In part 2 we understood that a increase in penetration levels, per capita consumptions, organized market share, industry size to GDP % can lead to great growth in an industry and for companies operating within that industry.
Let us again present some of the current penetration levels, Organized Vs Unorganized Market, expansion of target market, Industry as a % of GDP etc. in some product categories in India
These data point were presented in a brilliant presentation by Oaklane Capital's Fund Manager & Veteran investor Mr. Kuntal Shah.
A catch here is just seeing low penetration level, Low Per capita consumption, low organized share, expanding target market etc. should not excite you.
Basically what a lot of analysts end up doing is either:
a) Assuming the historical trend will continue without understanding the causes of that change
b) Benchmark India against countries like China, US, Europe etc. to establish that even India can reach that level of penetration, per capita consumption, organized share, industry as a % of GDP etc.
An analyst needs to answer a few questions before coming to any conclusion. In the below section we have tried to answer those with as much simplicity as possible
Question 1: How do we actually come to a conclusion that current penetration levels or PCC is low? Does comparison & taking other developed nations (Like US, China, Europe) as target makes sense after comparing operational detail (stage of industry evolution, demographics, income levels, cultural aspects) of that industry?
Question 2: What are the causes of current low penetration or PCC levels and what needs to change to act as a catalyst/inflection point (consumer behavior, income levels, government support etc.) to increase penetrations?
Answer: We will answer both of the question below through a case study on Power Tillers market in India
Suppose we are analyzing the opportunity size of Power Tillers (basically in simple terms small tractors with two wheels) business in India. VST Industries has approx. 50% market share in Power Tillers Industry and sold approx 27,000 tilers in FY21. This leads to a industry size of approx. 54,000 Tillers.
Now you think what can be the potential market size of Power Tillers in India so that VST can keep on growing and you come across a statistics - That in around 2015 itself "Japan had 6 million and China 1.9 million power tillers in use in their farms."
You get super excited that India is Just playing into thousands right now but countries like Japan & China are into Millions. Such excitement is unwarranted, we need to check lot of angles before coming onto this conclusion. See our pointers below:
a) Where are Power Tillers generally used? - Let's see the below excerpt from VST Tillers AR FY 20
So here we need to compare few things between India, China & Japan
First, what is arable Land as a % of total Land and what is per capita arable land in these countries (Basically if both these indicators are low that means the country needs to have high productivity in agriculture as they have very low cultivable land which can support population) - If these are comparable it will show that demand for tillers should be same across countries.
China Per Capita Arable Land:
Japan Per Capita Arable Land:
India Per Capita Arable Land:
Arable Land as % of total Land World Data:
The above data points clearly indicates that Japan has very low per capital arable land as compared to India/China and Japan and also very low % of Arable Land (only 12.5%) hence they need to be very efficient with production to support the population food demands hence obviously they will have higher consumption of farm mechanization equipment like Tillers.
See this dilutes your excitement regarding even we can sell like Japan. But still the difference is huge between India & Japan and especially between India & China as at least till now their demographics seems comparable. Even if we take japan the difference seems huge as it has approx. 1/4th arable land/per capita land than India
that might mean they require approx. 4 time more productivity than India that broadly means the difference between Tillers sold in Japan should be 4x than India but the difference is 120x. Also a good point to note is that area under cultivation because basically its the area of land on which tillers will be used. Japan and China both have much lower areas under cultivation but still much higher Tillers demand. We than might need to dig more.
2 - Do even these countries have fragmented land like India? (Because generally Tillers are used more on fragmented lands - small parcels of land)
Japan:
China:
India:
USA
Japan, China and India all have extremely fragmented & small farms and the height of fragmentation can be clearly seen when compared to USA.
Fragmentation points to a clear direction that even in India than the consumption of Tillers should be extremely high like China & japan. Still let's go one more step further
3 - Do even these countries have crops like Rice as their major crop produced - Because as per VST AR FY21 rice has major usage of Tillers?
We should look at both the quantum of rice produced and area under cultivation for rice
Japan Qty of Rice
China Qty of Rice
India Quantity of Rice produced
The above Data clearly suggests that India in spite of producing 20x more rice and approx. 70% rice of China lacks far far behind in usage of Tillers. This is the point where we get a bit confident that Tillers Consumption should be High and India is currently at very low levels.
Hence in this scenario we can a bit more confident about penetration levels of Tillers increasing in India to a level comparable to China & Japan in future.
Note: None of our team members is invested in VST Tillers. Neither we are SEBI registered advisors & not in business of advising investments. This is just a case study to teach the process of comparing Industry Level statistics. For all primary data around Tillers & crop patterns Visit: VST ARs, Power Tillers Manufacturers Association (PTMA), https://un-csam.org/sites/default/files/2021-01/RF2020.pdf and https://agricoop.nic.in/sites/default/files/pocketbook_0.pdf
As always there has to be some catalyst that can push penetration number up and it's very important to think what has been holding consumers from increasing this consumption till now. For example in our Tiller scenario it was lack of farm power, proper financing/credit, lack of awareness in the farmers, stable subsidy regime by governments and low farm incomes. But this has started changing. Let us present a few snapshots from the concalls of VST Tillers July-Sep quarter of FY22:
Although in VST Industries above the specific triggers points have been discussed but Trigger points can take varied forms. We have discussed some below:
a) Inflexion in Income levels & changing in spending Levels:
(Source: BCG Reports & Bain &Co. Reports)
Slowly and steadily over a period of time with increase in Per capita Income the number of families coming in Upper Middle class and High Class are increasing. Such shifts basically causes a change in spending pattern. As generally when income level rises above a certain level the expenditure on basic necessities remain the same and extra income is spent on Discretionary items like Cars, ACs etc leading to increase in their penetration ratios. Let us also share a brilliant diagram presented at one of the meet by Mr. Ramdeo Agarwal depicting this relationship:
b) Strong correlation with GDP growth: We will request everyone to read this blog here on how to analyze GD growth rates Vs Industry growth rates relationships. We have nothing new to add. https://marcellus.in/blogs/credit-growth-and-per-capita-income-an-unforeseen-relationship/
c) Externalities : For example Advancement in internet Data connectivity increased penetration of e-commerce companies leading to more per capita spending on branded clothing, organized retail, OTT platforms etc.
d) Disruptions from new business models - Basically how zero cost brokerages like Zerodha, Upstock, 5 Paisa has lead to increased penetration in Demat accounts by attracting first time investors
e) Geopolitical Effects & Government regulations: Like sudden focus on ESG investing & government actions leading to increase in penetration and per capita consumption of Renewable form of energy. Similarly regulations like GST, E-Way Bill, Demonetizations, RERA etc. leading to formalization of Indian Economy causing huge shift from Unorganized to organized segment (Either the business is shifting to organized big players as smaller players are shutting down shops called as consolidation of Industry example: this is playing out in real estate currently or Unorganized players are themselves becoming organized example: this scenario is playing out in textiles currently)
Question 2: Have we adjusted for difference in per Capita Income Levels while analyzing per capita consumptions?
Answer: According to us rather than comparing per capita consumptions of two economies an analyst should look at Relative consumption Index. For example if India there are 100 crs people and per person is earning a very low income of INR 1,00,000 per annum and spending 1,000 rs of that on travel is basically 10% of his income similarly in US suppose population is 40 crs and on an average income (in INR) is 10,00,000 it's obvious that they might spend INR 1,00,000 on travel which is basically same 10% of their income. But per capita consumption of US will be Rs. 1,00,000/- and India will be 1,000/-.
Hence we can't compare per capita consumption on travel of India Vs Per capita consumption of Travel in US and communicate that even in India sometime in future people will send Rs50,000 or Rs 1,00,000/- on travel. As that will be 50% or 100% of their income.
Hence the data that get's circulated like Per capita consumption of cars in US Vs China Vs India etc. makes little sense to us.
Question 3: Have we Adjusted for difference in Industry Size and GDP Difference?
Answer: Let's us quote an excellent piece of work by Kotak Institutional Equities here. Relative Consumption Index is a better metric to judge potential of under-penetration.
Question 5: What is the relevant timeframe we can assume in which we expect our expected penetrations levels to get achieved i.e. looking like those of developed nations or comparable nations? Have we analyzed Developed countries own evolutions of this metrics?
Answer:
Question 6 - Even if Penetration Levels don't increase too much but can target market itself increase?
In Part 2 in hypothetical example we saw that the target market itself grew from 15 to 18 people providing an opportunity to sell more candy. We took an assumption of future population growth rate same as historic growth rate and decrease in number of diabetic population.
In reality, such assumptions require strong understanding of a country's demographics age, sex, income etc
Assume we are analyzing alcoholic beverage industry here we can clearly see that because India has one of the highest % of young population and one of the highest % of population coming into legal drinking bracket over coming decade a logical expansion of target market makes sense.
Let's see a quote from Pernod Ricard Financial statements
"India is a fascinating market with sizable potential: more than 22 million people reach the legal age of alcohol consumption each year. That’s 220 million people over the course of a decade."
Also read this excellent blogpost by Ahmed Mahda, Deep Gandhi & Darshil Jain on Expansion in target market for broking industry due to entry of players like Zerodha:
Question 7: Is it a megatrend which will continue for coming 10-20 years?
Answer: For these let's straight away look at the following Excerpts (selected by us) From Marcellus Newsletter on megatrend in AMC's and a brilliant blog published by Jana Vembunarayanan on "Lay of Indian Banks" portraying megatrends in Private Banking
AMC Industry:
· If India’s per capita income – which is around US$2000 today – grows at 5% per annum (which is what it has done in the last 10 years) over the next 10 years, the country’s per capita income will be around US$3,300. AsÂsuming a population of 1.5 billion, this gives India a US$5 trillion GDP ten years hence. Assuming further that our household savings rate will stay at broadly 20% a decade out gives us annual household savings of US$1 trillion. At present, roughly half of household savings in India are in financial assets (the rest is in physical). If this ratio persists, then a decade out, annual household savings in financial assets should be around US$500 billion in India.
· Simultaneously there is also more money coming into financial assets through SMEs. As SME owners realize that they need to save more through financial rather than physical savings, they will start selling their real estate to invest in financial assets.
· The question is at what rate will this shift take place? As per RBI data, presently 95% of total Indian wealth is in physical assets. If this number drops by 1% point per annum (which is what our reading of the Credit Suisse World Wealth Yearbook suggests) then that implies that around $100 billion per annum could get added to the annual flow into financial savings.
· With potentially $500 billion of financial savings arising from annual income and with potentially another $100 billion arising from the balance sheet shift (from physical to financial), our back-of-the-envelope estimates suggest that the annual flow into financial savings could triple over the next decade (from US$200 billion today to US$600 billion)."
On Private Banking
"Banks play an essential role in supplying credit, which in turn helps drive economic growth. From 1998 to 2018, India’s GDP went up from $415 billion to $2.5 trillion, representing a CAGR of 9.9%. During the same period, advances given out by Indian banks compounded at 18%. Private banks compounded at a faster rate, 24%, by taking market share from the weaker public sector banks. Value migration from the public sector banks to private banks will continue as public sector banks still control 65% of all the advances in the banking system. It is a reasonable assumption to make that private banks will grow their advances at 2-2.5x GDP. "
Question 8: Can the company under discussion increase or maintain its market share? As per our assumed market share does the future size of company defies logic or base rates? Does management has ability or a history of scaling up into adjacent product categories?
Answer: Three case studies in form of Page Industries, Relaxo have been discussed below. https://www.finnacleshahclasses.com/forum/top-blogs-in-finance/how-to-identify-characteristics-of-great-businesses-the-consistent-compounders
We are presenting just a excerpt from above article which will help you understand how to connect industry level data with company specific execution through a case study of Bajaj Finance:
New customer acquisition and mining wallet share of existing customers: Out of BAF’s 49 million customers, 27 million customers are its best customers with whom BAF is willing to do business. BAF has another 90 million prospects that they are willing to do business with today and who in general have 80-90% approval rate. The digital infrastructure under business transformation 2.0 is being built to tap these 117 (90+27) million Indians who Bajaj Finance want to do business with. While BAF’s loan book size is only Rs 1.5 lac crores, the 27 million good quality customers have Rs. 6 to 7 lac crores of outstanding credit in India’s lending sector (in addition to the amount outstanding with BAF) thus providing significant headroom to mine wallet share of existing customers. The app based ecosystem will help in mining this wallet share not only on the lending side but also on the savings side through the investment and insurance marketplaces and the brokerage app.
We Suggest Following readings to understand this crucial topic much more in detail. Please find attached links below:
1. Motilal Oswal Next Trillions Opportunity/Winner categories, category Winner - 14th wealth creation study: https://www.motilaloswalwcs.com/wcs-series
3. Motilal Oswal Value Migration report - https://www.motilaloswalgroup.com/AnalystVideo/Pdf/906027005VALUE%20MIGRATION-MOSL-20170106-SU-PG0100.pdf
4. Michael Mauboussin - Base Rate Paper and Impact of intangibles on Base rates
5. FY 41 Guy on Nykaa - https://fy41guy.blogspot.com/2021/10/finance-gurus-on-twitter-pranam-this-is.html
6. BCG Reports on demographics
7. G Maran's (Unifi Capital) Know your country - https://www.youtube.com/watch?v=OCElrQmsPS8
8 - HDFC Bank - https://janav.files.wordpress.com/2020/01/hdfc-bank.pdf
9 - Utpal Seth (Rare Enterprise) Presentation on Megatrend hosted by Prof. Sanjay Bakshi at CFA Value Investing Conclave: https://www.youtube.com/watch?v=G1d-42_hZ0E
10. Presentation on Waves of Consolidation by Jatin Khemani (Stalwart Advisors): https://www.youtube.com/watch?v=AQgyd5xmLX4 (supporting article: http://stalwartvalue.com/3-wave-framework/ )
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