Please find below key excerpts (emphasis ours) from three brilliant newsletters published by outstanding team at Marcellus Investment Managers. The key focus of these three annual letters was to make us understand through case studies why big can become bigger and how to analyze future topline of businesses.
Consistent compounders who have grown well maintaining or increasing their ROCE's over last 15-20 years have following characteristics:
a) Demographic Dividend: Orienting their product portfolio towards a high volume of small ticket day-to-day essentials in a country which offers a long run-way for growth in middle class household consumption
Case Study: Relaxo
"India’s footwear industry is approx. Rs 40,000 crores in size. Relaxo’s revenues only Rs 2,300 crores (approx.) i.e. less than 6% of the market. 70% of the footwear industry is unorganized and the industry is likely to undergo a consistent shift from unorganized to organized footwear as GST compliance increases, aspirational consumption rises and customers look for better quality branded products. Products with a price point of Rs 2,000 or higher contribute to less than 15% of the overall market. Relaxo is the largest organized player in the economy segment of the industry because its inhouse manufacturing enables it to provide superior quality products at affordable price points (average revenue per unit sold for Relaxo stood at Rs 125 in FY19), backed by an aspirational brand recall (Sparx, Relaxo, Flite, Bahamas etc) and an efficient distribution network."
b) Ability to grow Revenue even from seemingly looking large base
Case Study 1 : Relaxo
"Provided Relaxo continues to sustain and enhance its competitive advantages, it should not be difficult for the firm to increase its market share from 6% currently to 12% or higher over the next 10 years. Mathematically, doubling of market share over a decade contributes 7% to revenue CAGR. Alongside, if the overall footwear industry continues to grow at 10% CAGR or higher over the next decade, the runway for growth doesn’t appear to be a constraint for Relaxo"
Case Study 2: Curious Case of HDFC Bank & Bajaj Finance
"HDFC Bank’s loan book size is around Rs 9.5 lakh crores currently (Rs 9.5 tn). JP Morgan Chase, one of America’s largest banks is only 7 times bigger than HDFC Bank in terms of loan book size. If HDFC Bank keeps compounding at 20-25% CAGR, it will become as big as JP Morgan Chase in a decade! Given the slow pace of financial inclusion in India, and the low per capita household income compared to the US, how can HDFC Bank become as large as US’s largest retail bank after only 10 years?"
"Bajaj Finance’s customer franchise has increased from 35 lakh (3,500 K) customers 10 years ago, to 4 crore (40 mn) customers today. At this pace, Bajaj Finance’s customer franchise will increase to 40 crores (400 mn) by 2029. With only 25 crore households in India today, achieving a customer base of 40 crores might mean that there is a Bajaj Finance customer in every household of the country after a decade."
The Right Mindset:
Credit (loans) in the Indian banking industry has grown at 13% CAGR over the past decade, broadly in line with India’s nominal GDP growth rate. HDFC Bank currently has 7% market share in this industry and Bajaj Finance has approximately 1 % market share.
HDFC Bank and Bajaj Finance are amongst the best placed lenders in terms of their access to low cost funds (liabilities side of the balance sheet) and their ability to grow their loan book ahead of their competitors, particularly in the aftermath of the ongoing financial crisis. Both these banks have also demonstrated their ability to use technology as an enabler to manage high quality of large volumes in small ticket size loans as the external environment evolves whilst also widening the basket of products being offered to their customers.
Hence, if the broader credit industry continues to grow at a rate higher than 10% CAGR over the next decade, and within that if firms like HDFC Bank and Bajaj Finance double (to 12%) and treble (to 3%) their market share respectively, the current size of these lenders won’t be an impediment to growth.
To draw a parallel – it is true that America’s largest bank JP Morgan Chase is only 7x bigger than HDFC Bank, and only thrice as big as State Bank of India in terms of its loan book size. However, it is also true that China has four state owned banks – ICBC, China Construction Bank Corp, Agriculture Bank of China, and Bank of China – each of these is twice as big as JP Morgan.
b) Executing business expansion through institutionalized systems and processes
"consistent compounders has been a strong focus on institutionalizing: a) IT investments in distribution and sales; b) professional empowerment of high quality talent; and c) strategic decision-making through an empowered and independent board of directors."
c) Minimizing product price hikes
" price elasticity of demand being particularly high in low-ticket size product categories of day-to-day essentials, most Consistent Compounders minimise product price hikes while focusing on operating efficiencies to protect their profitability over time"
Case Study: Asian Paints & Dr. Lal pathlabs
" over the last couple of decades, Asian Paints has hiked product prices on a like for like basis by around 2.5% CAGR. Similarly, over the past 3-4 years, Dr. Lal Pathlabs has not hiked prices for its diagnostics tests at all."
d) Successfully expanding their product portfolio over time in adjacent product categories
Case Study: Page Industries
"Page Industries started its business in India with only mens innerwear 25 years ago – a category which is ~Rs 10,000 crores in category size currently. However, today under the same brand Jockey, Page has successfully expanded into women’s innerwear, leisurewear (outerwear), and kidswear – a total category size of over Rs 40,000 crores currently."
"Bajaj Finance was focused predominantly on consumer durable loans 8-10 years ago, today consumer durable loans contribute to no more than 10% of its overall loan book with the balance being diversified across home loans, business loans, personal loans etc. "