Motilaloswal

17th Annual Wealth Creation Study 2007-2012
Economic Moat
By Raamdeo Agrawal
12 December 2012
17th Annual Wealth Creation Study
www.motilaloswal.com
Discussion Points
17th Wealth Creation Study Findings Theme 2013:
Fountainhead of Wealth Creation
Market Outlook Conclusions

17th Annual Wealth Creation Study www.motilaloswal.com
Wealth Creation 2007-12 Study Findings
Study Methodology
Concept of Wealth Creation
The process by which a company enhances market value of the capital entrusted to it by its shareholders
Net Wealth Created

Change in Market Cap over the study period (2007-12), adjusted for corporate actions like dilutions
Study Methodology (contd)
Fastest Wealth Creators

The top 100 wealth creators are sorted by fastest rise in their adjusted stock price
Most Consistent Wealth Creators

Based on no. of times a company appeared in the last 10 studies
Study Methodology (contd)
Biggest Wealth Creators

Top 100 Wealth Creators subject to a new condition that stock performance beats the benchmark (Sensex)
Who missed the bus because of the market outperformance filter
Company ONGC Wipro IOCL NTPC
NWC (Rs cr) 40,863 26,602 15,839 10,678
Price CAGR 4.0 5.6 5.6 1.7
Company Hindalco BHEL Cipla Oracle Finl
NWC (Rs cr) 8,838 7,557 5,463 4,594
Price CAGR 1.8 2.6 5.3 4.7
NOTE: 5-time topper Reliance Industries did not make it on both counts absolute wealth created and market outperformance
17th Annual Wealth Creation Study 6 www.motilaloswal.com
Top 10 Biggest Wealth Creators

Rank, Company NWC (Rs cr) Price CAGR Rank, Company NWC Price (Rs cr) CAGR
1. ITC 2. TCS 3. HDFC Bank 4. MMTC 5. H D F C
118,681 108,186 74,425 67,110 55,793
26 14 32 48 21
6. SBI 7. Infosys 8. Tata Motors
55,595 51,573 49,946
21 8 26 15 47
9. Hind Unilever 45,746 10. Jindal Steel 43,647
ITC largest wealth creator for the first time ever, beating RIL Total wealth created during 2007-12: Rs16+ lakh crores HUL has made it to the top 10 after a long time
Top 10 Fastest Wealth Creators

Rank, Company Mult. Price (x) CAGR Rank, Company Mult. Price (x) CAGR
1. TTK Prestige 2. LIC Housing 3. Coromandel Inter 4. Eicher Motors 5. IndusInd Bank
24 10 9 8 8
89 57 54 52 50
6. MMTC 7. Jindal Steel 8. Bata India 9. Titan Inds 10. GSK Consumer
7 7 6 5 5
48 47 41 40 39
TTK Prestige is the Top 10 fastest wealth creator 4 Consumer companies in Top 10 fastest wealth creators; sector hitherto associated with steady growth seems to be enjoying tailwind of Indias NTD era
Most Consistent Wealth Creators

Rank, Company WCS Price (x) CAGR Rank, Company WCS Price (x) CAGR
1. Kotak Mahindra 2. Siemens 3. Sun Pharma 4. Asian Paints 5. HDFC Bank
10 10 10 10 10
48 44 40 35 31
6. Hero Motocorp 7. H D F C 8. ACC 9. Ambuja Cement 10. Infosys
10 10 10 10 10
30 29 29 26 21
Kotak Mahindra Most Consistent for 2nd year in a row Holcim Group is getting its act together in India both ACC and Ambuja among Most Consistent Wealth Creators
Wealth Creators v/s Sensex

Mar-07
BSE Sensex Wealthex re-based Sensex EPS (Rs) Sensex PE (x) Wealthex EPS (Rs) Wealthex PE (x) 13,072 13,072 718 18 809 16
Mar-12
17,404 32,884 1,125 15 2,102 16
5-yr CAGR
6 20 9 21
Wealth-creating companies financial and stock market performance is above benchmark.
10
Wealth Creation by Industry

Industry
(No of cos.) Financials (21) Consumer (21) Metals / Mining (8) Technology (3) Auto (11) Healthcare (11) (Rs cr) 367,223 335,845 209,492 173,419 163,007 121,480
WC
2012 2007 Industry

(%) 22 21 13 11 10 7 (%) 13 5 9 10 6 4
(No of cos.) (Rs cr) 99,634 66,842 23,549 16,629
WC
2012 2007
(%) 6 4 4 1 1 (%) 24 3 10 2 15
100
Oil & Gas (7) Cement (5) Ultility (3) Others (4)
Total
Cap Goods(6) 60,902
1,638,021 100
Financials the biggest wealth creating sector for 2nd year in a row. Absence of new banks has led to widespread profitability and stock performance. Consumer sector a very close second.
11
Wealth Creation by PAT growth

Price CAGR (%)
2007-12 PAT growth range (%)
Markets can neither price hyper-growth or high quality growth, resulting in huge wealth creation at a rapid pace.
Wealth Creation by base RoE
Avg Price CAGR: 20%
High RoE alone does not guarantee superior Wealth Creation. Profit growth is equally important. Economic Moat (or competitive advantage) protects profits and ensures Wealth Creation.
Wealth Creation & Valuation Metrics P/E (x) <10 10-15 15-20 20-25 25-30 >30 Total No. of Cos. 18 21 19 13 13 16 100 % Wealth Price PAT Created CAGR % CAGR % 17 20 18 18 22 24 10 21 20 18 25 24 28 16 21 10 25 24 100 20 21
Unlike most past studies, low P/E alone did not ensure high speed of wealth creation during 2007-12. PAT CAGR was a key determinant of Price CAGR.
Wealth Creation & Valuation Metrics P/B (x) <1 1-2 2-3 3-4 4-5 5-6 >6 Total No. of Cos. 6 20 10 11 13 11 29 100 % Wealth Created 6 12 7 13 14 14 34 100 Price PAT CAGR % CAGR % 25 28 20 19 24 21 20 20 22 24 26 21 17 19 20 21
P/B below 1x did deliver high returns, but returns from higher P/B stocks were also comparable (except when P/B > 6)
Wealth Creation & Valuation Metrics Payback Ratio (x) No. of Cos. % Wealth Price PAT Created CAGR % CAGR %
<1 1-2 2-3 >3 Total
19 37 26 18 100
14 33 29 23 100
26 23 20 15 20
25 24 15 16 21
Payback ratio (Mkt Cap / 5-years forward PAT) of less than 1x in 2007 did ensure superior wealth creation. Also, again here, correlation of PAT and Price CAGR is high. Economic Moats help sustain PAT and PAT growth.
Wealth Destruction
Company Wealth Destroyed Rs crores % Share Price CAGR (%)
Reliance Communication 67,698 12 -28 Unitech 29,399 5 -32 Suzlon Energy 27,558 5 -34 Satyam Computer 24,948 5 -30 Bharti Airtel 16,918 3 -2 SAIL 8,280 2 -4 Tech Mahindra 8,161 2 -13 MTNL 7,519 1 -29 Himachal Futuristic 7,367 1 -12 B F Utilities 7,315 1 -30 Total of Above 190,482 35 Total Wealth Destroyed 542,546 100 4 of top 10 wealth destroyers are telecoms. Breach of Economic Moat causes massive wealth destruction.
Theme Study
18
Moat Quote
"(Great companies to invest are like) wonderful castles, surrounded by deep, dangerous moats where the leader inside is an honest and decent person. Preferably, the castle gets its strength from the genius inside; the moat is permanent and acts as a powerful deterrent to those considering an attack; and inside, the leader makes gold but doesn't keep it all for himself. Roughly translated, we like great companies with dominant positions, whose franchise is hard to duplicate and has tremendous staying power or some permanence to it. Warren Buffett
What is an Economic Moat?

The concept of 'Economic Moat' has its roots in the idea of a traditional moat
A moat is a deep, wide trench filled with water, that surrounds the rampart of a castle or fortified place.
An Economic Moat protects a company's profits from being attacked by business forces
Traditional management theory terms: "Sustainable Competitive Advantage" or "Entry Barriers"
20
Why Economic Moat?

Without Economic Moat, competition from rivals will ensure that high returns of a company are lowered to the level of economic cost of capital or even below
What is happening in the Indian Telecom sector is a classic example of this Moat Quote
The dynamics of capitalism guarantee that competitors will repeatedly assault any business "castle" that is earning high returns Business history is filled with "Roman Candles," companies whose moats proved illusory and were soon crossed. Warren Buffett
Why Economic Moat?
Economic Moat helps sustain superior profitability multiple pulls and pressures
Companies do not compete only with rivals for profit, but also with customers, suppliers, potential entrants and substitute products
Porter's Five Forces of Industry Economic Moat protects profits being eroded by such forces
22
Economic Moat & investing

Much like companies, equity investors too chase high returns on their investments
In the long run, equity investors can only make as much money and return as the company itself makes
Investing in companies with Economic Moats is the only way to enjoy a share of their high profits and create wealth
Moat Quote A truly great business must have an enduring moat that protects excellent returns on invested capital. Buffett
Economic Moat & investing
Companies with "deep, dangerous moats outperform those without, both in terms of financial performance and stock returns.
Markets worldwide are replete with examples similar to cross-sector cases given below in India
1. Hero MotoCorp v/s TVS Motors 2. Bharti Airtel v/s Tata Teleservices 3. L&T v/s HCC 4. HDFC Bank v/s Central Bank
24
Hero MotoCorp v/s TVS Motors

The facts Both started business around the same time in the 1980s Both were Indo-Japanese JVs
Hero Group with Honda and TVS Group with Suzuki
MOAT IMPACT: Hero MotoCorp: Worlds
largest two-wheeler company TVS Motor: Struggling to retain its hitherto No 3 spot in India
Bharti Airtel v/s Tata Teleservices

The facts Both incorporated in 1995 on the eve of Indias telecom
boom. In fact, Tata Tele had the rich Tata legacy
Both journeyed Indias wireless
explosion massive value migration from wired telephony.
MOAT IMPACT: Bharti: Indias No1 telecom co
with global aspirations Tata Tele: Yet to report a single quarter of profit
26
L&T v/s HCC

The facts Both long standing construction players in India. In fact,
HCC was incorporated in 1926, earlier than L&T (1946)

Both have benefited from
Indias exponential growth in infra, construction, real estate
MOAT IMPACT: L&T: Arguably Indias answer
to General Electric HCC: Struggling to make profit plus issues like BOTs, Lavasa
HDFC Bank v/s Central Bank

The facts Central Bank has recently completed 100 years. HDFC
Bank, in contrast, is less than 20 years old.
Central Banks has 60% more
branches than HDFC Bank (4,000+ v/s 2,500)
MOAT IMPACT: HDFC Bank: FY12 PAT 10x of
Central Bank, Mkt Cap 24x Central Bank: Lagging on most metrics NPA, RoE, RoTA, etc
Economic Moat: Two factors

1. INDUSTRY STRUCTURE
Interplay of Buyer power, Supplier Power, Threat of new entrants/substitutes, etc
2. COMPANY STRATEGY
5 elements (1) Distinct value proposition (2) Tailored value chain (3) Trade-offs (4) Fit (5) Continuity over time
Moat Quote Why are some companies more profitable than others? First, companies benefit from (or are hurt by) the structure of their industry. Second, a companys relative position within its industry can account for even more of the difference. Joan Magretta, in her book Understanding Porter
Economic Moat: Applying in equity investing

1. The Economic Moat hypothesis
Investing in a portfolio of EMCs (Economic Moat Companies) should lead to sustained outperformance over benchmark indices across years, irrespective of market conditions.
2. Backtesting the hypothesis

Step 1: The backtesting framework 1. Arrive at a list of EMCs as on March 2002 and invest in them 2. Monitor price performance from March 2002 to March 2012

Backtesting the Economic Moat hypothesis (contd)
Step 2: Deciding Economic Moat criteria 2A. The principles: 1. Economic Moat ultimately reflects in financials, with RoI significantly superior to peers 2. Competitive advantage is relevant only within sectors 2B. The practice: 1. For each of the last 8 years, calculate for all sectors RoE of companies and sector average RoE 2. A company is an EMC if for at least 6 years, its RoE exceeds industry average 3. Discretionary adjustment to the final list based on then known facts and figures

Step 3: The findings #1 EMCs handsomely outperform #2 EMCs outperformance is earnings and valuations agnostic #3 EMCs outperformance is sector agnostic #4 Future not too meaningful for EMCs, but critical for non-EMCs
32

Finding #1: EMCs handsomely outperform Over 2003-12, overall return of 177 companies was 18% EMCs returned 25% whereas non-EMCs returned 12% Sensex return was 18%, implying 7% Alpha for EMCs and negative 6% Alpha for non-EMCs
2003-12 Avg Price CAGR (%) EMCs Non-EMCs Overall
Return Sensex Alpha

25% 18% +7%

33
12% 18% -6%
18% 18% 0%

Finding #1: EMCs handsomely outperform (contd) Besides point-to-point outperformance, EMCs outperformed
the Sensex in every year over the 10 years Also, after 3 years, EMCs outperformed even non-EMCs
Payoff profile
34

Finding #2: EMCs outperformance is earnings and valuations agnostic The most plausible explanation for this:
Earnings agnosticism
EMCs strong competitive advantage which ensures that they enjoy a more-than-fair share of the growth inherent in most sectors in India
Valuation agnosticism
Continuous rollover of EMCs competitive advantage period (CAP)
35

Explaining EMCs valuation agnosticism: CAP Competitive advantage period (CAP) is the time during which a company is expected to generate returns on incremental investment that exceed its cost of capital. Markets do assign premium valuations to EMCs, given their reasonably accurate assessment that such companies enjoy a very long CAP. Where the markets fail is in recognizing that barring a low mortality rate of less than 15%, EMCs leverage their moat and sustain high return even with passage of time. The CAP of EMCs simply rolls over with each passing year, creating incremental excess return for investors.

Backtesting the Economic Moat hypothesis (contd) CAP rollover plausibly explains EMCs valuation agnosticism
Return=WACC
CAP in Year 0
CAP rolls over by 1 year
37

Finding #3: EMCs outperformance is sector agnostic EMCs are likely to outperform benchmarks across sectors, even if the sector itself is out of market favor. Thus, out of our 22 homogenous sector groupings, EMCs underperformed the Sensex in only two sectors Oil Refining and Textiles.
38

Backtesting the Economic Moat hypothesis (contd) Finding #4: Future not too meaningful for EMCs, critical for non-EMCs Mortality rate of EMCs is likely to be low. By 2012 only 11 of 74 turned into non-EMCs (mortality<15%). But even these companies beat the Sensex EMCs which remained so did not do much better than initial performance Non-EMCs who upgraded into EMCs delivered the highest return at 27%, albeit with a mortality rate of 75% Worse of all, non-EMCs which remained so delivered only 8% return.
Payoff Matrix
2003-12 EMCs Yes No 27% 8% No
2003-12 Sensex return was 18%
26% 20% Yes

1995-02 EMCs
39

Backtesting the Economic Moat hypothesis (contd) Applying the methodology to Nifty constituents in year 2002 We applied our backtesting methodology to 38 constituents of Nifty in 2002. The results were similar to that of the broader universe EMCs outperform both non-EMCs and overall Nifty Non-EMCs underperform Nifty EMCs which maintain status quo do not report materially high returns But non-EMCs which upgrade to EMCs deliver high returns Non-EMCs which stay so perform the worst Stock returns on 2002 Nifty
Price CAGR EMC Non-EMC 22% 16% No. of cos. 29 9 Nifty payoff matrix 2003-12 EMCs Yes No 21% 4% No 22% 14% Yes
38 stocks return: 20% Nifty return: 16%
1995-02 EMCs
40
Applying the methodology to current Nifty

We have bifurcated current Nifty stocks into EMCs and nonEMCs using the backtesting methodology 1. Company and sector average RoE data 2005 to 2012, and 2. In some cases, discretion based on currently known information and subjective opinion
Prognosis based on past experience

1. In our view, there are 27 EMCs and 23 non-EMCs in the current Nifty 2. Expect EMC basket to outperform non-EMCs and Nifty itself 3. Expect about 6 non-EMCs (25% of 23) to upgrade to EMCs and deliver handsome returns 4. Non-EMCs which maintain status quo will eventually be replaced in the Nifty
Nifty: The Economic Moat classification
42
Market Outlook
Seems poised for new highs
43
Market Outlook
Corporate Profit to GDP should be around 5% for 2013
44
Market Outlook
Interest rates have softened to 8.2%; expect further fall
45
Market Outlook
Earnings Yield to Bond Yield at 0.9x is just below parity
46
Market Outlook
Sensex forward P/E is currently at 14.4x around LPA
47
Market Outlook
Sensex EPS is expected to grow 11% over FY12-14
48
In Conclusion
Consumer sector has bounced back into wealth creation ITC is the largest wealth creator, TTK Prestige the fastest, HUL back in top 10. Financials has emerged the largest wealth creating sector for the second time in a row. Absence of new entrants is leading to widespread profitability and stock performance. Economic Moat protects the profit and profitability of companies from competitive attack. Extended CAP of EMCs drives superior profits and stock returns. Over 2002-2012, EMCs in India have meaningfully outperformed benchmarks. Breach of Economic Moat causes massive wealth destruction. The Telecom sector is a classis case. Markets seem poised to touch new highs in the next 12 months. On the back of earnings growth of 10-11%, imminent moderation in interest rate, and reasonable current valuation.
49 www.motilaloswal.com
Thank You ! & Happy Investing In
Economic Moats
Motilal Oswal Wealth Creation Gallery

Motilaloswal

Загружено:

Сведения о документе

Авторское право

Доступные форматы

Поделиться этим документом

Поделиться или встроить документ

Параметры публикации

Этот документ был вам полезен?

Это неприемлемый материал?

Авторское право:

Доступные форматы

Motilaloswal

Загружено:

Авторское право:

Доступные форматы

17th Annual Wealth Creation Study 2007-2012

17th Annual Wealth Creation Study

Market Outlook Conclusions

Wealth Creation 2007-12 Study Findings

17th Annual Wealth Creation Study

Net Wealth Created

17th Annual Wealth Creation Study

Study Methodology (contd)

Fastest Wealth Creators

Most Consistent Wealth Creators

17th Annual Wealth Creation Study

Study Methodology (contd)

Biggest Wealth Creators

Company ONGC Wipro IOCL NTPC

NWC (Rs cr) 40,863 26,602 15,839 10,678

Price CAGR 4.0 5.6 5.6 1.7

Company Hindalco BHEL Cipla Oracle Finl

NWC (Rs cr) 8,838 7,557 5,463 4,594

Price CAGR 1.8 2.6 5.3 4.7

Top 10 Biggest Wealth Creators

1. ITC 2. TCS 3. HDFC Bank 4. MMTC 5. H D F C

118,681 108,186 74,425 67,110 55,793

6. SBI 7. Infosys 8. Tata Motors

55,595 51,573 49,946

9. Hind Unilever 45,746 10. Jindal Steel 43,647

Top 10 Fastest Wealth Creators

Most Consistent Wealth Creators

1. Kotak Mahindra 2. Siemens 3. Sun Pharma 4. Asian Paints 5. HDFC Bank

6. Hero Motocorp 7. H D F C 8. ACC 9. Ambuja Cement 10. Infosys

17th Annual Wealth Creation Study

Wealth Creators v/s Sensex

Wealth-creating companies financial and stock market performance is above benchmark.

17th Annual Wealth Creation Study

Wealth Creation by Industry

2012 2007 Industry

(No of cos.) (Rs cr) 99,634 66,842 23,549 16,629

Cap Goods(6) 60,902

17th Annual Wealth Creation Study

Wealth Creation by PAT growth

2007-12 PAT growth range (%)

Wealth Creation by base RoE

Avg Price CAGR: 20%

<1 1-2 2-3 >3 Total

17th Annual Wealth Creation Study

What is an Economic Moat?

17th Annual Wealth Creation Study

Why Economic Moat?

Why Economic Moat?

17th Annual Wealth Creation Study

Economic Moat & investing

Economic Moat & investing

17th Annual Wealth Creation Study

Hero MotoCorp v/s TVS Motors

Hero Group with Honda and TVS Group with Suzuki

MOAT IMPACT: Hero MotoCorp: Worlds

Bharti Airtel v/s Tata Teleservices

boom. In fact, Tata Tele had the rich Tata legacy

Both journeyed Indias wireless

explosion massive value migration from wired telephony.

MOAT IMPACT: Bharti: Indias No1 telecom co

L&T v/s HCC

HCC was incorporated in 1926, earlier than L&T (1946)

Indias exponential growth in infra, construction, real estate

MOAT IMPACT: L&T: Arguably Indias answer