All the data below has been sourced from the Investor Diaries of Arisaig Partners, $471mn India Fund focussing on Consumer stocks in Asia. The Fund holds Colgate, Nestle, GSK Consumer, Marico, Godrej Consumer, Britannia and Jubilant Foodworks.
Approach: Our approach involves two stages:
Firstly, we try to predict the long term potential size of each of the key consumer segments in which we invest (e.g. confectionery, soft drinks, detergents, noodles, fast food, beer, etc.). We do so by comparing consumption trends globally in relation to GDP per capita at various stages of economic development. We have been pleasantly surprised by how much data is available in this area. This allows us to create a scatter diagram, and then a “best fit” curve – a guide as to how demand for a product or service can be expected to develop as GDP expands, structural barriers decline and, most importantly, consumers’ propensity to spend higher proportions of their income on discretionary items rises. This “triple whammy” can lead to sector growth rates well above general levels of economic growth. We refer to this as our “scale factor”. It invariably takes the shape of an “S” when graphed.
Having established a number for the sector growth potential by country, the second stage of our model looks at company specifics. We estimate the potential for a company to increase its market share and then try to assess its likely economic value added. We do this by making assessments of long term trends in margins, tax rates and fixed and operating asset intensity. This allows us to establish a long term cash flow profile for each company based on its value adding capabilities. Then we discount the cash flows back to provide a current valuation.
Long term Strategy: We say this strategy will outperform because over long periods dominant consumer companies always do. This is for obvious reasons: low capital intensity, high cash generation, defensible moats (brands, distribution etc), and resilience against external shocks (we all need to eat, drink, wash and brush our teeth). The equivalent companies in the US have compounded at 15% per annum over the last thirty years. Add in emerging market tail winds in the form of: (a) disposable incomes rising faster than absolute incomes; (b) the evolution of a credit culture (mortgages and credit cards); (c) favorable demographics (except in China); (d) urbanisation; (e) formalisation of consumption (i.e. more supermarkets / fewer Mom & Pops); and (f) improving distribution reach as a result of infrastructure development, then these Asian businesses should do even better over the long haul.
HUL: We met the CEO to review our seventy page research report which concludes that the company will struggle both to retain market share in soaps and detergents and to drive growth from food and cosmetics (it is really only strong in deodorants, where, admittedly, wider usage would bring immediate benefit). Whilst he impressed us with his plans to improve distribution and product time-to-market, we feel our money is better placed with the more focused Nestle and Colgate.
Colgate: We were told that they have no plans to introduce non-oral hygiene products, such as the Palmolive range, until their market share in toothpaste reaches 70% from the 50% currently. The risk is the possible entry of P&G into this sector with Crest, the largest selling toothpaste brand globally, although, for now, P&G seems more concerned with battling Unilever in detergents.
Nestle: Despite dominant market shares in baby food, instant noodles, soups, sauces, coffee, etc., annual sales have only just surpassed USD 1 billion. Of course, this is miles above the USD 8 million revenues recorded when the company first listed in India in 1978 – at Rps 12.5 per share versus today’s Rps 2400 per share. We expect revenues to be in the order of USD 12 billion twenty years hence. This does not take into account the likely launch of the Perrier, Haagen-Dazs and Gerber brands.
Britannia: Indians eat more biscuits than anybody else in the world – about 150 per annum each; yet their market remains tiny, barely USD 1.9 billion in size. The bulk of, course, are the plain glucose variety costing only USD 1.4 per kilo (versus USD 16 in Japan!). Britannia Industries, has been the only disappointment, as last year’s decline in raw material prices allowed a flood of opportunistic, cheap glucose biscuit manufacturers to take market share. The introduction, however, of a unified sales tax across the country from 2010 will see off many of the fly-by-night producers who in this sector, as in many others, depend on tax dodging to stay competitive. The tax will free up fixed and working capital as producers will no longer be obliged to operate multiple factories and warehouses to qualify for tax advantages on a state-by-state basis.
GSK Consumer: Although the Horlicks malt drink accounts for 75% of the India business, plans are well advanced to extend this brand into nutrition bars and the like, as well as to launch the Lucozade energy drink brand.
Potential: Right now market share is, in the case of India, 12% of its packaged food (Nestle), 33% of its biscuit (Britannia), 40% of its toothpaste (Colgate) and 20% of its hair care sectors (Marico). What’s more, it is worth remembering that the market share data only refers to the “organised” sector. As consumers shift from the informal market, often equal in size to the visible sector, the overall scale of the addressable opportunity will increase dramatically. Just by holding their current market shares, these companies could eventually become global leaders.
Risks: The risks to this rosy scenario are mainly geo-political – China and India could go to war over water. Six out of seven of the region’s largest rivers originate from the Tibetan plateau, which could explain why the area is so hotly contested.
Valuation: In the old days we thought it was better to own the third player on 10x versus the market leader on 20x. Well, that was misguided. The third player invariably gets marginalised, resorting to dodgy practices to stay alive, whilst the market leader consistently surprises positively, using the cash flow from its dominant position to reinforce its brands, etc. Our men may be de-rated, but they won’t be de-railed. As brand owners, they have pricing power. Indeed they tend to push up prices faster than their costs. They don’t have debt and, if rates rise, will simply earn more on their cash holdings. Meanwhile, their customers still need to eat, drink and wash. A portfolio of dominant consumer companies is the best inflation hedge of all.