Understanding the moat of page industries (jockey)

NPage Industries which is the licensor of the jockey brand in India is a very successful and well recognised story in the Indian stock market. Stock price of page industries has grown at a phenomenal rate. Their revenue and profit have grown at a cagr of 35 and 37% respectively over the past 10 years. Over the same period their average return on equity is 55%. Which means that they definitely have a very strong moat. In this post my endevour is to try to explain the reason behind the strength of the moat. 

I believe that page's moat comes in large part from the specific attributes of their product - which is undergarments, predominantly men's undergarments. I would venture that they were quite lucky to get into this business which lends itself readily to formation of a moat. In fact, men's undergarments business fits quite nicely in the first category of moat which I have described in my post below - product moat. Let us explore various unique attributes of this product which help in the moat formation:

1. Strong demand plus replacement demand

I don't have to do any analysis to prove that there is a strong demand for undergarments. Everyone uses them and everyone buys more of them every year. Replacement demand is very important and in that sense it is not as strong as say Coca Cola for which all the demand is replacement demand. It is also not as strong as Colgate where you have to buy a new product once he existing one is finished. In that sense undergarments do not "perish", although they can develop holes and sometimes people continue using them because what the hell - no one is going to notice (I'm talking about people in general here and not about me). In college people are known to brag about wearing the same underwear for weeks on end as well, again not me. However the replacement demand is stronger than Hawkins where once you have bought the product you can continue to use it for 4,5,6 or more years. So it is definitely not one and done.

2. Standardised product

The beautiful thing about undergarments is that we don't care too much about their design as long as it's quality is good. From this perspective it is much more standardised product, when compared to other garments. So an arrow or a Louis Philippe or a levis has to make thousands of different designs while jockey has to make only a few. Of course the more standardised a product the less is the cost to manufacture it on a per unit basis. In more technical terms this is referred to as economies of scale. Of course the gold standard in terms of standardisation is Coca Cola. If there is a more standardised product, please do let me know. 

3. Unaffected by changes in technology or changes in consumer taste/ preferences

Let me take the change in technology first. While we have seen phenomenal changes in technology in the last 3-4 decades, however this has not really affected the garment industry in any meaningful way leave alone the undergarment industry. There have been a few products such as anti-odour, iron-free shirts etc but that's it. For the undergarment industry I can't even say that.

Let me turn now to change in consumer preferences. Consumer tastes have undergone a sea change in every conceivable product including garments. I laugh every time I see a movie from 70s or 80s or 90s. If this is what the movie stars were wearing in those days, I don't even want to think about the clothing preferences of the average guy. But even here, our mighty undergarments have stood the test of time. Apart from boxers, I don't think there has been any major change in consumer preferences here. And let's face it our ancestors have been wearing boxers since hundreds of years, maybe they called it by some other name. Doesn't change the fact that there have been almost no change in consumer preferences when it comes to men's undergarments.

If we put all the three factors together, they make quite a potent force. But these factors are applicable to all the companies in this industry, what is so special about page? It is quite simple really - page had the good fortune of being in the right place at the right time. The thing about the undergarments industry is that there will be a few big players - like the cola drink or the oral care industry because of the economics of the industry. Additionally it doesn't harm that page is the licensor of the jockey brand which was already a well established and respected brand globally. Additionally there is something unique about men's undergarments from a psychological perspective. I say men because I'm not sure the same thing applies to women's undergarments as well. Anyway, as we all know men are not in general terrifically excited by the prospect of shopping. When we do go for shopping, we want to spend most of the time on shopping for garments which other will be able to see. And when it comes to undergarments, we do not have any time for them. We go like zombies and pick up what is familiar in the least amount of time. If we have been wearing jockey, we are unlikely to change our brand anytime soon.

Page will continue to get bigger, the recurrent demand for their products will ensure that. However more importantly and this is where lollapalooza comes from - they will keep on becoming stronger as they get bigger. Why is that? Couple of points here - 1) due to economies of scale their bottom line will increase at a rate higher than the top line. They can invest a part of that money towards advertising to strengthen the brand. 2) as the brand becomes stronger their products will be ubiquitous. The distributors will want to stock jockey because it sells. The consumers come like zombies and pick it up without thinking. What better product to sell can there be!

So Page will continue to do well, well into the future. But in my view they should keep away from unnecessary diversification. I heard that page has also acquired licensing rights to the swimwear brand speedo and people were quite hung Ho about it expecting it to be another jockey. But if we compare speedo on the three parameters listed above, it will become clear that speedo is no jockey. It falls well short on the very first parameter of demand. 1) how many people are regular swimmers in India. 2) how many trunks do even regular swimmers buy? My guess is it is a "one and done" product and doesnt come close to jockey and all the enthusiasm of investors is probably misplaced.

Finally, Even though we have established that page is a great business, I'm not saying go and buy it. Valuation is as important as any other factor in investing. A good business can turn out to be a pretty bad investment if bought at the wrong price. As investors we will make outsized returns only if we can identify a story which is not known or underappreciated by the market. Page is a very well known story. But this post was to identify the factors behind this compelling story and to see if we can identify similar stories elsewhere which are waiting to be discovered. 

I want to make one more final point before I close. I think this three factor framework is a good tool to compare businesses which fall under the product moat category. We discussed this in the post as well and I hope it has become clear that Coca Cola is definitely a better business than even page. In my view they score above page in both demand and standardisation. What about Colgate? Again scores more on both demand and standardisation in my view. What about Hawkins? Page scores above Hawkins on all three I would think. 

So that's it for now folks. If you think we can make this model better by addin or deleting any factors, please let me know in the comments. I would appreciate any feedback.

A new beginning - search for lollapalooza

"So I have decided to resuscitate (look at me using fancy words like resuscitate, I seriously don't know where that came from) this blog after a long time. It is high time given that investing is one of the very few things I'm really passionate about. When I started this blog I invested in companies like venkys, ess dee aluminium, educomp as you can see from the posts below. I don't know what I was smoking back then, I don't even remember. 

During this period my investing philosophy has evolved and hopefully for the better. In this post I want to give a brief overview of my philosophy as it stands currently. Of course it will hopefully keep on changing and getting better as I learn more. My outlook towards investing in this period has been shaped mostly by warren buffet and Sanjay Bakshi and other investors of their ilk. I like to invest in companies with a sustainable moat being run by honest and intelligent management whose shares can be acquired at a reasonable price. Before acquiring any company I ask the following questions:

Question 1: does the company have a moat or competitive advantage?

A good return on equity for a sustained period in the past is generally a good indicator of the evidence of a moat. The return should be generated by very low amount of leverage.

The next two questions are more qualitative in nature and most of the time is spent on these two questions. I have realised that investing is almost All art and very little science. I must caveat here that I'm talking here of the investing style which I have decided to practise inspired by people I've already mentioned above. There are of course various other investing styles and these lie on a wide continuum starting from pure science to pure art. 

Question 2: is the moat sustainable?

To answer this question I use the porters five forces analysis and that has proved quite helpful to me. I try to identify the most important forces and focus on these to try to understand the origin and sustainability of the moat. I would not go into too many details here but hopefully the construct will become clearer as I talk about the specific investments in the coming posts.

But so far I have realised that the moat of the company would generally fall into one of the following categories. I'm sure this is not an exhaustive list and I will keep on adding to this as I come across other categories.

Category 1: Product moat

Moat derived from the specific quality of the Product the company is selling. Typically the product will have one or all of the following characteristics:

- standardised product

- low cost

- can be sold to a wide set of customers and not focused on a niche customer set

- the product has to be bought multiple times by the customers

- produced on a mass scale and hence lends itself to economies of scale in the manufacturing process

Examples of companies in this category include coca cola, relaxo, page industries (jockey), suprajit engineering, Colgate 

Category 2: Process moat

Moat derived from the specific process which the company has developed and perfected over a long period of time to profitably serve a niche set of clients. This category typically has the following characteristics:

- process tailored to a niche set of clients

- process has multiple steps which reinforce each other

- strong focus on the niche set of clients

Examples include dell in the 90s, Shriram transport, gruh finance, etc.

Category 3: conglomerate moat (if there is a good capital allocator at the helm)

Diversification can be good in a very select few cases when there is a good capital allocator running the show. I picked this up from a book which has chronicled what these extraordinary people have accomplished through their capital allocation skills, the book being - the outsiders.

Examples include Berkshire Hathaway, Piramal enterprises, Thomas Cook ( the latter two are very much work in progress and I continue to hold them).

Category 4: high switching cost moat

There are cases where it becomes difficult for the customers to switch to a different company due to cost or time or any other reason. In such cases typically the customer is locked in once acquired and she continues using the service for her lifetime.

Examples include hdfc bank (or any other bank for that matter), AIA engineering, dish TV, etc.

Category 5: network effects moat

This is self explanatory and has been covered at multiple other places. Examples include Facebook, Microsoft, rating agencies, etc. This is a very powerful moat as it possesses what is referred to as lollapalooza effect (please see question 3 below). Even such a strong blow to the integrity and reputation such as the financial crisis of 2008 was not enough to dislodge any of the rating agencies. They continue to stand tall to perpetrate their misdemeanour for one more or maybe many more crises.

Next question is probably the most important of all.

Question 3: is there lollapalooza effect? OR in other words - will the moat become stronger with time?

This one was proposed by Charlie munger when he explained the moat of coca cola. Please read it here. Link- http://mungerisms.blogspot.in/2010/04/charlie-munger-turning-2-million-into-2.html

Notice how many factors including operant conditioning, Pavlovian conditioning, economies of scale, etc. come together and reinforce each other and the sum of the parts is much greater than the parts. This is what Charlie refers to as the lollapalooza effect. 

This is the dream of any investor. To correctly identify conditions which will give rise to lollapalooza effects. Because when that happens the moat of the company keeps getting stronger with time. Talking about time, I hope you noticed the time period used by Charlie in the above example - more than a century! Ideally that is the desired time period for me - to identify and acquire companies which I never have to sell. Our work will be done if we are able to identify a handful of such companies (or compounders as they are known) over our lifetime. 

Which brings me to another factor of my investing philosophy - concentration, which is again borrowed from others. But it does make a lot of sense for investors of this style. First of all it is difficult to identify these compounders which can also be acquired for a reasonable price. Hence when we do identify them, we would expect to reap the benefits for years to come. And it would be a shame to dilute the results by holding less extraordinary companies in the portfolio.

Another related factor which I should talk about is the management. When I invest in a company which I want to hold onto forever, it becomes imperative that the management of the company should work with integrity. Because over long periods of time it is difficult to sustain success which is built on shaky foundations. Hence I don't have a separate question dealing with the integrity of the management. If the company in question does not have it, I would not look at it to begin with.

Let me end by talking about one final point. What happens to our compounders during a recession or downturn? And again I'm not making it a separate question because some compounders are affected more than others. But we might still want to hold them even if they are adversely affected by a slowdown in demand if their moat is intact. Of course, many times this is the best time to acquire the compounders. However, one thing which has become clear to me is that the companies which fall into Product moat category are least affected by the slowdown. The reason could be that most of them sell products which form a small part of our total budgets and in many cases are essential items such as toothpaste and footwear and we have to keep buying them. These companies usually sell at a premium to other compounders. Other than that I'm not still clear whether one category of moat is stronger than the others. 

I will end this post here and will keep on modifying or changing the construct above as I discover and learn more. Happy investing and appreciate and welcome comments and criticisms and suggestions.