- 10 Years, Top 10 Learnings: Spark Consumption Desk

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SPARK CONSUMPTION DESK - 10 YEARS, TOP 10 LEARNINGS Diary of a Consumer Analyst July 23, 2020

 TEJASH SHAH  [email protected]  +91 22 6176 6802  MADHAV PVR  [email protected]  +91 44 4344 0060  SANTOSHKUMAR  [email protected]  +91 44 6660 3037  Analyst Certification and Required Disclosures begin on last two pages – Click here Page 1

SPARK CONSUMPTION DESK 10 Years, Top 10 Learnings In one of the most acclaimed movies of our times – The Dark Knight, there is a legendary dialogue by Harvey Dent – “You either die a hero or live long enough to see yourself become the villain”. The philosophy is applicable to many fields, but in our opinion, it resonates most with the world of investing. Come August, as SPARK CONSUMPTION DESK reaches the milestone of a decade of its existence, we ask the same question to ourselves, on how to survive long enough and yet not turn into a villain.

SPARK CONSUMPTION 23 July 2020

Honestly, just in the sheer mood of reflection (and bugged by WFH) we started scribbling our top observations/learnings of the last decade as a 400 team. As a lot of these learnings have come from our clients, hence in the spirit of sharing, it is fair that the same, if documented, should be 300 shared back with the clients at large. And as Jim Collins [Good to Great fame] says that for an academician or a teacher, his/her experiences are utter waste, if they can’t be shared with 200 the world at large. The same applies to relatively lowly learnings of SELL side analysts as well. 1.

Personal Biases should be kept Personal – The worst part of being a consumer analyst is that everyone & their uncles will have opinions on your sector and hence you’ll have to overcome a plethora of PERSONAL BIASES. And the most dangerous of all will be your own. Initially, we missed many good stocks (footwear, FMCG etc.) because the consumer in us couldn’t align with the brand. But Indian consumer is way more plural and complicated to be fully defined by an analyst stuffed in his AC cubicle. Hence, looking at the aggregate number is the best way to overcome the bias. BTW, on this point, a consumer analyst envies his Pharma counterpart the most, because it is easier for a layman to argue with a consumer analyst on Horlicks than a pharma analyst on Hydroxychloroquine.

2.

IPOs + Financial investor exits = Premature deliveries – As they say, IPO = It’s Perhaps Over-priced. Though we can’t generalize, but can safely state from experience that in IPOs. one needs to bring his/her best analytical foot forward. The game isn’t designed fairly, and information asymmetry can be perilous, mainly because of the limited cyclical history of the business. Though in the last decade, we have had blockbuster IPOs in the sector like Avenue Supermart, V-Mart, etc., but as far as the total count goes, the scale is very much tilted in favour of disappointing results. As per our read, the most unsuccessful consumption IPOs in the last decade were great developing stories but sub-scale businesses. And pre-mature IPOs burdened the weak model further with heavy expectations.

3.

Growth is a ‘Gangajal’ for most Corporate Governance Sins – Perhaps not true for other sectors, but largely true for consumption. The huge gulf between a bad management and a visionary management can be bridged with maximum of 3-4 quarters of consistent growth and good guidance. Similarly, the journey works backwards as well. In consumption, market sensitivity to Corporate Governance concerns like Pledge shares, Inter Corporate Deposits, Related Party transactions, etc. get active only during a bad growth phase and is forgotten during a good phase. Sometimes even a quarter of robust growth is good enough to jump the CG hump. Obviously, integrity violation of reported financials is beyond any redemption. But for lower degree Corporate Governance issues – Growth is a time-tested vaccine.

4.

Have Faith on your thesis and doubt your Faith – The worst phase of an analyst (or any practicing investor) is to stop questioning his/her investment thesis. In the VUCA world, where business cycles are getting compressed and disrupted on a regular basis, having doubts on your thesis helps to refine the thesis further. Hence, we frequently resort to our favourite INVERT THINKING framework, it has helped us to avoid many (not all) mistakes. But, still sometimes we get carried away.

find SPARK RESEARCH on Bloomberg [RESP SPAK ] | FACTSET | REFINITIV EIKON

100 0 Mar-10

Mar-14

NSEFMCG

Mar-18 NSECON

NIFTY

RESEARCH ANALYSTS TEJASH SHAH [email protected] +91 22 6176 6802 MADHAV PVR [email protected] +91 44 4344 0060 SANTOSHKUMAR [email protected] +91 44 6660 3037 Page 2

Spark Consumption Desk | 10 YEARS, TOP 10 LEARNINGS

5.

Channel Check is a necessary Condition but not a Sufficient One – Philip Fisher popularised the tool of ‘Scuttlebutt’ AKA ‘Channel Checks’. It is a very powerful tool to neutralise the management bias and get a 360* feedback on the business. But then channel checks can be one of the many tools but not the only one. Interestingly, both our top picks (Paints, LOG, Footwear stock turnaround etc.) and top blunders (mainly in small cap retail) had a fair contribution of channel checks. Hence, it is a tool to be used with extra sophistication. In our experience, sometimes two brothers in the same shop will have different outlooks on the same business. So, one needs to develop a robust filter to separate biases from facts. If done rightly, Channel checks can be a fabulous tool to evaluate customer loyalty. And yes, channel checks should be avoided for Quarterly previews, a very low strike rate.

6.

All things being equal, back the most articulate management – Articulation of business strategy is an art and a rare one. And it can have a huge bearing on P/E a stock will command. Let us elaborate with an example. Around 2014, 2 FMCG companies took price cuts in the same quarter. – in respective earning calls, one called it a “PRICE CUT” and the other “Democratisation of Prices”. The former was accused of lack of pricing power, while the later was praised for reaching out to the mass consumers. On a serious note, better articulation also signifies management’s clarity of thought, ability to think through complicated business problems and ability to write problem statements correctly. So no doubt, execution is the key, but better articulation helps.

7.

Wealth Destruction vs Value Destruction – The last 5 years of the decade have taught us this better than before. Though leverage is not a big concern for the sector, in some cases, promoters’ ambitious bets in the personal domain weighed heavily on the listed companies. Hence, a lot of wealth destruction happened without much value destruction in the business. Similarly, led by value migration, wealth destruction can start way before visible value destruction begins. Viz. TV Broadcasters, GT only oriented fashion brands, newspapers, etc. As we look ahead, we see many such value migration led possible disruptions in the offing in the consumption space (Perhaps a separate note on that later).

8.

Every price demands a narrative, sometimes “We don’t know” is the best one to offer – So, this one is our favourite. Throughout the last decade, a 10%+ monthly fall in a particular paint company stock fuels the narrative that there is some turbulence in promoters’ families and at every 52-week high, it becomes a world class professionally managed company. Similarly, in a packaged foods company, at every 10%+ correction, “CEO is resigning” becomes the favorite narrative to offer. We have learnt that, even at the risk of sounding uninformed to clients, many times “I don’t know” is the best and honest answer one can offer.

9.

Spreadsheets are overrated, Framework under rated – The initial urge to capture every moving part of the business in MS excel is tempting. But with experience the limitations of the same starts surfacing. In our experience, our best ideas came from a comprehensive sector framework rather than the precision in forecasting next year’s EPS. Spreadsheet is an imperative analytical tool to aid the process but relying solely on models to generate insights can generate faulty outcomes.

10. Corporate access, a double-edged sword – Meeting management is imperative, and can't be underemphasised. Especially in India, where the pilot is as important, if not more, than the plane, at no point Management access can be underplayed. But purely from an objectivity angle, an overreach of the same has proved to be counterproductive. And again, in our limited experience, we have realized that, most managements’ (there are exceptions) long term outlook is also vulnerable to get colored by current business momentum. So like channel checks, we have learnt to utilize corporate access also with a lot of caution. Interestingly, on hindsight, we can assign our biggest mistakes to corporate access overdose. At some passive level, it clouds thinking. Our best calls have come where we have restricted access largely to earning calls only. Finally, it seems, the odds of winning in stock markets are not necessarily directly proportional to the years spent in markets. Market has humbled us more than often in the last 10 years and we don’t expect it to change materially in the coming 10 years. The only endeavor from our side will be not to repeat the causes of getting humbled.

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Spark Consumption Desk | 10 YEARS, TOP 10 LEARNINGS Nifty FMCG Index outperformed broader market (NIFTY Index) by 2x over the last 10 years 5-yr CAGR FY10-FY15

5-yr CAGR FY15-FY20*

FMCG 22%; CONSUMPTION 16%; NIFTY 10%

FMCG 10%; CONSUMPTION 8%; NIFTY 5%

450

Continuation of BJP government in May-19

400

FMCG 10-yr CAGR*

Implementation of GST in Jun-17

350

300

Currently at ~4% below peak level

Rural slowdown impacting FMCG performance

Demonetisation announcement in Nov-16

CONSUMPTION 10-yr CAGR*

BJP government formed in May-14

12%

Currently at ~8% below peak level

250

NIFTY 10-yr CAGR*

200

8%

Currently at ~12% below peak level

150

Strong market rally across most sectors led by government capex spending (double-digit growth in both Nifty & FMCG index each year b/w FY16-19)

100

50 Mar-10

16%

Strong market performance of ~22% CAGR from FY13-15 Mar-11

Mar-12

Mar-13

Mar-14

Mar-15 NIFTY

Mar-16

Mar-17

NSEFMCG

NSECON

Mar-18

Mar-19

COVID-19 impact since Feb’20

Mar-20 Jul-20

Source: Bloomberg, Spark Capital Research; *5-yr & 10-yr CAGR until 17th July 2020; NSECON refers to Nifty Consumption Index which includes Auto & other boarder consumption sectors

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Spark Consumption Desk | 10 YEARS, TOP 10 LEARNINGS Consumption IPOs in last decade WEALTH CREATORS

WEALTH DESTRUCTORS

900 700

RETURN: ~77% CAGR in last 3.5 years, up 565% since listing

500 300

100 Mar-17

Mar-18

Mar-19

Company Name

Years since listing

Absolute Returns (%)

BAJAJ CONSUMER CARE

10

32%

PRABHAT DAIRY

5

-39%

PRATAAP SNACKS

3

-41%

TCNS CLOTHING

2

-53%

PARAG DAIRY

4

-59%

TBZ JEWELLERS

8

-75%

PC JEWELLERS

7.5

-78%

SPECIALITY RESTAURANTS

8

-79%

KHADIM

3

-85%

CAFÉ COFFEE DAY

5

-94%

MANPASAND BEVERAGES

5

-96%

ADLABS ENTERTAINMENT

5

-98%

Mar-20

1500 1000

RETURN: ~34% CAGR in last 7.5 years, up 767% since listing

500 0 Feb-13 Feb-14 Feb-15 Feb-16 Feb-17 Feb-18 Feb-19 Feb-20 300 250 200

RETURN: ~20-25% CAGR in last 3.5+ years, up 100%+ since listing

150 100 50 Nov-16

Jun-17

Jan-18

Aug-18

Mar-19

Oct-19

May-20

400 300 Jan’20 RETURN: ~12% CAGR in

200

0 May-14

last 6 years, up 100% since listing (as of Jan’20)

CAGR ~13%

100 May-15

May-16

May-17

May-18

May-19

May-20

*current price deeply impacted by COVID

Source: Bloomberg, Spark Capital Research;

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Spark Consumption Desk | 10 YEARS, TOP 10 LEARNINGS Performance of our coverage names in the last decade Performance (10-yr CAGR) of FMCG coverage; ‘Unloved Unfavoured’ basket is the clear underperformer

Paints pack significantly outperformed the market in the last decade (10-yr CAGR)

33%

31% 25%

23% 20%

20%

19%

18%

16%

8% 6%

BRIT

HUVR

NEST

MRCO

DABUR

ZYWL

5%

ITC

JYL

8% 5%

HMN

3%

BAJAJCON

NIFTY

Performance (10-yr CAGR) of Discretionary coverage; Smaller retail names (KHDM, KEKC) are the underperformers 41%

40%

34%

22%

20%

VMART

KNPL

Stocks which got significantly impacted due to recent COVID-led disruptions since Feb’20; 10-yr performance CAGR as of 31st Dec 2019

19% 10%

RLXF

APNT

28%

6%

6%

0% LOG

PIDI

30% 23%

ABFRL

BRGR

PAG

BATA

JUBI

TTAN

TRENT

VIP

ITFL

KEKC

8%

2%

16%

WONH KHDM

16%

NIFTY

13% 9%

-51% BATA

VIP

ITFL

WONH

NIFTY

Source: Bloomberg, Spark Capital Research; Note: 10-yr CAGR until 17th July 2020 & CAGR performance of BAJAJCON, ITFL, KHDM, VMART, WONH since respective listing

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Spark Consumption Desk | 10 YEARS, TOP 10 LEARNINGS

Absolute Rating Interpretation

BUY

Stock expected to provide positive returns of >15% over a 1-year horizon

ADD

Stock expected to provide positive returns of >5% – <15% over a 1-year horizon

REDUCE SELL

Stock expected to provide returns of <5% – -10% over a 1-year horizon Stock expected to fall >10% over a 1-year horizon

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Spark Capital and/or its affiliates and/or employees may have interests/positions, financial or otherwise in the securities mentioned in this report. To enhance transparency, Spark Capital has incorporated a disclosure of interest statement in this document. This should however not be treated as endorsement of views expressed in this report:

Details of Financial Interest of Research Entity [Spark Capital Advisors (India) Private Limited] and its Associates

No

Details of Financial Interest of covering analyst/ and his relatives

No

Investment banking relationship with the company covered

No

Any other material conflict of interest at the time of publishing the research report by Spark and its associates

No

Receipt of compensation by Spark Capital or its Associate Companies from the subject company covered for in the last twelve months:  Managing/co-managing public offering of securities ; Investment banking/merchant banking/brokerage services ; Products or services other than those above in connection with research report; Compensation or other benefits from the subject company or third party in connection with the research report

No

Whether covering analyst has served as an officer, director or employee of the subject company covered

No

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No

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No

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Spark Consumption Desk | 10 YEARS, TOP 10 LEARNINGS

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Ltd only to major U.S. institutional investors (as defined in Rule 15a-6 under the U.S. Securities Exchange Act of 1934 (the “Exchange Act”)) pursuant to the exemption in Rule 15a-6 and any transaction effected by a U.S. customer in the securities described in this report must be effected through LXM LLP USA. Neither the report nor any analyst who prepared or approved the report is subject to U.S. legal requirements or the Financial Industry Regulatory Authority, Inc. (“FINRA”) or other regulatory requirements pertaining to research reports or research analysts. No non-US Group Company is registered as a broker-dealer under the Exchange Act or is a member of the Financial Industry Regulatory Authority, Inc. or any other U.S. self-regulatory organization. Analyst Certification. Each of the analysts identified in this report certifies, with respect to the companies or securities that the individual analyses, that (1) the views expressed in this report reflect his or her personal views about all of the subject companies and securities and (2) no part of his or her compensation was, is or will be directly or indirectly dependent on the specific recommendations or views expressed in this report. Please bear in mind that (i) Spark Capital Advisors (India) Pvt. Ltd is the employer of the research analyst(s) responsible for the content of this report and (ii) research analysts preparing this report are resident outside the United States and are not associated persons of any US regulated broker-dealer and that therefore the analyst(s) is/are not subject to supervision by a US broker-dealer, and are not required to satisfy the regulatory licensing requirements of FINRA or required to otherwise comply with US rules or regulations regarding, among other things, communications with a subject company, public appearances and trading securities held by a research analyst account. Important US Regulatory Disclosures on Subject Companies. This material was produced by Spark Capital Advisors (India) Pvt. Ltd solely for information purposes and for the use of the recipient. It is not to be reproduced under any circumstances and is not to be copied or made available to any person other than the recipient. It is distributed in the United States of America by LXM LL P USA and elsewhere in the world by Spark Capital Advisors (India) Pvt. Ltd or an authorized affiliate of Spark Capital Advisors (India) Pvt. Ltd . This document does not constitute an offer of, or an invitation by or on behalf of Spark Capital Advisors (India) Pvt. Ltd or its affiliates or any other company to any person, to buy or sell any security. The information contained herein has been obtained from published information and other sources, which Spark Capital Advisors (India) Pvt. Ltd or its Affiliates consider to be reliable. None of Spark Capital Advisors (India) Pvt. Ltd accepts any liability or responsibility whatsoever for the accuracy or completeness of any such information. All estimates, expressions of opinion and other subjective judgments contained herein are made as of the date of this document. Emerging securities markets may be subject to risks significantly higher than more established markets. In particular, the political and economic environment, company practices and market prices and volumes may be subject to significant variations. The ability to assess such risks may also be limited due to significantly lower information quantity and quality. By accepting this document, you agree to be bound by all the foregoing provisions. LXM LLP USA assumes responsibility for the research reports content in regards to research distributed in the U.S. LXM LLP USA or its affiliates has not managed or co-managed a public offering of securities for the subject company in the past 12 months, has not received compensation for investment banking services from the subject company in the past 12 months, does not expect to receive and does not intend to seek compensation for investment banking services from the subject company in the next 3 months. LXM LLP USA has never owned any class of equity securities of the subject company. There are not any other actual, material conflicts of interest of LXM LLP USA at the time of the publication of this research report. As of the publication of this report LXM LLP USA, does not make a market in the subject securities. Additional Disclaimer for UK Investors Spark Capital’s research, including the recommendations recorded therein, have been objectively prepared from public sources which it believed to be reliable and therefore constitutes independent investment research, and is presented as such. Note that Spark Capital has concluded an agreement with Avior Capital Markets International Limited (“ACMI”), regulated by the Financial Conduct Authority (FRN: 191074), pursuant to which ACMI promotes and markets the products and research of Spark Capital, provides investment advice in respect thereof to the extent permissible. In return for this Spark Capital pays a monthly fee and commissions earned on certain qualifying transactions to ACMI. Spark Capital’s research reports, including any recommendations in respect thereof, may only be distributed to, and relied on by, qualifying investors, who are permitted to receive the same in the UK. A list of Spark Capital’s research reports disseminated in the UK over the past 12 months is available on request. This material produced by Spark Capital is solely for information purposes only and for the personal use of the recipient. It is not to be reproduced under any circumstances and is not to be copied or made available to any person other than the recipient. It is distributed in the UK by ACMI and elsewhere in the world by Spark Capital or an authorized affiliate of Spark Capital. This document does not constitute an offer of, or an invitation by or on behalf of Spark Capital or its affiliates or any other company to any person, to buy or sell any security. Securities, money market instruments, strategies, financial or investment instruments mentioned herein may not be suitable for all investors. The information and opinions provided in this note do not constitute a personal recommendation and take no account of the investor's individual circumstances. Investors should consider this research as only a single factor in making any investment decisions and, if appropriate, should seek advice from an investment advisor. Spark Capital or its affiliates does not accept any liability or responsibility whatsoever for the accuracy or completeness of any information contained in its research reports. All estimates, expressions of opinion and other subjective judgments contained herein are made as of the date of this document. Emerging securities markets may be subject to risks significantly higher than more established markets. In particular, the political and economic environment, company practices and market prices and volumes may be subject to significant variations. Save as specifically disclosed otherwise, Spark Capital’s relationship with ACMI is not reasonably expected to impair the objective presentation of the recommendations in respect of in the research report, including any interests or conflicts of interest concerning any financial instruments or the issuers to which the recommendations, directly or indirectly, relate. The research report is deemed to be first disseminated at the date and time recorded on Spark Capital’s distribution platform or data network, and which information is available on request. ACMI does not assume any responsibility, or liability of any nature whatsoever, arising from or in connection with the contents, use, reliance or dissemination of Spark Capital’s research or any recommendation in respect thereof and disclaims any such liability.

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