In this blogpost we will discuss various angles through which we can derive the potential industry size and understand the runway available for growth of a business within an industry.
First thing first - We should never comment "This company has already grown so much/its market cap has already increased by 5/10 times etc. Hence, now it's not possible to grow further."
Let us share some excellent excerpts from a newsletter published by Marcellus Investment Managers.
"Some of the common apprehensions that an investor might come across while investing in Consistent Compounders are:
Relaxo Footwears manufactured and sold 18 crores (180 mn) pairs of footwears in FY19 in India. Compared to this number, India’s population of Rs 125 crores is only 7-times bigger – two thirds of which lives in rural areas. In comparison, Adidas (including Reebok) sold 40 crores (400 mn) pairs across the world in CY18! With Relaxo’s volumes sold being half that of Adidas globally and half of urban India’s population count, isn’t it too large already to deliver consistent growth over the next decade?
HDFC Bank’s loan book size is around Rs 9.5 lakh crores currently (Rs 9.5 tn). JP Morgan Chase, one of America’s largest banks is only 7 times bigger than HDFC Bank in terms of loan book size. If HDFC Bank keeps compounding at 20-25% CAGR, it will become as big as JP Morgan Chase in a decade! Given the slow pace of financial inclusion in India, and the low per capita household income compared to the US, how can HDFC Bank become as large as US’s largest retail bank after only 10 years?
Bajaj Finance’s customer franchise has increased from 35 lakh (3,500 K) customers 10 years ago, to 4 crore (40 mn) customers today. At this pace, Bajaj Finance’s customer franchise will increase to 40 crores (400 mn) by 2029. With only 25 crore households in India today, achieving a customer base of 40 crores might mean that there is a Bajaj Finance customer in every household of the country after a decade.
Let’s consider the following points about the three companies mentioned above – Relaxo, HDFC Bank and Bajaj Finance:
Relaxo: India’s footwear industry is approx. Rs 40,000 crores in size. Relaxo’s revenues only Rs 2,300 crores (approx.) i.e. less than 6% of the market. 70% of the footwear industry is unorganized and the industry is likely to undergo a consistent shift from unorganized to organized footwear as GST compliance increases, aspirational consumption rises and customers look for better quality branded products. Products with a price point of Rs 2,000 or higher contribute to less than 15% of the overall market. Relaxo is the largest organized player in the economy segment of the industry because its inhouse manufacturing enables it to provide superior quality products at affordable price points (average revenue per unit sold for Relaxo stood at Rs 125 in FY19), backed by an aspirational brand recall (Sparx, Relaxo, Flite, Bahamas etc) and an efficient distribution network. Moreover, Relaxo has demonstrated its ability to: a) expand its product portfolio across sub-segments of the industry – from economy flip-flops 20 years ago to a sports shoes, sandals, women’s footwear, etc today; and b) premiumise its product portfolio over time – e.g. from white-and-blue economy flip flops (hawai chappals) to the Bahamas range of premium flip flops today. Hence, provided Relaxo continues to sustain and enhance its competitive advantages, it should not be difficult for the firm to increase its market share from 6% currently to 12% or higher over the next 10 years. Mathematically, doubling of market share over a decade contributes 7% to revenue CAGR. Alongside, if the overall footwear industry continues to grow at 10% CAGR or higher over the next decade, the runway for growth doesn’t appear to be a constraint for Relaxo .
HDFC Bank and Bajaj Finance: Credit (loans) in the Indian banking industry has grown at 13% CAGR over the past decade, broadly in line with India’s nominal GDP growth rate. HDFC Bank currently has 7% market share in this industry and Bajaj Finance has approximately 1 % market share. As highlighted in our newsletter last month (click here), HDFC Bank and Bajaj Finance are amongst the best placed lenders in terms of their access to low cost funds (liabilities side of the balance sheet) and their ability to grow their loan book ahead of their competitors, particularly in the aftermath of the ongoing financial crisis. Both these banks have also demonstrated their ability to use technology as an enabler to manage high quality of large volumes in small ticket size loans as the external environment evolves whilst also widening the basket of products being offered to their customers. Hence, if the broader credit industry continues to grow at a rate higher than 10% CAGR over the next decade, and within that if firms like HDFC Bank and Bajaj Finance double (to 12%) and treble (to 3%) their market share respectively, the current size of these lenders won’t be an impediment to growth."
Read Full: https://marcellus.in/newsletter/consistent-compounders/are-consistent-compounders-too-big-to-grow-2/
A point to note is that a huge opportunity size is no guarantee whether a company will be able to capture it. You require tremendous management execution, right capital allocation (in product innovation, team hiring, marketing, asset expansion, working capital, inorganic growth) and industry tailwinds to convert potential opportunity size into actual revenues.
Analyst generally uses demographic based primary data like Per Capita Consumptions, Penetration Levels, income levels, spending habits, age brackets, Industry growth Vs GDP growth relationship etc. or industry tailwinds like organized Vs unorganized market, Domestic Market vs Global Markets, Export Vs Imports etc. to forecast the estimated industry size.
Note: Please also visit our blog https://www.finnacleshahclasses.com/forum/business-analysis-series/blog-104-creating-database-for-industry-company-research - on Preparing research repository to understand the sources from where you can obtain such data points
This type of analysis is more suitable to broad sectors like Banking, Insurance, consumer durables, autos, retail etc. A lot of times such deep understanding of what exactly is the opportunity size of sector/industry is technically not required imagine scenarios like expecting some margin expansion or some cycle based turnaround or some arbitrage like open de-merger or basket theme or some valuation play like buying some big player around replacement cost during market corrections etc. In such scenarios where our holding period will vary from 6 months -1.5 years calculating long run opportunity size is sheer waste of time and a perfect case of analysis-paralysis.
Now let's start with the basics of various angles used by industry professionals in arriving at the opportunity size.
Method 1 - What are penetration levels and how to interpret them?
Penetration level means how many quantities are being consumed of a product Vs how many quantities can actually be consumed of a product.
Let's say there are total 20 people in a country and 5 have people have diabetes and you are calculating how many sugar candies you can sell ?
Logically the maximum potential is 15 person or 75% (i.e. 15/20). Also let assume one person will buy a max of 2 candies per year.
Target market = Population * Target Market % * quantity per person = 20 * 75% * 2 = 15*2 = 30
Now suppose you ended up selling a total of 10 candies to 5 person.
Penetration level = actual qty sold/target market = 10 / 30 = 33.33%
As per this example you can clearly see you can sell more as market is still hugely unpenetrated approx. 50% more people can buy your sugar candy or approx. 2x more candies can be sold as compared the existing sales volume you are generating. This is considering that population is not growing, some world war event does not destroys half the population on this country and diabetic people remains constant.
Well even such simple example requires such assumptions 😐😐😐
All such things which look so simple and logical on the face of it definitely comes with some baggage. Coming to our example it's important to understand from where did you source the data for diabetic people? Was that data right?
Imagine if you come to know that actually total 12 people were diabetic... ahhh!!! Now the math changes.
Target market =Population * Target Market % *rational quantity per person = 20* 40% (i.e. 8/20) * 2 = 8 * 2 = 16
Penetration level = actual qty sold/target market = 10 / 16 = 62.5%
You suddenly realize actually 62.5% of the market is penetrated and not 33.33% as you calculated earlier and potential to sell more here is now much dimmer than earlier prospects.
Also, a very important angle is analyzing this in practical world sis that is does not count second hand sales in penetration level especially in India. If we pick up examples of washing machines & ACs on the face of it the penetration level looks very low but a lot of lower middle class may have already bought them but in second hand market,
Method 2 - What is per Capita Consumption and it's usage while calculating future industry size?
Per capita consumption is total quantity sold divided by total population. Basically how much is a single person consuming.
Let's continue our candy example.
Per Capita Consumption = Total quantity sold / Total Population = 10 / 20 = 0.5 Units
You get super excited that people are consuming less units of candy and you can change consumer behavior which will convince them to consume more candy's.
Again like penetration levels this topic needs some clarity.
First of all taking total population in the denominator is a big crime. Everyone is not your target market. Remember 5 people were diabetic. Logically why will they even buy a single quantity of a candy.
So adjust the denominator first
Per Capita Consumption = Total quantity sold / Total target Market (in person)
Per Capita Consumption = 10/15 = 0.67 units
You see a clear bum up in Per capita consumption here. Diluting a bit your excitement about consumers can easily buy more candy's theory.
The main point to note here is this that the product categories or industries which have very low penetrations today or low per capita consumption (PCC) have high growth potential in future.
Method 3 - The Great Shift from Unorganized to Organized
Organized market means branded goods and/or national &state level brands and/or sold with official receipts (basically white money 😀) whereas Unorganized market means unbranded goods and/or local a single city level stores and/or sold without official receipts (basically tax evasion 😀).
A common mistake that people make is that they assume all private players (Unlisted) are unorganized and only listed players are organized. That's not the right way to look at it.
Imagine you are analyzing Cera Sanitary ware and you see that it's biggest competitor is an unlisted private player - Jaguar (in faucet ware segment). So would you end up concluding Jaguar is unorganized player? Actually, Jaguar is the biggest player in Faucet Ware 😀. The same thing will happen if we talk about Quick Service Restaurant (QSR) industry. Will we tell subway or Haldirams are unorganized because they are unlisted in India, no right?.
If an industry has high % of revenues coming unorganized market and there are factors which are changing consumer behavior to buy from the organized market, than organized segment of such industries can grow at a much higher rate than overall industry growth.
A clear example of such scenario playing out is in Retail especially F&G segment (Food & Grocery segment). Even after all the hullabaloo around VC funding, Kirana Stores dying etc. organized retail industry is still only approx. 7% organized and 93% unorganized. This change from 1% organized to 7% organized itself has taken a decade to come. Even with such a small shift the organized retailers in India have found it comfortable to grow their topline at 15% CAGR. Quoting Management of one of listed retailers here: "In retail the problem is not of growth, there's plenty of growth available for coming decade, it's about how much growth can you capture while still maintaining profitability/returns of the company"
Method 4 - Industry Size as a % of GDP Vs Benchmark Country
Anyone who has read even one annual report or research report on AMC, Insurance, auto industry or Housing Finance Industry would know this is the most highlighted data point about these sectors.
Let's take the example of AMC industry to understand this metric in detail.
The Indian Mutual Fund or AMC (Asset Management Companies) industry AUM (Assets Under Management) as % of GDP is 11% which basically means is that Indian GDP is approx. 230 lakhs crores today and AMC Industry is 11% of it today i.e. 25.3 Lakhs Crore.
Now this metric is basically compared with other countries to see the potential left. Approx. a year back AMC's AUM in US as a % of GDP was approx. 101%.
This might portray a huge opportunity left for Indian AMC to grow as if we reach the same level as US growth will be exponential.
See the math:
AMC Industry Current Size: 25.3 Lakhs Crore;
Current Indian GDP: 230 lakhs Crs, ;
Assumed growth rate of Indian Economy for 10 years: 8%;
Indian GDP at end of 10 years from now: 496 lakhs crores;
Assumed penetration at end of 10 years (2031/2032) (same as current level of US - 2020/2021): 101%;
AMC industry size 10 years from now: Approx. 501 Lakhs Crore
AMC Industry 10 Year CAGR: 34.8%
ya ya we know how will India reach same level of financial saving penetration as US in 10 year itself, Indian Income and US income are not comparable etc. 😀😀. Please read the below paragraph.
This is just part 1 of the three part Forecasting Industry Size series. In this part 1 we have only introduced the basic terms related to industry size for detailed understanding on them read part 2 here: https://www.finnacleshahclasses.com/forum/business-analysis-series/blog-109-masterclass-on-forecasting-industry-size-part-2 and Part 3 here: https://www.finnacleshahclasses.com/forum/business-analysis-series/blog-110-masterclass-on-forecasting-industry-size-part-3-final-part
Please check out part 2 of this masterclass series to understand how to run these numbers on an excel and check out part 3 of the series to understand there are lot of angles involved in such analysis without which the entire thesis will be meaningless.