Branded Consumer facing Non-FMCG: Best Buys

Investing Strategies
1

There are several long-standing non-FMCG reputed names in Indian markets that have demonstrated strength of their brands & pricing power.

Businesses like Titan, Asian Paints, CRISIL, Castrol, Pidilite, Page Industries immediately come to mind. This thread is dedicated to dissecting their commonalities as also their unique differentiation. First form a historical perspective and then we will go on to dissect recent performances, opportunities before them, likelihood of getting stronger in the years to come.

If we think about this properly, its essentially 3 important characteristics that we want to see in these businesses, demonstrated well over a long enough period (say 10 years).

1). Consistently high (incremental) Return on Equity

2). Consistently low Capital Intensity (negligible capex and low/neg working capital)

3). Consistently high Dividend Payouts (say excess of 40%?)

These kind of businesses don’t need much capital to grow, are able to throw out lot of cash, leading to higher total returns (Capital appreciation+ Dividends) usually.

Banking & Finance/Insurance businesses we might like to tackle in a separate thread.

Shrey has volunteered to throw up voluminous data for this using some of the learnings from the ongoing Large-Cap Bluechips discussion thread. Over to Shrey.

Those familiar/invested in these businesses - look forward to your help/direction setting for the dissection.

2

Will this thread include valuepickr favourites like Cera , Amararaja, La Opala or are we going to discuss only high PE shares. These companies at least fit the description of branded consumer facing non-FMCG companies, but may not be in the same league as companies mentioned above.

3

They might or might not fit the pattern - but they are still emerging companies. Let’s leave out companies like Cera, Amara Raja, La Opala and other emerging companies. They are anyways being discussed extensively in individual threads on ValuePickr.

The focus is on the biggies with a long standing record to see if we can extract some lessons and some patterns. And then zero down on a chosen 1 or 2 or 3 to lend stability to ValuePickr portfolio.

4

Apologies for a silly question but do we already have a valuepickr portfolio thread or are we building one?

~Supratik

5

ValuePickr Recommended Portfolio is available in the ValuePickr Scorecard thread. This was introduced in 2011 to review a year of ValuePickr performance.

It is usually updated once every 6 months.

6

Thanks Admin.

@Donald - it might be a good idea to specify the entry conditions of companies in this thread (for every thread on valuepickr) - from MCap, profit growth, non-fmc, non-financials etc and then boil down to 10 names.

7

Hey Folks,

The following is a snap short of Page Industries.Please help me digdeeperinto thequantitativeand qualitative aspects of the business.

Page Industries Ltd.
PAGE INDUSTRIES LTD. SALES EBITDA PAT EPA MKTCAP CFO NET WORTH
9 YR CAGR 35.03% 42.93% 42.58% 43.34% N.A N.A 46.24%
5 YR CAGR 37.46% 39.22% 39.42% 46.34% 53.01% 78.19% 20.99%
3 YR CAGR 40.33% 47.34% 50.73% 73.58% 90.11% 102.96% 29.40%
1 YR GROWTH 35.06% 49.10% 53.70% 100.01% 89.44% N.A
 33.95%
PAGE INDUSTRIES LTD. 31-03-2012 31-03-2011 31-03-2010 31-03-2009 31-03-2008 31-03-2007 31-03-2006 31-03-2005 31-03-2004 31-03-2003
Financial Leverage 1.39 1.93 1.55 1.48 1.48 1.37 2.05 2.97 3.05 2.56
Total liability/Earning 2.31 3.69 4.41 4.00 4.09 3.13 2.88 7.06 4.36 6.66
Debt/Equity 0.39 0.93 0.55 0.48 0.48 0.37 1.05 1.97 2.05 1.56
Interest Coverage 14.44 13.85 15.19 12.34 11.20 11.45 11.99 5.66 7.32 3.98
Working Capital/Sales 15.07% 26.48% 19.49% 22.07% 21.19% 40.01% 12.57% 13.33% 12.38% 15.22%
Debtor Days 23 18 21 23 17 15 21 25 27 38
Inventory Days 91 118 98 97 108 97 84 96 77 90
Cash In/Cash Out Ratio 1.50 1.88 0.96 0.99 1.10 1.50 1.49 1.45 1.44 1.41
CFO/PAT 1.36 0.00 0.75 1.05 0.51 0.60 0.95 0.88 N.A N.A
Gross Margin 59.78% 55.97% 65.95% 61.27% 59.40% 55.11% 59.50% 53.72% N.A N.A
EBITDA Margin 22.56% 20.43% 20.46% 22.74% 21.44% 21.13% 19.53% 11.08% 14.31% 13.51%
Net Margin 13.04% 11.45% 11.30% 12.31% 12.32% 12.50% 11.24% 5.80% 8.44% 6.29%
Capital Turns 3.26 2.24 2.40 2.30 2.35 1.86 4.19 3.82 4.10 3.58
Fixed Asset Turns 6.42 5.49 4.52 4.67 4.68 7.26 8.84 7.80 8.32 7.85
Total Asset Turns 3.00 2.14 2.28 2.00 1.69 1.46 3.94 3.67 3.94 3.57
RoA 39.14% 24.52% 25.76% 24.57% 20.79% 18.30% 44.28% 21.31% 33.27% 22.46%
RoE 54.28% 47.31% 40.00% 36.43% 30.79% 25.15% 90.90% 63.32% 101.54% 57.56%
RoCE 63.12% 39.62% 40.80% 39.68% 33.03% 29.29% 73.68% 37.08% 51.77% 42.98%
RoIC 47.59% 28.49% 29.13% 31.58% 31.96% 24.05% 50.89% 26.94% 39.73% 30.72%

Growth Rates:The company has been growing atphenomenalpace.The numbers speak for themselves.

Solvency &liquidity:The companies solvencypositionhas improved drastically over the years.The financial leverage ratio has almosthalvedand the debt to equity has reduced to less than 25% of its value in FY03!The company can take care of all its liabilities in little over two years with its current earnings,the ratio has followed a declining trend and is a third of what it was 10 years ago,this indicates significant improvement in both liquidity and solvency.

Efficiency:The company has become more efficient over the years.It virtually takes no time to collect money and the trend of debtor days is reallyexciting.The inventory days also has followed a decliningtrend.The company is also able to hold cash much longer than it use to 10 years ago,evident from the near consistently declining cash in/cash out ratio.

Cash backing:The erratic trend of CFO/PAT can be a matter of concern.It has been very low(and once negative) in last 10 years.

Margins,Turnover & Returns:The gross margins have remained high with minimum variation,EBIDTA Margin has near doubled and Net Margin has more than doubled over the years.The turnovers have declined marginally over the years and the return ratios has improved except ROE.

Some qualitative aspects worth noting:

High quality processed input: The processing of elastic and knitted elastic is done in house,Through this it maintains the quality of its product.The elastic used issophisticated and does not leave marks on the skin,this gives both male and female customers the extra comfort and feel good factor.

Economies of scales: The company'scapacity for undergarments is 90 million pieces per annum,for elastic 29 million meters per annum,for knittedelastic is 14 million meters per annum,forsocks is 4.4 million pairs per annum and for other garments also the numbers are significant.The company hasworkforce numbered 13,000 people with manufacturing operations spread over ten plants in Bangalore, totaling 1,050,000 square feet of space.The numbers are huge and by far it is the largest undergarment manufacturer in India and hence yields significant economies of scale.

StrongDistributionnetwork: The companycommands wide spread pan India distribution encompassing over 23,000 plus retail outlets in 1,200 cities and towns and has revolutionized the innerwear market by launching exclusive JOCKEY outlets across India numbering 79 as of September 2012.

Consumer Monopoly: The company sells undergarments which has above average penetration in urban areas and low in rural areas.The companies under garments fall in the price range of Rs.100-Rs.350 for men and women.The product is of high quality and durable too.Its target customersvary across the spectrum.The maximum price realization products made up of knitted elastic are intended for Urban upper middle class and above segment.This segment commands significant brand loyalty because of the quality of the product at reasonable price compared to companies selling reasonable product.These customers stick to the brand as long as they are not very unsatisfied with either quality or price.This gives the company decent pricing power.In thehierarchy of priority this comes probably in the middle to higher segment of necessity.On an average a customer buysat least two pair of undergarments in a year generating ~Rs.600 revenue for the company.In the lower segment its deep distribution network ensures healthy sales.The Products are fairly inelastic.

Licence:Page Industries Ltd. are the exclusive licensees of JOCKEY International Inc. (USA) for manufacture and distribution of the JOCKEY brand Innerwear/Leisurewear for Men and Women in India, Sri Lanka, Bangladesh ,Nepal and UAE till 2030. Page Industries is also the exclusive licensee of Speedo International Ltd. for the manufacture, marketing and distribution of the Speedo brand in India.

Future growth engine:

1. Womenâs inner wear was largely dominated by unorganized and low end players, thus leavingthe womenâs premium inner wear market largely under penetrated. Page, with the Jockeybrand and strong distribution reach has successfully penetrated this segment.

2. The company is now into manufacturing and distribution of swim ware of Speedo.The sales of which are expected to go up with the increase indevelopmentofapartmentsandcomplexes withswimming pools.

3.The largely unpenetrated Rural market where +70% of India leaves,its distribution licence forSri Lanka, Bangladesh ,Nepal and UAE (where the company has sold very little) defines pretty much a very wide scope for expansion.

8

I believe Bluedart would also be an appropriate candidate in this section. Fantastic performance period of time but still kind of under the radar due perhaps to low liquidity (but thats primarily due to the high stake held by promoters and other long-standing public investors)

regards

9

Thanks Shrey, very nice details. I am inquisitive to know

Cash In/Cash Out Ratio - High would mean a lot of inventory. I remember you had pulled the data for Nestle (not comparable) and it was around .03.

Can you please help me what does CFO/PAT indicate? Would it mean the total cash generated from operations to the PAT component…hence lower the ratio better it is?

Thanks

Supratik

10

Relevance and experience â Each of these brands have innovated either their product offering or their promotion at regular intervals such that they increase relevance / relation with the target segment.

a. Asian Paints started a gallery in Mumbai to give consumers a feel of how a certain shade would look like. I have read online that the experience of visiting this store gallery was splendid.

b. Titan started with watches but later introduced jewellery, eye wear and other accessories to stay relevant.

c. Pidilite started Hobby Ideas to directly connect with the consumers and offer them an in-store brand experience.

d. Page Industries never offers discount in any of its stores. This gives the brand bit of a snob value (which is a big deal for generation Z). Off late they have also gotten into women innerwear (an effort to increase relevance).

11

Also, CRISIL may not be a good fit into this; it isnt really consumer facing rather business facing (which would include IT stocks as well as a bunch of others); perhaps that could be another thread

over a long

12

Hey Supratik,

Cash In/Cash Out Ratio interpretation runs opposite to theconventional interpretation.The formula for cash in cash out ratio used here is:** inventory+debtors/current liabilities**.The lower the ratio the better for the company as the company gets to hold on to cash for longer period of time, either by holding lower inventory or lower debtors or both or by paying creditors(suppliers of raw material) late,or all at the same time.Getting to hold cash for longer period is always a good thing.The ratio can be more meaningful and will reflect a better picture, if short term borrowings if at all any are subtracted from current liabilities.

CFO/PAT is basically a risk based measure,it measures what percentage of the net income is backed by cash.It ideally should be close to 1 and should not fluctuate wildly.

13

Thanks a lot Shrey for helping me with this explanation

Regards

Supratik

***************** fluctuate wildly.

14

Good question/suggestion Supratik.

If we think about this properly, its essentially 3 important characteristics that we want to see in these businesses, demonstrated well over a long enough period (say 10 years atleast).

1). Consistently high (incremental) Return on Equity

2). Consistently low Capital Intensity (negligible capex and low/neg working capital)

3). Consistently high Dividend Payouts (say excess of 40%)

These kind of businesses don’t need much capital to grow, are able to throw out lot of cash, leading to higher total returns (Capital appreciation+ Dividends) usually.

To appreciate this better - how significant a combination these are - it may be a good idea to go through this excellent video presentationFinancial Equivalents of the Optical Illusion Link: http://www.youtube.com/watch?v=EyRlrjl4eKE by Rajiv Thakkar, PPFAS driving home this point

15

digdeeperinto thequantitativeand … reallyexciting.The decliningtrend.The

Hey folks,

Please make a note that the comments regarding the efficiency that i have made areerroneous.I interpreted another company’s data thinking it to be Page Industries.Sorry for the confusion.The efficiency numbers speak for themselves and there is not much to be elaborate actually.

Regards,

Shrey.

16

Shrey/Ayush, other Accounting experts

When you say CFO/PAT should be close to 1 - I notice this is true mostly for FMCG or other consumer facing non-fmcg companies (who are working capital efficient?).

In these cases only Depreciation & Amortisation costs are the Non-Cash items added, is that the reason for ratio close to 1?

We also see several companies with CFO/PAT consistently above 1 but usually around 2x or 3x - Exide industries, Glenmark, Ajanta Pharma to mention a few. As I look through I can cite more.

For the benefit of us all who are learning on-the job/have not been trained in accounting, perhaps you would like to elaborate some more on this aspect. This will help us really get it. Some base level queries like

1). âIf cash flows from operations are consistently lower than net income, what could this be an indication of?

)- aggressive revenue accruals, channel stuffing, what else

2). âCan a company showing increasing operating cash flows relative to net income be in financial distress?

)- If yes, in which cases

3). “CFO/PAT is basically a risk based measure”. Please elaborate what kind of risks (other than malpractice which we covered in 1 above)?

)- e.g. an earnings slowdown in the offing? what else?

because it appears that the occurrence of rising earnings combined with falling cash flow doesn’t necessarily imply accounting shenanigans".Accounts receivables could increase because customers donât have the cash to pay.An unforeseen sales slowdown could push inventory levels up. We see these things all the time.

-Donald

17

Cash FLow is Cash and is a Fact: Net Income is just an opinion

Nice working paper from IESE business school that covers some of my questions above.

I was particularly looking for this one:

When is Profit after Tax (PAT) equal to Cash Flow (or close)

When the company is not growing, buys fixed assets for an amount identical to depreciation, keeps debt constant, and only writes of or sells fully depreciated assets.

Another case is that of a company that collects form its customers in cash, pays in cash to its suppliers, holds no inventory stock (these 3 conditions can be summarised as this company’s working capital is zero), and buys fixed assets for an amount identical to depreciation.

18

Hey folks,

Here is snap short of another company CRISIL, that provides a unique service.It is not consumer facing, but its strong underlying business economics, consistent track record and its direct linkage to economic activitymakes it worthdiscussing .Please Include this too in the discussion.

CRISIL
CRISIL LTD. SALES EBITDA PAT EPA MKTCAP TOTAL RETURN CFO
5 YR CAGR 18.71% 21.73% 25.33% 19.80% 22.40% 46.81% 38.43%
3 YR CAGR 22.40% 13.97% 13.31% 3.89% 45.72% 47.84% 22.24%
1 YR GROWTH 28.25% 20.73% 0.46% 23.79% 31.74% 34.47% 78.35%
CRISIL LTD. FY 2012 FY2011 FY2010 FY2009 FY2008 FY2007
Financial Leverage 1.00 1.00 1.00 1.00 1.00 1.00
Total liability/Earning 1.43 1.08 1.25 1.16 1.65 1.48
Debt/Equity 0.00 0.00 0.00 0.00 0.00 0.00
Interest Coverage N.A N.A N.A N.A N.A N.A
Working Capital/Sales 21.44% 23.10% 24.95% 21.45% 10.40% 11.13%
Debtor Days 40 64 63 55 82 85
Inventory Days N.A N.A N.A N.A N.A N.A
Cash In/Cash Out Ratio 0.30 0.49 0.46 0.48 0.65 0.73
CFO/PAT 1.26 0.71 1.08 1.17 0.85 1.02
Direct margin 55.64% 58.18% 60.68% 62.14% 61.84% 59.37%
EBITDA Margin 35.22% 37.42% 40.63% 38.22% 31.86% 29.30%
Net Margin 25.94% 33.11% 30.27% 27.68% 20.88% 21.57%
Capital Turns 2.01 1.69 2.10 2.16 2.35 1.92
Fixed Asset Turns 3.52 2.76 4.42 4.03 3.10 2.44
Total Asset Turns 1.93 1.57 1.22 1.42 1.45 1.51
RoA 49.94% 52.09% 37.06% 39.32% 30.26% 32.52%
RoE 49.94% 52.09% 37.06% 39.32% 30.26% 32.52%
RoIncE(1yr) 1.55% 50.48% 22.46% 86.75% 43.33% N.A
RoIncE(3yr) 19.03% 26.59% 37.28% 67.70% 163.08% N.A
RoCE 60.60% 53.47% 46.32% 50.48% 40.51% 40.03%
RoIC 45.70% 41.35% 61.06% 57.01% 50.01% 38.23%

*Definition of a few new Items included in the frame work.

Total return CAGR: In this i have approximated the total return by adding all the dividends of the years between initial and final to the final years market cap and then calculated the return CAGR using that Market cap. (Eg:For 5 year CAGR i have added year last 5 years dividend to the current years market cap and then computed the CAGR for the period)

Direct Margin: As the company is a service company,it does not have a gross margin.But it does have a direct cost that is employee cost.This cost has beendeductedfrom net sales to determine the direct profit,from which direct margin has been derived.

RoIncE: it is incremental return on incremental reserves over the period.Here we take a period long enough so that the company incurs all its expenses that it has to,to maintain its operations(including CAPEX).the formula is RoIR=(PAT(of current year)-PAT(of initial year(in this case FY07))/(sum of (PAT-Dividend) from a year before current year to 1 year prior to initial year)

Some quantitative aspects worth noting:

Growth rate:The company has registered healthy growth rate,which has accelerated (1Yr>3Yr>5Yr).Whereas the profits have increased,but its growth has been lower than growth in the near term,probably because of the increased direct cost(employee cost).

Solvency:The company is totally debt free!Its amazing considering its size(sales size of Rs.800 crs).Its the underlying economics of the business that makes it less capital intensive.

Liquidity:The company's requirement for working capital to generate sales has almost doubled over the years,with that the declining cash in/cash out ratio,which has almost halved over the years, gives an indication that the company is probably holding a lot of cash.Apart from the cash holding the company's liquidity position looks strong as it has no short term borrowings.

Margins,Turnover and Returns:The margins have fluctuated,but are high and indicate that the company operates in a monopolisticenvironment.The turnover ratios have declined except the total asset turnover.The probable reasons for decline in capital turns are Increase in net working capital requirement and opening of a second researchcenterin Buenos Aires, and a new research centre in Pune, whose benefits are yet to be reaped.This picture may improve as the global economicscenario improves and the fund raising activity picks up.(The turnover declined significantly in FY09,because ofdeclinein fund raising activity due to adverse market condition of the economic slow down).stand alone returns have increased over the period,except ROIC. The incremental returns have declined over the years,the trend is pretty clear in the 3 years ratio.

Some qualitative aspects worth noting:

Suppliers: It is the man power which is the major input for the company.The company's employee cost has gone up in the recent years significantly.But looking at the cue of the aspirants outside the CRISIL's office on an Interview day(the numbers run into thousands for 20 or less openings) and the fact that It is considered to be apreferredemployer by job aspirants,gives the company high bargaining power with its suppliers.

Types of businesses: It draws ~41% of its revenue from rating segment in which it has a near monopoly with a market share of +50%,it has rating outstanding on 10500 companies.It has highest operating margins in the rating segment (~43% ,6 yearsaverage).it has rated 2/3 of the total corporate bond issues,45 Banks that account for 90 % of Indian banking industry are its customers.It has a client base~500 large companies in the CP/Bond Rating.It has a client base of ~9000 large and medium companies in Bank Loan Rating segment.It has 35000 SME clientsand has a strong monopoly in this segment.

Due to its established position and credibility it has been able to establish itself as a significantresearchhouse too,which is the second highest margin segment (~31%,6 years average),this segment contributes 52.5% to total revenue.it Serves more than 1200 Indian and global clients. 90% of banks in India, 22 of 30 Indian companies (by market capitalization), entire mutual fund industry, 19 out of 23 life insurance companies and 4 of top 5 global consulting firms.In the research industry too it enjoys high margins.

Innovative strategy for growth with limited resources:In the SME Rating Segment.the company started by scratching the surface with 3,500 employees.To expand reach and still maintain the quality of analysis,The company came up with an innovative way ofoutsourcingitsdata collection activity to accounting firms.But to ensure the quality the core analytical activity, which includes the analysis and discussion with the management, was done by inhouse team in every single case.The process is still very much the same and has ensured faster growth in this segment.With 20-25 million SMEs the market isunder penetrated and the company is well positioned to capitalize on it.

UniqueTemporaryProblems:The company's core business rating has not done well in last 3 years,evident from the decelerating revenue growth.This has been due to the economic slowdown and a slow recovery.However,with improving conditions the fund raising activity will soon pick up and will drive revenue growth in the segment.

19

Wonderful thread (amazing value pickr:)).

Can wefit Supreme Industriesin this long-standing non-FMCG list?

20

While going through this thread, came across this ratio cash-in/cash-out. I am still perplexed how this ratios adds value over to “working capital/sales” ratio already available for us ?