Reckon it is time to mix things up a little bit. Looking at the same old macro data points time and again doesn’t deliver incremental value, even if a lot is happening in the world. For this month’s edition, we will take a cursory look at the evolution of the consumer discretionary segment over the past few years.
The consumption theme in India has overly relied on FMCG stories such as HUL, Dabur, ITC, Nestle and the like for long. Other than these usual suspects the only good options available were a few stories like Jubilant Food, Page Industries, VIP Industries, Bata India, Relaxo Footwear and TTK Prestige. For the longest time there were limited options in India where the business had already attained respectable scale.
Over the past few years though, we have more options across themes like –
QSR (Quick Service Restaurants) – Westlife Development, Burger King, Devyani International, Sapphire Foods, Barbeque Nation now provide more options to play this theme than just the lone Jubilant Food. The QSR segment in India consists of franchise operators for global chains and can derive multi year growth from the urban and semi urban segments for a long time to come. 15% revenue growth at healthy unit economics (beyond a scale) is possible while having long term visibility through franchise agreements.
Specialized Garment & Footwear makers – TCNS Clothing, Metro Shoes, Vedant Fashion, Go Fashion now present interesting opportunities to tap into consumer segments that are upwardly mobile and aspirational. Each one of these is a market leader in it’s segment of operation and can deliver 15%+ revenue growth at good profitability & good return ratios. Business is backed by solid brands and managements that are contemporary enough to leverage all channels without stressing balance sheets too much.
Barring the rare frauds and non performers, the consumer segment has historically offered a high base rate of success in India. History tells us that once a consumer brand crosses a threshold of annual revenue, the unit economics become much more favorable due to the ability to spread market developments spends over a higher revenue base. See the margin profile of the listed innerwear makers today compared to where they were 7-8 years ago. Their EBITDA margin profile has moved from ~9% to ~15% as annual revenue scaled beyond 1,000 Cr over the years.
The other big change is the ability of the managements to execute an omnichannel approach today as compared to the distribution heavy model 10 years ago. Many of these derive ~15% revenue from online channels today, this was less than 5% pre COVID. In the case of QSR higher proportion of revenue from online orders is enabling them to reduce store size and increase throughput even if there is a price to pay on the margin front. Excessive reliance on a single channel was always a risk in India, that risk is much lower today and is likely to further reduce from here.
Given such a plethora of options today that can deliver 15% revenue growth at 20%+ ROCE at healthy corporate governance, I often find myself racking my brains on why I would want to pay premium valuation multiples to an FMCG giant that can consistently grow at 10% but does not have enough avenues to reinvest cash flows to derive higher growth. Unless the growth rate can be 16-18% over the next 10 years, it looks tough to justify current valuations in a reverse DCF exercise. This is the reason we don’t have consumer staples in the portfolio right now. Numbers beat narratives more often than not in investing, even over the long term.
On the other hand, some of these newer options might deliver attractive returns to investors so long as the entry valuation is reasonable.
Fishing in waters where the base rate of success has historically been high is a smart thing to do, even if it is not a unique approach.
We have more choices today that we have ever had in this segment, we can look outside of the usual consumer names that appear to be priced to the brim. A nuanced approach to valuation should lead us to a few businesses that can get the job done from here.