If you are given a particular Industry/company to cover what you will do? How are you going to start? What are the things you’ll have to cover to understand the basics of the same?
Here are the steps you need to follow to get a quick glimpse of any Industry:
Note: Just to be very clear this is NOT called Industry Analysis/company analysis. Please note this is just First step of Analysis i.e. having a brief idea about the industry/company.
Step 1. Language of the Sector/business
First step would be to understand the language of the sector in order to understand the sector properly. Language of the sector includes technical/ specific terms related to sectors for example API (Active pharmaceutical ingredient) for pharma, Gross NPA/ Net NPA for banking & NBFC, Clinker Ratio for cement etc. If you know the technical terms of a sector then it tremendously increases your understanding of what management of the company is trying to convey in annual report/ Con-call/ Interview.
To give you a sample on how in-depth this can be below are the links of language of the sector prepared by our students on the steel pipe industry by Mukul Jain and insurance industry by Krisha Kansara. They have covered in depth about all the technical/ sector specific terms which are required to understand that sector. If one reads it first and than proceeds with analyzing insurance or steel pipe business a clear difference will emerge in the ability to understand business model of such companies.
Krisha Kansara, FE (from Finbridge): https://krishakansara.wordpress.com/2020/05/03/key-terminologies-of-insurance-industry/
Mukul Jain, FE (from Finplus):
https://wittiestinvesting.wordpress.com/2020/07/20/understanding-the-language-of-steel/
Step 2. Define the product/service
Business are mainly of three types 1) Which manufactures products and sells that product in the market. For example FMCG (Fast-moving consumer goods) company and 2) Service Industry, Which provides service to the customers like the education industry 3) Marketplace Platform: in very simple terms they act as a bridge between buyer & seller like India-Mart
To Define product/services better you need to judge the following points TWO POINTS:
A. Usage and Applicability of the product/services: Let us understand this point through examples. If someone is analyzing Agro-Chemical Industry - He will have to understand what is usage of insecticides, fungicides, herbicides, plant nutrients in farming value chain. If someone is analyzing cement than he should understand difference between usage of grey cement & white cement.
Source: QIP document P I Industries
Herbicide: Kills or inhibit the growth of unwanted plants.
Insecticides: Insecticides are used to control insects.
Fungicides: Fungicides are used to control fungal problems like molds, mildew and rust.
Biopesticides: Biopesticides are certain types of pesticides derived from such natural materials as animals, plants, bacteria, and certain minerals.
Source: AR-21, UltraTech Cement
Grey Cement or ordinary portland cement (OPC): Grey cement is grey because of the presence of high amounts of iron, manganese and chromium oxide, which are found only in small traces in white cement. Grey cement is used purely for construction purposes only.
White Cement or white ordinary Portland cement (WOPC): White cement contains high amounts of the whitest chalk and light-coloured sand. White and grey cement have three other contrasting differences which make them well-suited for different purposes in the construction industry. White cement is primarily used to enhance the aesthetic look and feel of the internal and external aspects of a building structure such as ornamental decorations and flooring.
Note: This type of details are present in company's Annual report/ Investor Presentation/ QIP document (if any) or in concall.
B. Product/Service Scope: There are two sub-categories under this line item.
Product scope: Like for example Aarti Industries, They have a diverse portfolio of basic chemicals, agrochemicals, Benzene based specialty chemicals and intermediates which are extensively used in the manufacture of Pharmaceuticals, Agri-products, polymers, additives, pigments and dyes. Majority of revenue for Aarti Industries is generated through Speciality chemical segment.
Source: Investor Presentation
End-usage of their products are mainly in:
1) In the ironic red colour of supercars.
2) In the paints that colour home.
3) In the medicines.
4) In the shampoo.
5) It’s present in almost every farmer's toolkit.
6) It is also used in aeroplanes shown in snapshot below.
Source: Analyst Presentation Nov-18
Another example here can be of a very complex product which is unknown to lot of people like for example if you are analyzing company called "Shivalik Bimetal" their one of the major product is "Shunt Resistor". A resistor having a very low value of resistance such type of resistor is termed as "shunt Resistor"
It becomes very important to understand the usage of shunt resistors. So below is the snapshot explaining where the shunt resistors are being used.
Source: ValuePickr, Shivalik Bimetal thread
Geographical scope: You need to understand the geographical reach of the industry.
For example Cement commodity has the least value to weight ratio. As a result, the transportation cost is extremely high relative to the revenue figures cement may bring to the company. So for cement companies, it's really important to be able to sell their final product in that limited geography from their grinding unit, at a lucrative price to end up being profitable. Freight/ transportation cost (per tonne) for an cement company is almost between 20-25% of realization (per tonne) shown in snapshot below.
The firms can't open grinding units across the nation to be able to sell the product, as grinding units need to be close to the Limestone mines to avoid high transportation costs for the raw materials. Limestone mines are auctioned upon expiry of their current leases, so eventually, where a company is going to sell its products mainly boils down to one single thing, limestone mine lease allocation!
Also when it comes to export sales in cement there's no major scope in cement for export as cement is too heavy and transportation cost for cement is too high so even if some companies decides to export it will make cement cost unrealistic (due to heavy transportation cost) for the buyer. Hence a buyer will prefer to buy from local source at a cheaper rate.
Source: Care Ratings, Rating Methodology Cement document
Source: OEC
Despite being 637 billion industry only 275 million $ export was done in 2019 that depicts that majority of cement produced by India is consumed domestically only.
Whereas if we compare cement to lets say a pharma business (API or formulations) or IT industry even greater than 50% of revenues can be from export for some companies. Let us look at one example for the same.
Alembic Pharmaceutical generates 68.8% of its top line from outside India shown in snapshot below.
Source: AR-21, Alembic Pharmaceutical Ltd
Hence it's becomes very important to understand geographical scope of an industry's products & services
Step 3. Who’s the buyer?
After understanding usage/ Applicability and scope you need to identify who is the buyer of the product/ service which the business is offering. Like for example you are covering ferrochrome Industry so ferrochrome is a product which is developed through iron ore and chromium which is majorly used by Auto companies in auto preparation and mining companies in mineral extraction.
AIA Engineering manufactures “grinding media” what company calls as High Chrome consumable wear parts. Raw material required to produce high chrome consumable wear parts is "Ferro Chrome" shown in the snapshot below.
Source: Annual Report 2021, AIA Engineering
High chrome consumable wear parts are typically used in Cement & Mining industry shown in the snapshot below.
Alloy: Metal made by combining two or more metallic elements, especially to give greater strength or resistance to corrosion.
Source: Annual Report 2021, AIA Engineering
It is extremely important to understand the end buyer because if some issues prop up in the end buyer market it directly affects the growth prospects of a company. Let us see AIA's geographical revenue to understand buyer.
Source: Annual Report 2021, AIA Engineering
AIA Engineering has global presence in 120+ countries including China, Thailand and Canada. Majority of their revenue comes from outside India, shown in snapshot below.
Source: Annual Report 2021, AIA Engineering
AIA Engineering generates more than 75% of their revenue from outside India but what happened was in the year 2018 Brazil has implemented Anti-Dumping duty on "Grinding Media" shown in the snapshot below.
Source: CNBC News, June 2018
Recently in September 2021, AIA has announced that South African government has also imposed 15% Custom duty/ Import duty on imports of grinding media shown in snapshot below.
Source: Corporate Announcement, AIA Engineering
Understanding buyer/ buyer's market becomes very important as these news might/ might not impact company's sales (volume) depending upon the what utility this product is serving to the buyer.
4) How does it serve the buyer? The importance/ utility of an industry/company's product for the buyers?
Survival of any business is dependent on what utility their product is serving to the buyer. What exact benefit is being provided to the customers?
For example,
a) Let us continue above example of "Grinding media" and understand its usage grinding media in Tube mill. Tube mill produces pipe and tube.
Source: DRHP document, AIA Engineering
b) Why Formulation company (pharma) buys API from API manufacturer? Because API is the raw material to produce medicines and it becomes less costly to buy API from outside than to produce it because the API manufacturers produces them in huge scale/bulk leading to economics of scale and lower cost.
Source: Divi's Lab Website
Source: ValuePickr Thread, Divi's Lab
c) Why is NESCO Ltd's BEC & Lease business so valuable? - It has huge utility for the buyer because this is the best way to conduct Trade shows and crack a country’s market because every company needs a platform where they can interact with distributors/retailers (especially B2B businesses) in bulk to showcase a range of their existing & upcoming products. whereas for corporates who take office on lease from NESCO save tremendous amounts of upfront Capex and maintenance cost by just paying rent. Also they don't have the headache of shifting as NESCO does long term contracts with corporates.
Source: Annual Report 2021, Nesco Ltd
Main Advantage which company enjoys is location of the land (Goregaon East, Western Express Highway) and the timing at which they purchased land. Company has acquired 65 acre of land in Goregaon in the early 1960's said by management in AGM on 14 August 2017.
Source: AR-21, Nesco Ltd
It becomes very costly and time taking for an company to acquire a land and conduct trade shows or to build offices (Entry barrier) so companies prefer to use nesco properties along with that nesco also allows long term contracts.
So if you see this angle of analyzing utility is much more specific than just understanding usage or applicability that we studied in defining the product stage.
Hence a thorough application of above process leads to a decent understanding of an important question - "what does this business do?"
After this you should look at the business characteristics table which defines the key element of the business. It contains all the relevant data point that will guide you with a broad understanding of financials of a company. We uploaded the template below and explanation of the same can be found in our YouTube Video of this blog also attached below:
YouTube Video Link: