Indian Companies with Economic Moat 2018

If Warren Buffett will look for investments in India, which Indian companies will attract his attention? The short answer is, he will look for companies having “economic moat“. 

Three questions arise here related to Warren Buffett type companies:

Q1: What it means by economic moat?

Q2: How to identify moat companies?

Q3: Which are the Indian companies with moats?

Before we understand economic moat, lets understand what is a “moat”. Moat is a “safety arrangement” built around the castles in ancient times. 

What is the safety arrangement? A hole dig all around the castle, which is later filled with water. Such an arrangement makes it tough for the attackers to access the castle. 

Indian Companies with Economic Moat -1.1

What is the analogy? 

  • The Castle: Represents a company.
  • Attackers: Represent competition from other companies. 
  • Water Body: Represents protection (The moat). 

When a castle is protected by a moat, attackers access to the castle is very limited. 

Similarly when a company is protected by a moat, competitors will find it difficult to dethrone the company from its current position.

What is the current position of the company? High market share, high profits, high margins etc. 

Now lets get slightly deeper into the financial side of “moat” (economic moat)… 

#1. What it means by Economic Moat?

In investment terms, economic moat can also be called as “competitive advantage“. 

As the name suggests, a company with economic moat has an advantage over its competitors. 

What is the advantage?

Due to the competition, the company’s market share, profit is not in danger.  

What gives the competitive advantage (economic moat) to a company?

There can be several factors. Two of them which are more evident and are also logical are these:

  • Customer’s preference.
  • Market’s Limitation. 
Indian Companies with Economic Moat -2

Customers preference

This plays a more dominant role in giving a company its economic moat. How?

Its a simple logic, if we as a customer is convinced that a particular product is good for us, no matter how much the competitors might try, customers will go their way. 

Such an example in India is the brand “Patanjali”. In last 4-5 years, this brand has given competition to giants like HUL, P&G, Nestle etc.

What gives such a conviction to customers in favour of a brand? Again there can be several reasons, but what looks more logical to me are these:

  • Product is useful & unique. 
  • It is value for money
  • People buy for owning the brand
  • There is no alternative (R&D, patents etc). 
  • Product is currently trending.

Market Limitations 

This also has its role in allowing a brand to build its economic moat (competitive advantage). 

Example is Maruti Suzuki and Fiat. In 1980’s in India, 90% people used to own cars from the following three brands only:

  • Hindustan Motors.
  • Fiat (Premier Padmini).
  • Maruti (Suzuki). 

Fiat and Maruti entered India market in 1970’s and 1980’s respectively. Before that (from 1950’s to 1970’s) it was only Hindustan Motor’s Ambassador. 

It will not be wrong to say that that was an era where these three brand-names enjoyed phenomenal “economic moat” in India. 

What gave these companies their competitive advantage? Three things:

  • Indian market was not ready for more brands. 
  • It was a closed economy. 
  • Auto giants like Ford, VW, Toyota didn’t find Indian market suitable for entry. 

What is the point? For we as an investor, it is essential to keep looking for “companies with moats”. Why?

Because such companies can grow faster and generate more profits in times to come. The higher will be the profits, better will be the returns of the shareholders. 

But how economic moat leads to higher profits?

#1.1 Economic moat and Profitability of a company…

I hope we have understood what it means by economic moat. 

Here, we must also understand how economic moat leads to more profits (and profitability) for the company. And as the company becomes more profitable, it creates value for its owners (and shareholders). 

There is critical power bestowed in the hands of economic moat companies by the market. What is this power?

A company with wider economic moat has a “pricing power”. 

Lets take an example to understand the “concept of pricing power”. 

Let’s take names of few companies whose products we love. We will continue to buy their products no matter what. Why? Because literally there are no comparable alternatives for them in the market…

  • Maggie, Nescafe (Nestle India).
  • Good Day Biscuits (Britannia).
  • Chawanprash (Dabur).
  • Paints (Asian Paints, Berger).
  • Pizza (Dominoes – Jubilant Foodworks).
  • Etc

I have listed here the names of few products which has become perhaps bigger than its brands itself. 

In many ways they have transformed themselves from “mere products” to “necessity” for its customers. How this happened? 

This credit must go to the company. They have used their money for the following:

  1. Product development (R&D).
  2. Marketing.
  3. Distribution and sales. 

When a company invest their money in the above 3 areas, they are actually building a “moat”.

When a company keeps investing large sums of money in the above areas over a period of time, their moat becomes phenomenally big. 

Examples of few company & products with widest moats are: BMW Car, Apple iPhone, Bose’s music system, Rolex’s Watch, Gucci’s clothing line etc. 

These are products and brands which has become a status symbol for its customers. People stretch their spending-powers to buy them.

These products have reached almost a cult stature. How it happened?

It is the result of a combination of money spent for product development, and a well crafted sales and marketing strategy. 

In short we can say that a “good product package” will ultimately sell, no matter how expensive is their price range. 

This is the magic of building an economic moat around a product (or around a brand name). 

But everything said and done, how to identify “moat companies”? Do only luxury brands enjoy moat? No, even non-luxury brands can have decent moat. Let’s see how to identify such companies.

#2. How to identify companies with moats?

I personally feel that identification of such companies are easy. But before I disclose the “easy way”, let’s understand first what leads us to this easy answer… 

Let’s ask a very basic question? What is the economic benefit to a company which enjoys a wide moat?

  • Such companies can operate at high profitability levels.
  • They can maintain (or even improve) their profitability year after year. 

So what we can understand from this is:

“Economic moat” companies stay consistently profitable over a period of time.

So what should be the measure of profitability to establish “economic moat”?

To answer this question, let’s think like business men. 

There are two companies ABC and XYZ. The financials of these companies are like this:

ABC

  • Cost of doing business: Rs.100 
  • Profit: Rs.10.

XYZ

  • Cost of doing business: Rs.100 
    Profit: Rs.12.

What is shown by the above numbers? For every Rs.100 put in the business, ABC is generating less profit (Rs.10) compared to XYZ (Rs.12).

So which company is more profitable? XYZ. If these numbers are presented to business men, the decision making becomes easy. XYZ will be anyones choice. 

We will use the same logic to identify our companies with moat. How?

Indian Companies with Economic Moat -3
  • Step 1: RoCE will be used as a measure of profitability.
  • Step 2: Sustainability of RoCE will also be given due weightage. 

RoCE calculation can be done using the formula shown above. 

Sustainability of RoCE can be established in the following ways:

  1. Note down last 10 years RoCE.
  2. Check if the current RoCE is greater than or equal to the last years RoCE. 
  3. Check if in last 10 years period, ROCE has increased or decreased. 

A company with moat shall show the following characteristics:

  • High RoCE in current year. 
  • RoCE has consistently increased in the past (year after year). 
Indian Companies with Economic Moat -4

#3. Which are the Indian companies with moats?

I have checked financial of Nifty-500 stocks.

Out of these 500 companies, I have screened those companies which has current years RoCE of 30% or more. 

Once I have this list of high RoCE stocks, I checked their last 10 years RoCE.

The best that I could find, companies with widest economic moat, was these:

United Breweries…

Indian Companies with Economic Moat -5-UB3
  • CE = Capital Employed.
  • OP = Operating Profit.
  • RoCE = Return on Capital Employed.
  • YOYG = Year on year Growth (from previous year).
  • 10YG = RoCE growth in last 10 years (Mar’09 to Mar’18)

What the above numbers say about the Economic Moat of United Breweries (UB)?

RoCE of UB increased in 5 years out of 10 years. 

RoCE of UB increased from 13.0% (Mar’09) to 30.6% (Mar’18) in span of last 10 years. 

RoCE of UB is as high as 30.6% in last FY year. (Mar’18). 

Caplin Point Lab.

Indian Companies with Economic Moat -5-Caplin2
  • CE = Capital Employed.
  • OP = Operating Profit.
  • RoCE = Return on Capital Employed.
  • YOYG = Year on year Growth.
  • 10YG = RoCE growth in last 10 years.

What the above numbers say about the Economic Moat of Caplin Point Lab?

RoCE of Caplin Point Lab increased in 6 years out of 10 years. 

RoCE of Caplin Point Lab increased from 18% to 47.9% in span of last 10 years. 

RoCE of Caplin Point Lab is as high as 47.91% in last FY year. 

Avanti Feeds

Indian Companies with Economic Moat -5-Avanti
  • CE = Capital Employed.
  • OP = Operating Profit.
  • RoCE = Return on Capital Employed.
  • YOYG = Year on year Growth.
  • 10YG = RoCE growth in last 10 years.

What the above numbers say about the Economic Moat of Avanti Feeds?

RoCE of Avanti Feeds increased in 6 years out of 10 years. 

RoCE of Avanti Feeds increased from 0.24% to 65.1% in span of last 10 years. 

RoCE of Avanti Feeds is as high as 65.1% in last FY year. 

VIP Industries

Indian Companies with Economic Moat -5-VIPInd
  • CE = Capital Employed.
  • OP = Operating Profit.
  • RoCE = Return on Capital Employed.
  • YOYG = Year on year Growth.
  • 10YG = RoCE growth in last 10 years.

What the above numbers say about the Economic Moat of VIP Ind.?

RoCE of VIP Ind. increased in 6 years out of 10 years. 

RoCE of VIP Ind. increased from 11.8% to 38% in span of last 10 years. 

RoCE of VIP Ind. is as high as 38% in last FY year (Mar’18). 

Page Industries

Indian Companies with Economic Moat -5-PageInd
  • CE = Capital Employed.
  • OP = Operating Profit.
  • RoCE = Return on Capital Employed.
  • YOYG = Year on year Growth.
  • 10YG = RoCE growth in last 10 years.

What the above numbers say about the Economic Moat of Page Ind.?

RoCE of Page Ind. increased in 8 years out of 10 years. 

RoCE of Page Ind. increased from 42% to 60% in span of last 10 years. 

RoCE of Page Ind. is as high as 60% in last FY year (Mar’18). 

Castrol India

Indian Companies with Economic Moat -5-Castrol
  • CE = Capital Employed.
  • OP = Operating Profit.
  • RoCE = Return on Capital Employed.
  • YOYG = Year on year Growth.
  • 10YG = RoCE growth in last 10 years.

What the above numbers say about the Economic Moat of Castrol?

RoCE of Castrol increased in 6 years out of 10 years. 

RoCE of Castrol increased from 86% to 101% in span of last 10 years. 

RoCE of Castrol is as high as 101% in last FY year (Mar’18). 

Conclusion…

Which stocks can be classified as Warren Buffett type stocks? Stocks of companies having wide economic moat. 

What makes wide economic moat so likeable by Warren Buffett?

  • Such companies are very profitable
  • Performance of such companies are more predictable
  • They are more resilient towards competitive pressures

One financial parameter that talks most about the economic moat of a company is RoCE (Return on Capital Employed). 

A company whose RoCE is increasing year on year since last 10-15 years are the ones which Warren Buffett loves to invest in. 

Limitation of economic moat…

Economic moat is more of a qualitative check. A company with wide economic moat means its business is stable and profitable. 

But wide economic moat does not talk about whether the stock is undervalued or overvalued. In other words, economic moat is not a check of stock’s price valuation.

What is the point?

The point is, just because a stock has wide economic moat, does not make it an instant buy. One must perform another fact check. 

Check of price valuation of the stocks is essential before purchase. 

Generally I use my stock analysis worksheet to estimate intrinsic value of my stocks. If the estimated intrinsic value is less than the current market price, it means the stocks is overvalued. 

For profitable investing, one cannot buy overvalued stocks. So how to avoid this mistake?

Always buy stocks having wide economic moat, and undervalued price levels

5 Comments

  1. Sir,
    I have been reading your valuable articles since January, 2018 and enriched myself. If I follow your articles next two years, I will be able to recover my money which have lost in stock market. This is one of the excellent articles presented to us.
    S. N. Sardar.

  2. What are the sectors Warren Buffett is progressing on?
    http://bit.ly/2JMCt5y
    The financial sector was a focus of Warren Buffett as he bought more of US Bancorp and Bank of New York Mellon Corp at the start of the year. The Financial sector lost 3.57% on a quarterly basis and his owned stock is performing badly and has changed 0.1% and 0.4% respectively.
    How will this year turn out for him as both these industries are trading down on a quarterly basis?

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