The big is getting bigger. Profits in India and across the world are getting concentrated in the hands of fewer & fewer companies. 75-90% of India's profit are being given by ONLY TOP 20 companies of India. A detailed study on the broader markets has already been published by Marcellus Investments through their newsletters. Let's look at some of the key highlights (selection & emphasis ours) from the same.
Key Highlight 1 On Profits- The 20 Leviathans in India now generate 70% of the country’s profits, up from 14% thirty years ago. The rise of India’s networked economy (highways, cheap flights, broadband, GST) has allowed large, efficient firms to use superior technology & better access to capital to squash smaller competitors. In line with what is being seen in the US, the growing dominance of a handful of very large companies in India is changing the template of capitalism in India.”
Key Highlight 2 on Free Cash Flows - "The top 20 Leviathans are also accounting for a growing share of the free cash flows generated by Indian companies. Nearly 60% of the country’s free cashflows now come from the top 20 Leviathans" .
" The reason for the lower share of the Leviathans in FCFE rather than PAT is because these giant companies are heavily reinvesting their PAT to fuel future growth. This reinvestment reduces their FCFE (since FCFE is calculated as operating cash flow less Capex plus net debt issued)."
Key Highlight 3 on ROEs - "In FY20, the median ROE of the top 20 Leviathans was 17.2% whereas India Inc’s average ROE was a mere 4%! This means that the top 20 firms are not just putting greater amounts of money to work, they are also applying these larger sums of money far more effectively and far more profitably than the rest of India."
Key Highlight 4 on causes behind Such Concentration of Profits in hands of few companies - "Superior access to capital, talent, tech, management focus on implementing latest changes quickly and most importantly Superior ability/strength when it comes to dealing exogenous shocks"
"Due to heavy investments in intangibles like brands, R&D, technology conventional idea of diminishing returns to scale is being replaced by businesses that are generating increasing returns to scale. Increasing returns basically mean the tendency of returns (on the goods produced or the services provided) to keep increasing as output increases whereas diminishing returns imply the opposite."
Key Highlight 5 on how Changing Indian economic landscape is helping big players to grow -
"Over the past 30 years the Indian economy has not only become more integrated with global capital and trade flows, it has also transitioned from being socialist economy (which used to have Soviet-style 5 year plans) to a more free market economy (where the role of the state is gradually but steadily reducing)."
"The corporate performance of the Leviathans is more immune to these shocks than the performance of smaller companies because the Leviathans have stronger balance sheets (and better access to capital) and superior access to talent & tech (which, ironically, allows them to adjust to shocks like GST, Covid-19 quicker than their smaller competitors). So, in common with what happened to the USA and Japan in the decades where they transitioned from being closed economies to open industrial economies (in the USA this happened in the 50 years between 1880-1930 and in Japan this happened in the 40 years after World War II)"
Key Highlight 6 on Churn rate in Leviathans - "Underneath the big picture of the rising dominance of the top 20 PAT generators is another story of churn: on an average, the decadal churn rate since FY02 has been 57% whereas the FY10-20 period saw the top 20 list churn by 45%."
"Every single exiting company is either a public sector entity and/or hails from a heavily regulated industry where manipulating the regulatory levers used to be the name of the game. Barring Coal India (which listed in FY11), Power Grid, GAIL and Power Finance Corporation, the majority of the entrants into the Leviathans list are private sector companies which have used skill, and superior access to capital, talent & technology to build world class businesses."
Key Highlight 7 on doing DCF valuations of such Leviathans - "A better way to value dominant market leading franchises we believe is to carefully calibrate the length of stage 1 in a typical 3-stage DCF model (where stage 2 is the fade period and stage 3 is perpetuity growth). In order to forecast the free cash flows of the company in stage 1 for a 15-30 year period, even the intangibles and the qualitative factors need to be incorporated in the DCF model."