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Monday, September 12, 2016

A guide to industry analysis for fundamental investors in India

·          Some points which struck me recently while listening to a friend: 

o    Industry Specific: Wherever there are specific statutes or regulators for an industry, understanding this is essential as also the dynamics. Some regulators are even handed(eg telecom, natural gas) while others leave much to be desired. Is there any possibility that your industry will be on the wrong side of these rulings Foreign regulation also matters as in FDA inspection of factories
o    Competition Law: Some industries like cement, tyres, shipping etc are perceived to be cartelistic, and therefore at risk of penalties from the Competition Commission.
o    Export/Import related-There have been export bans and/or pricing floors imposed on various commodities such as basmati rice, onions, sugar, iron ore.  Similarly, import tariffs have been raised on commodities supposedly dumped from China such as tiles, steel. Having an idea of the trade policy and the lobbying power of the industries(suppliers vs importers)
·          Banking/Finance regulations:
o    Foreign investment: Wherever there are foreign investments limits on shareholding and sectors and these are eased, the demand pool goes up therefore helping the stock price. Examples are industries where FDI limit raised from 49% to 75% or even to 100%-the stock prices goes up anticipating higher demand from FIIs/FPIs
o    Prudential Norm/Banking Regulation: When it becomes difficult for certain industries to raise more funds(say real estate, gems) from banks, they need to tap the bond market or expensive sources, and hence the stock price might fall. Same holds for regulations affecting troubled loan resolution(eg CDR, SARFAESI).
·          Taxation          
o    Indirect- some industries face ‘sin taxes’ such as tobacco, alcohol. This is a real risk for those companies
o    Direct-some benefit from tax holidays or weighted deductions on research, while some are tax free(eg SEZs, agriculture).
·          Customers
o    Pull vs Push: Is there a lockin of revenues or orders as evident via customer contracts and cash/carry, or is it a push driven credit dependent business
o    B2B or B2C: Is the company largely in B2B or B2C? If B2B, expect the margins to be lower unless it is a hidden champion. Just ask insurers who suffer from losses in group health insurance but who still continue it for revenues
o    ‘Sophistication’: Are the customers aware or do they think they are aware of the business? People may not understand paints or hardware (one reason why hardware shops mint money), but they ‘get’ FMCG and hence may not continue brands.
o    Value Migration: Is there a demographic migration from basic to luxury? Or do people migrate from products(eg scooters to bikes)? Implications
·          Competition/Industry
o    Market share of top few players: If the HHI index is below 50 or if the top few players do not exceed 50%, there is a sign of unorganized sector
o    Profit pool of industry and trends: Is the industry overall profitable or loss making(like airlines, ecommerce)? How has this trend changed in the last few periods?
o    Ecommerce/Online Impact: Is ecommerce favourable(say +ve for logistics, packaging, impulse purchases, advertising but –ve for brick and mortar)? Is there any industry where competitive advantage is negated via ecommerce distribution network access(eg ability to launch smartphones without dealer network, this has hit Samsung/Nokia/Apple)
o    Growth and import competition:  Is there a China threat? Are they getting bulk of the incremental demand(eg replacement tyres growth eaten up by China market)
o    Demand supply gap-presently and 5yrs: Do you have visibility on new capacities? Can  there be a scenario where the industry becomes surplus in capacity domestically or globally due to undergoing investments?
·          Suppliers:
o    Where the key suppliers are organized or have pricing power, expect your profits to be squeezed. Ask any customer of petrochemical firms in India
o    Statutory regulation on terms of trade-Whether it be quantity allocation(like natural gas priority allocation to power and fertilizers), price controls(coal, railway) or any statutory restriction on terms of trade, this has an impact.

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