Session 2

APPLIED
VALUE
INVESTING
Session 2
Assessing business quality (1 of 2)

1
Disclaimer – this is not the usual
stuff in fine print, so please do read!
• Please assume that I am interested / have a position in all the
stocks discussed through the course
• Please do not assume that a discussion on a stock is a
recommendation to buy or sell it
• Please do your own research before buying / selling any stock
• All examples are only meant to illustrate concepts and help you
learn
• The course really contains no ‘secrets’ – I have mostly synthesized
and built on the thoughts and ideas of hundreds of people who
have taught me in class, in conversations and through their books
• All copyrights and trademarks are acknowledged, and images
drawn from searches on the Internet are the property of their
respective owners

2
Agenda
• The importance of assessing business quality
• How to assess the quality of a business
• Assessing industry attractiveness

3
 As we saw in session 1, the ‘intrinsic value’ of a
business may lie mostly in its future cash flows
Indicative illustration of the share of AIP and PVGO in ‘intrinsic value’

100%
90%
80% 30%
70%
60% 70%
50% 100% 100%
40%
30% 70%
20%
10% 30%
0%
Benjamin Slow growing Acyclical Lossmaking but
Graham style cyclical steadily growing fast growing
'net net' business business tech startup
PVGO Assets in place

Greater the share of PVGO in ‘intrinsic value’,

greater is the need to assess quality of the business
4
Understanding the link between
growth and value creation (1 of 5)
• Consider three cash flow streams that have a finite 10 year horizon
• Company Slow: Free cash flow of 100 grows at 10% a year for
the next 10 years
• Company Medium: Free cash flow of 100 grows at 15% a year
• Company Fast: Free cash flow of 100 grows at 20% a year
• At 15% cost of capital for the above companies, Slow is worth 72,
Medium is worth 87 and Fast is worth 106
• So growth in revenue (and ultimately free cash flow) is a
significant driver of value, other things being equal
• But the quality of the business matters even in fast growing
companies, as rapid growth can in fact destroy value
• This is easiest to understand with examples

5
Understanding the link between
growth and value creation (2 of 5)
• Consider project A for company X. Should company X invest in this
project?
• 100 invested upfront at year 0, no further investments
• Cash inflow of 40 every year from year 1 to 10
• Cost of capital is 15%
• The NPV of the stream of cash flows (-100, 40, 40, 40, 40, 40, 40, 40,
40, 40, 40) at 15% cost of capital is 88 – this is a positive NPV project,
and so it is definitely worth investing in
• Rapid growth can be viewed as simultaneous investment into many
identical (or similar) projects at the same time, rather than investing
in them sequentially
• Now imagine that company X wants to grow faster - project A can be
done in 10 markets at the same time with identical cash flows as
above, and funding is not a constraint for company X
• Logically, X should invest in all 10 of these projects – the upfront
investment is 1000, and 880 of value will be created for the
shareholders of X

6
Understanding the link between
growth and value creation (3 of 5)
• Now consider project B for company Y. Should company Y invest in
this project?
• 100 invested upfront at year 0, no further investments
• Cash inflow of 20 every year from year 1 to 10
• Cost of capital is 15%
• The NPV of the stream of cash flows (-100, 20, 20, 20, 20, 20, 20, 20,
20, 20, 20) at 15% cost of capital is 0.3 (which is essentially zero) –
this is a project that creates no value
• An investment in project B is not value destructive, but does not create
value for shareholders of company Y
• Further, imagine that project B can be done in 10 markets at the same
time with identical cash flows as above, and funding is not a constraint
for company Y
• If Y invests in all 10 of these projects, the upfront investment is 1000,
and 3 of value (essentially zero) will be created. By doing so, company
Y can grow very rapidly but no value will be created for shareholders
of Y

7
Understanding the link between
growth and value creation (4 of 5)
• Consider project C for company Z. Should company Z invest in this
project?
• 100 invested upfront at year 0, no further investments
• Cash inflow of 10 every year from year 1 to 10
• Cost of capital is 15%
• The NPV of the stream of cash flows (-100, 10, 10, 10, 10, 10, 10, 10,
10, 10, 10) at 15% cost of capital is -43 – this is a project that
destroys a significant amount of value of shareholders of Z
• Now imagine that project C can be done in 10 markets at the same
time with identical cash flows as above, and funding is not a
constraint for company Z
• If Z invests in all 10 of these projects, the upfront investment is 1000,
and 430 of value will be destroyed. By doing so, company Z can
grow rapidly but it will destroy a lot of value for its shareholders of Z
• Company Z should in fact have returned the cash to its shareholders
instead of growing rapidly by investing in value destructive projects

8
Understanding the link between
growth and value creation (5 of 5)

Positive NPV
Growth creates value
projects

Zero NPV
Growth creates no value
projects

Negative NPV
Growth destroys value
projects

9
A modified view of the simplified corporate investment
and growth cycle which we saw in session 1

Value of Present Value of

assets in Growth Opportunities
Value of firm
place (‘AIP’) (‘PVGO’)
Investments for
Investments increase growth increase
PVGO only if they
the future value of AIP
earn above cost of
capital
Assets
Retain and invest cash
generate
for future growth
cash

Return to
providers of
debt / equity
10
A detour into micro-economics: a
simplified view of how competition works
Company X
launches a
Company X and new product Y
all new entrants
no longer make
abnormal profits If product Y is a
hit, X can earn
large abnormal
profits
Margins in product Y
fall sharply due to
competition
Other companies
are attracted by
the profit
opportunity and
enter the market

11
Competition thus drives returns
down to the cost of capital
Company X
Company X and all
launches a
new entrants NO
new product Y
LONGER EARN
RETURNS ABOVE
If product Y is a
COST OF
hit, X can earn
CAPITAL
RETURNS WELL
ABOVE COST OF
CAPITAL
Margins in product Y
fall sharply due to
competition Other companies
are attracted by
the profit
opportunity and
enter the market

So for a company to consistently create value, it has to

find ways to break this Darwinian cycle of competition!
Unless it can do so, growth will not create value
12
 While some companies that have earned below
cost of capital in the past may earn above cost of
capital in the future – we will look at some of
these situations later in this session –
understanding a company’s return on capital
history is the best starting point to assessing
its future returns on capital

13
Historical returns on capital are a good
indicator of future returns on capital

“From 1963 to 2004, the US market’s median ROIC, excluding

goodwill, averaged nearly 10 percent. That level of performance was
relatively constant and in line with the long-term cost of capital”
Source: https://www.mckinsey.com/business-functions/strategy-and-corporate-finance/our-insights/a-long-term-look-at-roic
14
Three questions to answer while
assessing business quality

1 Has the company earned returns above cost of capital in the past?

2 Why?

3 Is the company likely to earn returns above cost of capital in future?

15
To summarize
Most of the intrinsic value of a company may lie in the
present value of investments made for growth

For a company to have positive present value

from its growth investments, these
investments have to earn above the cost of capital

Assessing the quality of a business is therefore primarily

about assessing whether a company’s investments can earn
returns above cost of capital in future

16
Agenda
• The importance of assessing business quality
• How to assess the quality of a business
• Assessing industry attractiveness

17
How NOT to assess the quality of a
business
“The company “My wife “The
is in the ET enjoys company
500 / Fortune working pays large
500” there” dividends”

“My banker
friend tells me “The stock is
“I love their they repay up 10x in 3
products” their loans on years”
time”

18
The right way to assess business
quality

Return On Tangible Capital

Primary metric
Employed (ROTCE)

Secondary
Margin stability
metric

Other 6 factors – defensibility, growth,

qualitative cyclicality, cash generation, rate
factors of change, other business risks

We will look at ROTCE and margin stability in this session,

and continue with other qualitative factors in session 3
19
ROTCE is the best metric of ROTCE

business quality (1 of 2)
• Return on Tangible Capital Employed (‘ROTCE’) can best compare firms,
whether they grow organically or through M&A
• ROTCE = Operating EBIT / Average Tangible Capital Employed
• Operating EBIT = Sales – Cost of goods sold – Employee costs – Other
selling and administrative expenses – Depreciation and amortization
• Ignore non-operating ‘other income’ such as interest / dividend from
deposits / investments
• Ignore large, one-off amounts like foreign exchange translation gains
or losses (if one-off!)
• Ignore restructuring costs and asset impairments (if one-off!)
• Tangible Capital Employed = Net fixed tangible assets + operating current
assets excluding cash – operating current liabilities excluding debt
• Ignore non-operating assets / investments
• Ignore deferred tax (asset / liability)
• Ignore intangible assets like goodwill or patents
• In businesses with large lease commitments (such as airlines), the leases
should be capitalized as if they were on the Balance Sheet
ROTCE is the best metric of ROTCE

business quality (2 of 2)
• Compare ROTCE against pre-tax Weighted Average Cost of Capital (WACC) to
assess the quality of the business
• If ROTCE < pre-tax WACC over a business cycle, it is a bad business
• Business cycles usually last 4-6 years, so a 5 year median ROTCE is a good
measure of over-a-cycle ROTCE
• An alternative to the median ROTCE is a weighted average ROTCE over a
business cycle, where ROTCE of each year is weighted by capital employed for
that year
• Note that in some cases (such as in commodity cycles), the length of cycles
can be 10+ years, so an over-the-cycle perspective may need to include
many more years
• If ROTCE over a cycle >> pre-tax WACC, it is a good business
• A business consistently earning an over-the-cycle median ROTCE that is at least 5
to 10 percentage points above WACC is a good business
• In the Indian context, 20+% ROTCE is very good (and ~15% is a ‘middling’
business), while 15+% ROTCE is very good for developed markets which
have a lower cost of capital
• Note that we will further qualify this statement while considering additional risk
parameters in session 3, but this assessment is a good starting point
• Cash Return on Capital Invested (‘CROCI’) is an alternative to ROTCE, which uses
operating cash flow figures rather than EBIT
Walk-through of ROTCE – ROTCE

Hindustan Unilever
• Step 1: Calculate EBIT for year ended 3/18 (‘FY18’)
• Step 2: Calculate Tangible Capital Employed as at 3/17 and 3/18
• Step 3: Calculate Average Tangible Capital Employed
• Step 4: ROTCE = EBIT / Average Tangible Capital Employed
• The FY18 annual report for Hindustan Unilever (‘HUL’) is at
https://www.hul.co.in/Images/hul-annual-report-2017-18_tcm1255-
523195_en.pdf
• Bear in mind that HUL has a net cash financial position, no debt,
and that pre-tax WACC for HUL (depending on what assumptions
are made) would be 12-14%
• Note: 1 crore = 10 million

22
 ROTCE

Step 1: Operating EBIT calculation

₹ crores Amount
Sales 36,238
Less:
Materials 12,927
Purchases 3,875
Change in (72)
inventories
Excise duty 693
Employee 1,860
expenses
Depreciation 520
Other 9,456
expenses
Operating 6,979
EBIT
From Note 27, ‘other income’ is interest / dividend income and change
in fair value of investments, hence we exclude it from operating EBIT
23
Step 2: Tangible Capital ROTCE

Employed Calculation (1 of 2)

₹ crores As at As at
3/18 3/17

Property, plant, 4,080 3,968

equipment
Other non- 84 75
current assets
Inventories 2,513 2,541

Loans (security 4 0
deposits, loans
to employees)
Trade 1,310 1,085
receivables
Other current 656 552
assets
Sub-total A 8,647 8,221

Capital Work in Progress refers to Plants / Buildings that are under

construction and not operational at this point
24
 Step 2: Tangible Capital ROTCE

Employed Calculation (2 of 2)

₹ crores As at As at
3/18 3/17

Sub-total A 8,647 8,221

(see previous
slide)
Less: 800 514
Provisions
Other non- 197 207
current
liabilities
Trade payables 7,170 6,186

Other current 815 664

liabilities
HUL operates with large negative working capital:
the investment in inventory + receivables (see Provisions 688 392

previous page) is funded by trade payables Tangible (1,023) 258

capital
Tangible capital employed is negative in 3/18 – HUL employed
has no tangible capital invested in the business!
25
Step 3: Average Tangible Capital ROTCE

Employed calculation

₹ crores As at As at
₹ crores As at As at 3/18 3/17
3/18 3/17
Sub-total A 8,647 8,221
Tangible (1,023) 258 (see previous
capital slide)
employed Less: 800 514
Average (383) Provisions
Tangible Other non- 197 207
Capital current
Employed liabilities
Trade payables 7,170 6,186

Other current 815 664

liabilities
Provisions 688 392
Tangible (1,023) 258
capital
employed

26
 ROTCE

Step 4: ROTCE calculation

₹ crores FY18

Operating EBIT from step 1 (A) 6,979

Average Tangible Capital Employed (B) (383)

ROTCE (A/B) Infinite (!)

(as tangible
capital
employed is
negative)

In FY18, HUL generated ~ ₹

7000 crores of EBIT (~$1
billion) with negative average
tangible capital employed – a
great business!

27
Even including intangibles and other
assets, HUL is a great business ROTCE
As at As at
3/18 3/17

Total assets 17,862 15,706

Less:
2,871 3,788
Investments
Cash and
649 628
equivalents
Bank balances 2,836 1,200
Other financial FY18
805 331
assets
10,701 9,759 Operating EBIT (A) 6,979
Sub-total A
Less: 800 514 Average Capital 1,414
provisions Employed (B)
Other non- 197 207
current ROCE (A/B) 494%
liabilities
Trade payables 7,170 6,186
Other current
815 664
liabilities
Provisions 688 392
Total Capital 1,031 1,796
Employed
Average 1,414
Capital
Employed
28
29
 Which of these is the best
business? ROTCE

ROTCE of X, Y, Z
100% 72%
53%
X 50% 36% 29%

0%
Year 1 Year 2 Year 3 Year 4
20%
16% 16% 15%
15% 14% 13%
11%
9%
Y 10%
7%
5% 4%

0%
Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 Year 7 Year 8 Year 9
300% 254%
250% 204%
200% 159%
Z 140% 141% 133%
150% 123%
100%
50%
50%
0%
Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 Year 7 Year 8

Company Z has the highest ROTCE

30
But this is actually one company –
Sesa Goa from 1991 to 2011! ROTCE

Sesa Goa’s ROTCE varied

300%
widely, depending on the
state of the iron ore 254%
250%
commodity cycle
204%
200%
159%
141%
150% 140% 133%
123%

100%
72%
53% 50%
50% 36%
29%
14% 16% 9% 16% 15% 13%
4% 7% 11%
0%
1991
1992

1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
1993

2011
Would you say Sesa Goa is a good business?
31
32
In some situations, historical ROTCE may
not be the best indicator of future ROTCE
Upfront • With increasing scale, fixed costs can get
shared over a larger base of revenues, and
investments
profitability at company level can improve
and increasing significantly as the business grows
scale
• A portion of the company may have high
returns on capital, but the company’s return
on capital may be dragged down by other
Improved parts of the company that are laggards
capital • Divesting the laggard businesses that destroy
allocation value, or even stopping incremental
investment in them, over time, can improve
the return on capital profile of the company
• Improved industry dynamics and / or better
(usually new) management can lead a
business to perform substantially better than
Turnarounds it did in the past
• Some of these turnarounds may be primarily
due to factors outside the company’s control,
such as a sharp rise in a commodity price

We will better understand these situations with examples

33
Example 1: Fixed costs in a fast food
chain Upfront
investments and
increasing scale

• Consider a chain of fast food outlets with the following (simplified)

economics
• Each new outlet takes investment of 100 and earns 25 each year
• The corporate team – which scouts for new locations, works on
the menu, manages vendors and the supply chain, and does
marketing – costs a fixed 100 a year
• Assume the company launches 6 outlets in year 1 – total
investment is 600 (100 x 6) and EBIT is 50 [25 from each outlet x
6 – corporate cost of 100], giving a return on capital of 50 / 600
which is ~8%
• If the company had 25 outlets in year 2 – total investment is 2500
(25 x 100) and EBIT is 525 [25 x 25 – 100], giving a return on
capital of 525 / 2500 which is a much more exciting 21%!

34
In this example, understanding unit economics
can help assess if scale will matter Upfront
investments and
increasing scale

• In businesses such as retailers, restaurants, hospitals, movie chains

– broadly, any business that involves the rollout of mostly identical
units over time – it is critical to understand unit economics, which is
what one outlet takes in the form of investment and what returns it
earns
• In the previous example, each unit had good unit economics
with a 25% return on investment from year 1 (25 / 100 invested)
• Now imagine that each unit only earned 5 each year on an
investment of 100, in the previous example. No amount of scale
can to make this a good business!
• Understanding the unit economics of each outlet could indicate if
there is a chance that the company may earn attractive returns
on capital in future (in year 2, of our example), even if it does not
do so now (in year 1, of our example)
• Of course, the expected improvement in returns on capital may
not happen in future if unit economics deteriorate sharply, or
corporate costs increase significantly

35
Example 2: Upfront R&D costs in an
R&D intensive business (1 of 2) Upfront
investments and
increasing scale

• When there are upfront R&D costs that are relatively fixed,
increasing scale can significantly improve profitability and returns on
capital
• Facebook Inc. had been profitable and earned high ROTCE for
many years, but this example can still illustrate the impact of
growing scale on an R&D intensive businesses
• In the case of Facebook below – total costs in 2015 were 65% of
sales, falling to 50% of sales in 2017, and operating margins
expanded sharply

Source: Facebook SEC filings 36

Example 2: Upfront R&D costs in an
R&D intensive business (1 of 2) Upfront
investments and
increasing scale

• R&D is Facebook’s largest cost

• While Facebook increased R&D costs by 60% from 2015 to 2017,
R&D fell from 27% of sales in 2015 to 19% in 2017
• This decline in R&D costs as a % of sales was the biggest driver of
the significant expansion in Facebook’s margins from 2015-2017

Source: Facebook 10-K filing for 2017, from www.sec.gov

37
Example 3: Selling a division that
was a bad business Improved capital
allocation

• Consider a company L with 2 divisions:

• Leader, which earns divisional EBIT of 30 on capital employed of
100
• Laggard, which earns divisional EBIT of 10 on capital employed of
250
• Corporate costs are 5 per year
• Company L will earn return on capital of 10% [Total EBIT of (30 + 10 –
5) / Capital employed of (100 + 250)]
• Now suppose L sells Laggard division and returns all the money it
receives to shareholders
• Company L’s return on capital, even assuming no reduction in
corporate costs, will be 25% [EBIT of (30-5) / Capital employed of 100]
• [Note that, in addition to the obvious financial benefits of selling
Laggard, top management of company L can now refocus their efforts
on growing Leader, instead of being distracted by the problems in
Laggard]

38
Example 4: Turnaround of a company with Turnarounds

a poor track record (1 of 2)

• Alan Mulally became CEO of Ford in 2006, when it was losing
money in its automotive operations even during an industry up-
cycle!

Ford profit / (loss) before tax from automotive operations ($mm)

0
2002 2003 2004 2005 2006
-5,000 -957 -1,387 -178
-3,899
-10,000

-15,000
-17,045
-20,000

39
Example 4: Turnaround of a company with Turnarounds

a poor track record (1 of 2)

• Under Mulally, Ford turned around and became consistently
profitable

Ford profit / (loss) before tax from automotive operations ($mm)

10,000
6,250
4,146
5,000
785
0
-5,000
2002 2003 2004 2005 2006 2007 2008 2009 2010 2011
-957 -1,387 -178
-10,000 -3,899 -5,081 -11,917
-15,000
-17,045
-20,000

40
41
Stability of margins is a secondary
measure of business quality (1 of 2)
• A business’ ability to maintain its Margin
stability
margins over a business cycle is
indicative of its pricing power (to
raise selling prices when costs go
up) and / or good cost management
• Pricing power is most common in
industries where:
• Buyers are retail consumers who
are relatively less sophisticated
and not large individually – this is
true of most consumer products
and services
• The industry is oligopolistic, with
2-4 players accounting for most
of the industry – this limits the
options for buyers, and sellers
are able to raise prices

42
Stability of margins is a secondary
measure of business quality (2 of 2)
Margin
stability
• We study EBITDA or EBIT margins so that we can compare
different companies in the same industry with differing operating
models and capital structures
• One quantitative metric that can compare the stability of margins
across companies is the co-efficient of variation (standard
deviation of margin / average margin) of the margin – lower the
coefficient of variation, greater is the stability of the margin
• However, watch out for situations like a sharp turnaround in a
company with a patchy historical track record of profitability –
this company will also show up as having highly volatile
margins though the business may currently be in good shape
• In case a company is a ‘converter’ – such as a plastics processor
or packaging company – stability of EBITDA or EBIT per ton of
volume is a more appropriate measure than stability of % margin

43
 Which of these companies is the
best business? Margin
stability
EBITDA margins of 5 companies in the same industry
35.0%

30.0%

25.0%

20.0%

15.0%

10.0%

5.0%

0.0%
Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 Year 7 Year 8 Year 9

-5.0%

44
 These are 5 companies in the Indian
two-wheeler industry Margin
stability
EBITDA margin
35.0%
Hero Bajaj Company Standard Mean Co-efficient
30.0%
Eicher TVS
deviation (B) of variation
25.0%
(A) (A / B)
Honda
Hero 1.6% 14.6% 10.7%
20.0%
Bajaj 4.2% 17.7% 23.5%
15.0%
Eicher 10.8% 15.6% 68.9%
10.0%
TVS 1.6% 5.5% 29.9%
5.0%
Honda 2.0% 9.5% 20.7%
0.0%
Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 Year 7 Year 8 Year 9
-5.0%

Hero has the least volatile margins, followed by Honda

Eicher’s turnaround and sharp rise in margins

shows up as high volatility in margins

45
We will look at other dimensions of
business quality in session 3

Defensibility Growth

Cash
Cyclicality
generation

Other
Rate of
business
change
risks

46
Agenda
• The importance of assessing business quality
• How to assess the quality of a business
• Assessing industry attractiveness

47
Ideally, invest in a good industry

“When a management with a reputation for brilliance tackles a business with

a reputation for bad economics, it is the reputation of the business that
remains intact.”
- Warren Buffett

48
 Another way to look at this
Management track record

Best place
Can a company continue
Good for a long-term
to defy the industry?
shareholder

Do you really want Are you betting on new

Poor to be a long-term management to turn
shareholder here? around an underperformer?

Low High
Attractiveness of industry

49
 Empirically, returns on capital vary
widely across industries (1 of 2)
Median annual ROIC, excluding goodwill, for 7,000 US public companies

Better
industries

Source: https://www.mckinsey.com/business-functions/strategy-and-corporate-finance/our-insights/a-long-term-look-at-roic 50
 Empirically, returns on capital vary
widely across industries (2 of 2)
Median annual ROIC, excluding goodwill, for 7,000 US public companies

Worse
industries

Source: https://www.mckinsey.com/business-functions/strategy-and-corporate-finance/our-insights/a-long-term-look-at-roic 51
How do we figure out what is a good
industry?

Structural
Porters’ Five Forces framework
attractiveness

Empirical
Look at the numbers!
attractiveness

We will discuss the Indian two-wheeler industry

using both of these methods

52
Michael Porter’s ‘Five Forces’ framework assesses
the structural attractiveness of an industry

Bargaining
power of
customers
www.hbs.edu

Bargaining
Threat of new
power of
entrants
suppliers

Threat of Intra-industry
substitutes rivalry

53
Food for thought: 1 of 3
Food for
thought

• Take some time to think through the structural attractiveness of the

Indian two-wheeler industry using the Porter’s five forces
framework
• We will discuss this in class

54
Next, we empirically assess the
industry’s attractiveness
The Indian two-wheeler industry is the world’s largest and has many players

55
We will focus on 5 players who account
for 90+% of the market (1 of 2)
• Erstwhile joint venture partner of Honda,
separated in 2011
• Market leader, particularly strong in entry
level motorbikes
• For background information, see
https://www.heromotocorp.com/en-in/uploads/other_not
ifications/20180806043109-other-notifications-261.pdf

• #2 overall, with ~60% share in scooters

• Entered motorcycles after end of Hero
joint venture
• For background information about
Honda’s motorcycle business globally,
see slides 35 to 41 in
https://world.honda.com/content/dam/site/world/investo
rs/cq_img/library/road_show/FY201903_spring_corpora
te_update_1_e.pdf
• #3 in India, with a large export business
into emerging markets
• Global leader in (very profitable)
three- wheeler segment, but makes no
scooters
• For background information, see
https://www.bajajauto.com/-/media/bajaj-auto/Investors/ 56
We will focus on 5 players who
account for 90+% of the market (2 of 2)
• #4 in India
• Only player present across scooters,
motorcycles, three-wheelers and mopeds
• For background information, see
https://www.tvsmotor.com/pdf/f1cbacd1-6ac4-4037-
8177-53979dfff58d-636670886837437364.pdf

• Leader in mid-sized bikes (with 90%+

share in the segment) under ‘Royal
Enfield’ brand
• Also has a joint venture with Volvo for
commercial vehicles
• For background information, see
https://www.bseindia.com/xml-data/corpfiling/AttachHis/
88cf7cf7-7af1-4bc0-bf72-d5be4b33be16.pdf

57
Some housekeeping about the
numbers to use, before we go further
• Standalone financials, to focus on the India business

• Standalone financials of Honda Motorcycle and Scooters

India (‘HMSI’)
• Estimated cash flow for FY10 and FY17 where figures
were not available in the Capitaline database

• Standalone financials, though this includes motorcycle

exports (from India) and the three-wheeler business

• Standalone financials, to focus on the India business

• Standalone financials, to exclude joint venture with Volvo

• Used annualized financials for FY09 and FY15 due to
changes in financial year

Source: Data from Capitaline 58

We will also use Eicher as an example
through the next few sessions
• We will study Eicher’s Royal Enfield business (and (mostly) ignore
its commercial vehicles joint venture), in the context of
• Business quality
• Management quality
• Financial analysis
• Financial forecasting
• Valuation

59
Food for thought: 2 of 3
Food for
thought

• Think about what kind of work will help you understand if the Indian
two-wheeler industry is empirically attractive
• Pause here before moving to the rest of the slides
• We will discuss this in class

60
Food for thought: 3 of 3
Food for
thought

• Over the next few slides, review some information snippets about
the Indian two-wheeler industry. Think about the following
questions:
• What source data was used, and how was the analysis done?
• What does the analysis tell you?
• What important analysis is missing?

61
Snippet A
Total revenue of Indian two-wheeler industry (= sum of above 5 players)
₹ crores

Source: Data from Capitaline 62

Snippet B
Total EBITDA of Indian 2 wheeler industry (= sum of above 5 players)
₹ crores

Source: Data from Capitaline 63

Snippet C
Receivable days

Source: Data from Capitaline 64

Snippet D
Operating Cash Flow / EBITDA
Year
ended
March 2010 2011 2012 2013 2014 2015 2016
Hero 101% 89% 65% 58% 84% 66% 86%
Bajaj 137% 53% 89% 59% 86% 57% 76%
Eicher 92% 108% 106% 140% 117% 94% 86%
TVS 282% 60% 94% 136% 117% 14% 116%
Honda 94% 76% 126% 118% 123% 85% 85%

Source: Data from Capitaline 65

66