What is the company’s growth plan?

One must understand the opportunity size and look at the company’s growth plan to tap into the opportunity.

Company can grow on external funding but that may not be sustainable

Capacity expansion

If a company is expected to get more orders that will mean that the company needs to produce. In case the company does not have sufficient capacity to produce they need to set it up. This means that the company must set up new capacity or a factory. Usually setting up a new capacity takes a while. The company will be informing shareholders about these plans via annual and quarterly updates. Be on the lookout for companies that are expanding capacity. Also, be aware that capacity increase on its own is not the only thing because often companies commit to capacity expansion based on an aggressive future. If the plans don’t materialize, expansion is a wasted activity.

New product launches / Business diversification

A company must regularly launch products and create a new market. This is important for both consumer-facing companies as well as business-to-business companies. A consumer-facing company says an FMCG must regularly launch a product to capitalize on the brand name example Nestlé launching products across different categories. A business-to-business company must take feedback from its clients and work on those products. This will help them not only to grow the revenue line but also ensure that the customers stick to them.

New geographies/Exports

There is a limit to how much the market can expand within a certain geography. This is the reason that a company must go beyond its local geography. This may include moving to a different location for example DMart, which was primarily dominant in Maharashtra is now moving elsewhere. Similarly, an auto manufacturing company say Suprajit engineering caters to a lot of clients in Europe.

Mergers & Acquisitions

Product development or moving into new geography is a long process. A lot of companies to reduce the gestation period may acquire a product that is already consumed by people. Or it may acquire a company in a different geography. This sounds simple however mergers and acquisition history is not very positive. If you look at companies that have done a lot of M&A, the value creation is quite limited. There may be an example of companies like Motherson Sumi that has created immense wealth by doing mergers and acquisition activities.

Funding for the growth

Merely knowing a company’s growth plan is not enough. It is equally important to know it will be funded.

There are 3 forms of funding –

1. Self-funded i.e., through internal accruals

2. Externally funded i.e., through debt and/or equity

3. Mix both (1) and (2).

Growth through internal accruals is usually a recommended approach. If a company is regularly diluting its equity for growth, it’s not a positive sign.

Disclaimers

• Investment in securities market are subject to market risks. Read all the related documents carefully before investing.

• The securities quoted are for illustration only and are not recommendatory.

• Registration granted by SEBI, membership of BASL (in case of IAs) and certification from NISM in no way guarantee performance of the intermediary or provide any assurance of returns to investors.

Details of the advisor

• Advisor: Ankur Kapur

• SEBI RIA No.: INA100001406

• BASL Member ID: BASL1337

What are the addressable market opportunity and their key drivers?

This is a very important aspect to research the kind of themes that can play out in the future. Someone who had invested in Colgate in the 70s did the right investment. They anticipated dental hygiene growth in India. However, with a 50% plus market share of Colgate in India, the growth opportunities are now limited. The same theme will not extend in the future.

Look at sectors that stand to gain

The investor must evaluate the current economic environment to understand what can play out in the future.

One of the ways to look at sectors is to filter those that have a history of generating a high return. Or the other way is to avoid sectors that generate a low return. Here is a McKinsey report that shows ROIC across sectors. Focus on sectors that generate more than 15% per annum.

Here are a few of those themes:

Wealth management

As per the recent Morgan Stanley report, the number of households earning more than US$35,000 per year (~Rs 25L) is likely to rise fivefold in the coming decade, to over 25 million. This has a lot of implications but simply speaking, there will be more surplus income. This will lead to more business for asset management, broking, depositories, and wealth management companies.

Manufacturing

Here is a report indicating Performance Linked Incentives (PLI) across the industry announced by GoI in March 2020. This can be one way to look at sectors that can reap the benefit of PLI and China + 1 theme. The story of Apple manufacturing the iPhone in India is a reality now. In the future, we may hear more such news. Be on the lookout for companies that operate in the sector to reap the benefit.

PLI Scheme by industry

Watch out for electronics and semiconductor space in India.

Financial sector

The government’s initiative across digitalization (eSign, Aadhar, UPI, ONDC, OCEN) is bound to help the financial sector. India stands to gain due to the push of digitalization. This should help in creating ease of transaction, and an increase in client base for banks/NBFCs with reduced NPAs due to the tracking mechanism.

Energy

As per Paris Accord, our Prime Minister Narendra Modi announced five key commitments: 1) to increase the country's non-fossil-fuel energy capacity to 500GW by 2030; 2) to fulfill 50% of its energy requirements from renewable sources by 2030; 3) to reduce its total projected carbon emissions by 1bn tons by 2030; 4) to reduce the carbon intensity of its economy by 45% by 2030, and 5) to achieve net zero emissions by 2070.

These are extremely high targets and we may not be able to achieve them all. However, even if we partially achieve this, it will help reduce the oil import bill and manage inflation better.

Sectors that operate in the renewable energy space including EVs stand to benefit.

Real estate

India should hit a major inflection point for the next residential property boom in 2030 – a confluence of high per-capita income, a mid-30s median age, and higher urbanization. After a long gap, the real estate sector is showing positive signs. With growing commercial and residential real estate demand with improved regulations (RERA), the real estate sector stands to benefit.

The investor must evaluate ancillary sectors as well. This means from an industry standpoint, not just developers have to be evaluated but also cement, paint, sanitaryware, faucet ware, plywood manufacturer, etc. stand to gain.

Defense sector

The government has plans to procure Rs5trn of military equipment domestically over the next five years. India aspires to become an importer of defense equipment to exporters now. A lot of money has already moved into the defense sector over the last few quarters. This is a long-term theme and a prudent investment in the same stands to be beneficial.

Consumption theme

As the general wealth of people is increasing in India, there is increased spend across sectors including travel, apparel, eCommerce, jewelry, food, beverages, etc. Over the next decade, we may see multi-baggers from this theme.

Each sector and its associated sectors have to be evaluated like a detective. The idea should be to reject the sectors for any issue such as high leverage, slow growth, low ROIC, poor management, corporate governance, etc. In case you are not able to reject, then start doing an in-depth analysis.

Disclaimers

• Investment in securities market are subject to market risks. Read all the related documents carefully before investing.

• The securities quoted are for illustration only and are not recommendatory.

• Registration granted by SEBI, membership of BASL (in case of IAs) and certification from NISM in no way guarantee performance of the intermediary or provide any assurance of returns to investors.

Details of the advisor

• Advisor: Ankur Kapur

• SEBI RIA No.: INA100001406

• BASL Member ID: BASL1337
  

Does the company enjoy an Economic Moat?

An advantage that the company enjoys in comparison with the competition.

An advantage over competition

What is an Economic Moat?

A term given by Warren Buffett means that there is some competitive advantage that a company enjoys. Traditionally a castle would be surrounded by water with deadly animals including crocodiles, piranhas, etc. so that enemies could not enter the castle. The same concept is applied to businesses. An advantage that the company enjoys in comparison with the competition. An Economic Moat keeps the competition at bay.

One of the ways to understand whether a company enjoys a competitive advantage is to look at the return on invested capital. If a company generates ROIC substantially higher than its cost or on a sustainable basis ROIC > 15% per annum, there is some competitive advantage.

What can be the source of competitive advantage?

• Strong brand leading to customer loyalty – Nestle India

• Patents – Google

• Wide distribution network or service network – ITC

• Switching costs – Microsoft Excel

• Proximity to key raw materials and markets – UltraTech Cement

• Cost advantages due to scale – Dmart

How can an economic advantage fade away?

• Disruptive competition – Jio vs Airtel

• Drastic regulatory change – Price cap during the pandemic on certain pharma companies

• Capital misallocation by the management – Airtel buying Zain Telecom’s Africa assets

Disclaimers

• Investment in securities market are subject to market risks. Read all the related documents carefully before investing.

• The securities quoted are for illustration only and are not recommendatory.

• Registration granted by SEBI, membership of BASL (in case of IAs) and certification from NISM in no way guarantee performance of the intermediary or provide any assurance of returns to investors.

Details of the advisor

• Advisor: Ankur Kapur

• SEBI RIA No.: INA100001406

• BASL Member ID: BASL1337