang Zemin who had clung to power in a 'gradual retirement' in 2002, Hu Jintao will relinquish all positions to let Xi Jinping take over. He is expected to preside of an economy whose focus must shift from quantity (i.e. growth and export) to quality (private investments, consumer demand, reduced corruption). US Fiscal Cliff: US markets remained subdued and bond prices edged higher evidence that continued partisan divisions between Obama and Congress will prolong the impending crisis. o After the election Democrats have the upper hand in this game of fiscal chicken, with a recent poll confirming that a majority of Americans would blame Republicans for continued impasse. Finally the Israel-Hamas war reignited: Ahmed Jabari, the Hamas man 'responsible' for enforcing the truce got 'eliminated' for losing his grip on the southern border: this is also happening in the context of Israel upping the ante against Iran. A volatile situation with many consequences (including oil prices): on watch

Snapshots of the week: 2052 - a debrief of Jrgen Randers' visit Who is Jrgen Randers and his position among the various thinkers and schools of thought Jrgen Randers famously (co)authored the controversial and now classic The Limits to Growth in 1972 that modelled the consequences of unchecked economic and population growth with finite resource supplies. Back then he examined 5 macro variables (world population, industrialization, pollution, food production and resource depletion), and derived scenarios ranging from "stabilisation" to "overshoot and collapse" of the global system by the mid to latter part of the 21st century. In 2008 CSIRO published a paper called "A Comparison of `The Limits to Growth` with Thirty Years of Reality" examining the past 30 years of reality with the predictions made in 1972 and found that changes in industrial production, food production and pollution are all in line with the book's predictions of economic and societal collapse in the 21st century. This year Jrgen Randers published a book "2052 - A Global Forecast for the Next Forty Years" which he presented in Australia. An interesting angle is to confront Jrgen Randers' views with the spectrum of analyses made in such an uncertain period for the world economy: indeed the 'certainty' of the globalisation of the 1990-2000s that followed the end of the Cold War never quite delivered the expected 'end of history'. Instead, a period of contradicting trends (a key point highlighted at this year's board) and high volatility is leaving the jury of economists and policy makers out regarding our future prospects of growth... To make it super simple, 2 schools of thoughts emerge from the research... School of thoughts #1: School of thoughts #2: "Doom on the systemic crisis" (classic thought leaders worth following) "Once we pass the 'blip' of this crisis, a next wave of Growth awaits..." Economists like Nouriel Roubini (pic) who anticipated the Another body of work focuses collapse of the US housing market and the GFC. His main instead on the next wave of thesis is that the current recession is due to "boom-andgrowth. Management bust cycles" and a new path towards sustainable growth is consulting firms such as necessary. Economists Paul Krugman (pic - 2008 Econ Nobel McKinsey, BCG, Booz, Bain, Prize) , Jospeh Stiglitz (pic - 2001 Nobel Prize) also made it etal have all documented the to the mainstream for their critique of the system, but also next wave of growth coming specifically the way the Obama Administration's 'financialfrom Asia. industry rescue plan' has prevented collapse but has not Even Australian Treasury, fixed systemic issues. They also oppose austerity policies as through the voice of Dr Martin a way to end the crisis. Parkinson, also forecasts that Australia will keep benefiting 3 wave of Business commentators and 'innovators' like Umair Haque growth until 2050: the expansion of the mining sector, growing global (pic) from the Harvard Business Review, (or Garry Hamel) demand for agricultural products, and the rise of the middle class in who come at it from a more business / managerial angle Asia. (detailed in a previous Strategy Radar on 26/10/2012) and challenge existing business models. Jrgen Randers believes that whilst there will be growth in the coming period, it will stall by 2052. A summary of his views: Jrgen Randers' Framework: Global population will stagnate earlier than expected because fertility will fall Main cause-and-effect relationships behind the 2052 dramatically in the increasingly urbanized population. Population will peak at 8.1 billion forecast people just after 2040 and then decline. Global GDP will grow slower than expected, because of the lower population growth Urbanisation Health Services and declining growth rates in (gross labour) productivity. Global GDP will reach 2.2 times current levels around 2050. Fertility Life expectancy Social Productivity growth will be slower than in the past because: because economies are Tensions maturing, because of increased social strife, and because of negative interference from Population Labor inequity extreme weather. In fact Randers argues that an increasingly urban population will be productivity unwilling to protect nature for its own sake. Biodiversity will suffer. Workforce Growth rate in global consumption will slow because a greater share of GDP will have Growth in to be allocated to investment in order to solve the problems created by climate change, per capita Production resource scarcity, and biodiversity loss. Global consumption of goods and services will consumption (GDP) peak in 2045. Consumption As a consequence of increased social investment in the decades ahead (albeit often Energy Use involuntary and in reaction to crisis), resource and climate problems will not become Investment CO2 emissions catastrophic before 2052. But there will be much unnecessary suffering from unabated climate damage around the middle of the century. Resources and Slow growth in per capita consumption in much of the world (and stagnation in the climate problems rich world) will lead to increased social tension and conflict, which will further reduce orderly productivity growth. Limits Scenario of a Resource crisis The short-term focus of capitalism and democracy will prevent decisions needed for 3: Industrial output long-term well-being to be made in time. 5: Nonrenewable resources 1 3 2 The impact will differ among 5 regions: US, the other OECD nations (including EU, 1 5 2: Food Japan, and Canada among other industrialized nations); China; BRISE (Brazil, Russia, 5 output India, South Africa and 10 other big emerging economies); and the Rest of the World 4 (the 2.1 billion people at the bottom of the income ladder). 1 2 1: Population 3 2 The most surprising loser will be the current global economic elite, particularly the US 1 5 2 5 (which will experience stagnant per capita consumption for the next generation). China 3 4 3 4 4: Pollution level 4 will be the winner. BRISE will make progress. The Rest of the World will remain poor. 1900 1950 2000 2050 2100 Alland particularly the poorwill live in an increasingly disorderly and climatedamaged world. The world in 2052 will certainly not be uniform or flatthe sentiment and conditions in Sources: obtained from Jrgen Randers the 5 regions will differ dramatically. So what?... Randers argues that in 2052, if you ask a Chinese peasant, who is by then living in a high rise in Beijing he'll tell you the past 40 years have been the most marvellous epoch in the history of China. Someone in manufacturing in middle America will have seen their disposable income shrink; whereas a UK office worker will have stagnated with their real disposable income essentially the same as it is today. For us, at such a macro level, the point is not to draw insights on a page (it's impossible), but it is to understand and be familiar with the frame of the debate and where the various commentators are coming from. Even the "Resource Crisis" graph shows short-term growth, which businesses will undoubtedly harvest. The point here is to prepare for the coming strategic risks, which is what our programme of work is exactly doing...