PORTFOLIO OF BRANDS: An elixir for Alpha creation

Trideep BhattacharyaSenior Portfolio Manager , PMS – AXIS AMC

ANATOMY OF A BRAND2

- CONTENTS -

Sr. No. Page No.

1. Emerging Brand + Established Brand: An Elixir for Alpha Creation 03

2. Life-cycle of a Brand: A Framework 04

3. Stage 1: Emerging Brand: The Infancy 04

4. Stage 2: Established Brand: The Prime 05

5. Stage 3: Fading Brand A Passing Phase 06

6. Stage 4: Turn-around or Demise 06

7. Brand Life-cycle and Investor Returns: Applying the Framework 07

8. Investment Implications 08

3ANATOMY OF A BRAND

However, the progression across different stages of brand creation, is not homogenous across all brands. In that case, from investors’ perspective:

(a) What are the different stages of a life-cycle of a brand and which are the most profitable stages for investors?

(b) Should investors’ portfolio comprise of brands in their infancy (emerging brands) only? What are the risks?

(c) Is there any merit in owning established brands as well?

In this article, we use the benefit of hindsight to traverse the life-cycle of a brand, from infancy to maturity and look through the lens of our frame-work to decipher answers to questions above from an investors’ perspective.

At Axis PMS, our core investment philosophy revolves around the fact that brands lead to preference for a companies’ products/services in the minds of customers, leading to superior pricing power in front of customers, which helps companies navigate well during tough times and leads to superior wealth-creation for investors over time. A schematic representation of the same in highlighted below:

EMERGING BRAND + ESTABLISHED BRAND: AN ELIXIR FOR ALPHA CREATION

BRANDS CREATE BARGAINING POWER

ANATOMY OF A BRAND4

LIFE-CYCLE OF A BRAND: A FRAMEWORK

A brand typically goes through four stages in its life-cycle. While they may operate in different sectors of an economy, we note that the characteristics exhibited by the companies in each stage are similar to each other. We bring out these distinguishing characteristics in this section below:

This is the first/earliest stage of the life-cycle of the brand, wherein, founders typically start small with a narrow range of products/services, usually within the confines of their home state and look to differentiate their offerings as compared to competitors.

As its products/services are accepted by its initial customer base, it launches into a major expansion drive to increase its customer base. While business performance accelerates, it is far from consistent and the company has limited pricing power. Capital allocation is cautious even as business takes its first steps towards creating a brand for its products. To elaborate this further, let’s look at a few examples in Indian context:

Page Industries (2005-12)

Page Industries, with its flagship brand, Jockey, invested in two areas to make its presence felt in front of its customers during this period. Firstly, it launched several new products/sub-brands like Jockey Zone, Brasseries, at the rate of at least one new product every year. Secondly, these product launches were supported by capacity expansion, supply chain efficiencies and distribution expansion.

This resulted in meaningful improvement in ROCEs and hence, was accompanied with significant stock-returns during this period as highlighted in the chart below:

STAGE 1: Emerging Brand: The Infancy

We note that the

s tock generated

a v e r a g e a n n u a l

returns of 64% with

annual volatility of

54% during this time-

frame. While the

stock-returns were

very high, investors

had to live with

significantly higher

volatility as well.

25.0

35.0

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130%

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PAGE INDUSTRIES

Ann. Share price returns (LHS) ROCE (%, RHS)

Bajaj Finance (2008-13)

While Bajaj Finance was a niche captive player in consumer finance space for decades, during 2008-13, the company sowed the seeds for transforming it into a consumer durable franchise. Most notably, its product portfolio expanded from 3 products (Auto, Consumer Durable, Personal Computers) to 36 lending products including personal loans, business loans, loan against property and co-branded cards amongst others.

All these measures resulted in a meaningful improvement in ROCEs and also, reflected in strong share-price returns during this period as highlighted in the chart below:

We note that the stock

generated average

returns of 73% with

annual volatility of

155% during this

time-frame. While the

stock-returns were

very high but investors

had to live with

significantly higher

volatility as well. (7.0)

(2.0)

3.0

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0%

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BAJAJ FINANCE

Ann. Share price returns (LHS) RoE (%, RHS)

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9FY

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5ANATOMY OF A BRAND

By this stage, the brand, has acquired a stellar reputation, is a market-leader in its core segment and is well-regarded in equity markets. The brand resonates well and exhibits strong pricing power with a wide customer base. To elaborate this further, let’s look at a few examples in Indian context:

HDFC Bank (2003- Now)

HDFC Bank has been able to increase its competitive edge over peers by leveraging on technological superior systems and processes, and through laser-sharp focus on innovative products. These measures have made HDFC Bank, a prime beneficiary of value-migration from public sector banks over last two decades.

This period has been accompanied with steady and consistent high ROCEs along with steady investor returns as highlighted in the chart below:

Bajaj Finance (2014- Now)

By 2013, the seeds sown during emerging brand stage as described earlier bore fruits and Bajaj Finance was able to establish meaningful leadership against its competitors, as it had the best value-proposition for customers across multiple segments of consumer finance.

This period has been accompanied with steady and consistent high ROCEs along with steady investor returns as highlighted in the chart below:

STAGE 2: Established Brand: The Prime

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HDFC BANK

Ann. Share price returns (LHS) RoE (%, RHS)

We note that the

s tock generated

average returns of

29% with annual

volatility of 29%

during this time-

frame. While the

stock-returns have

b e e n s t e a d y ,

i n v e s t o r - r e t u r n s

were significantly

less volatile as well.

(7.0)

(2.0)

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FY17

BAJAJ FINANCE

Ann. Share price returns (LHS) RoE (%, RHS)

We note that the

s tock generated

average returns of

81% with annual

volatility of 33%

during this time-

frame. Hence, while

the stock-returns

have been steady,

i n v e s t o r - r e t u r n s

were significantly

less volatile as well.

FY03

FY04

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ANATOMY OF A BRAND6

This stage is typically characterised by weakening pricing power in front of customers. This could be driven by a host of factors, which include company-specific actions, changing industry dynamics or changing macro-economic/regulatory dynamics.

Company-specific actions may include imprudent capital allocation, lack of investment in the brand, lack of innovation at the peak of success, un-related diversification into other areas, which leads them to believe that their brand is un-assailable.

Changing industry dynamics, could include demand migration into newer areas leading to weakening pricing power in traditional areas and a slower pace of adoption by the company in these newer areas. To elaborate this further, let’s look at an example in Indian context:

Infosys (FY2013-17)

Infosys has been one of the most successful B2B brands from India in the post-liberalisation era. However, during the period of 2013-17, it went through a phase wherein, its pricing power was hampered by changing industry dynamics. More specifically, demand migration to newer areas like cloud-computing and digital arena has led to pricing pressure in its core areas of application development and maintenance.

This period has been accompanied with weakening ROCEs, reflective of weakening pricing power along with weak investor returns as highlighted in the chart below:

We note that the

s tock generated

average returns of

9% with annual

volatility of 19%

during this time-

frame. This hasn’t

been a profitable

period for investors.

This stage is usually characterised with hard-decisions. As the management board or the company-founders realise the gravity of the situation, tough decisions are taken in order to conserve cash, management teams are changed/replaced, non-core businesses are terminated/sold-off and a turn-around plan with time-bound, measurable targets is put in place. To elaborate this further, let’s look at a few examples in Indian context:

Infosys (FY2018-Now)

Most recently, along with recent management changes, Infosys is looking to revitalise its innovation engine, adjust it more suitably to the current demand scenario and turn-around its brand-promise, thus, leading to improving pricing power in front of customers.

IndusInd Bank (2009-11)

Post-restructuring and management changes during this period, IndusInd Bank turned around its operations in subsequent years leading to better ROCEs and investor returns as highlighted in the chart below:

STAGE 3: Fading Brand: A Passing Phase

STAGE 4: Turn-around or Demise

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INFOSYS

Ann. Share price returns (LHS) ROCE (%, RHS)

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INDUSIND BANK

Ann. Share price returns (LHS) RoE (%, RHS)

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9FY

09

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1

INDUSIND BANK

We note that the

s t o c k g e n e r a t e d

average returns of

142% with annual

volatility of 256%

d u r i n g t h i s

timeframe. This has

been a profitable

period for investors.

7ANATOMY OF A BRAND

We now look to apply the Brand Life-cycle frame-work elaborated in the previous section, to understand the implications for investor portfolios.

Life-cycle of Infosys: As a brand

Infosys, has been one of the long-standing and successful B2B brands from India. We group the various stages of life-cycle of Infosys as per our Brand life-cycle framework and analyse the investor returns in each of these stages. More specifically, for Infosys:

(a) Emerging Brand (FY95-02): Infosys established its business presence into newer western markets, popularising the concept of ‘Offshore outsourcing’ and its cost-benefits for its customers, led to increasing acceptance with its customer base over time.

(b) Established Brand (FY03-12): Through sustained and consistent delivery, Infosys was able to establish a strong brand for itself, leading to strong pricing power in front of its customers, thus gaining market-share from global outsourcing providers.

(c) Fading Brand (FY13-17): While outsourcing continued to remain a dominant theme, Infosys’ pricing power was impacted by demand migration to newer areas like cloud-computing and digital arena.

(d) Turn-around or Demise (FY18- Now): Most recently, Infosys announced an evolutionary strategy through which, the company is looking to revitalise its innovation engine and turn-around its brand-promise in front of customers.

The above mentioned stages are aptly depicted in the chart below:

BRAND LIFE-CYCLE AND INVESTOR RETURNS: APPLYING THE FRAMEWORK

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INFOSYS

Ann. Share price returns (LHS) ROCE (%, RHS)

Return and Risk metrics: Through the life-cycle of Infosys

We now analyse the investor-experience of owning the ‘Infosys’ stock through various stages of the life-cycle described above. In this context, we analysed the investor returns and its volatility across life-cycle and summarise the key findings in the table below:

Stock Period Average Return Volatility Stage of Cycle

Infosys 1995-2002 135% 187% Emerging Brand

Infosys 2003-2012 25% 40% Established Brand

Infosys 2013 - 2017 9% 19% Fading Brand

Average returns and volatility calculated based on absolute FY returns for the respective period.

We note, investors’ average annual return was highest, while it was an emerging brand, volatility of returns were also meaningfully higher during this stage. On the other hand, owning Infosys, as an established brand, generated steady returns with significantly lower volatility-profile. Also, owning the stock during ‘Fading’ brand and ‘Turn-around or Demise’ stage wasn’t profitable for investors.

On net balance, on generalised basis, we conclude that while absolute returns of emerging brands are high, established brands stage stocks also provide strong equity-returns on risk-adjusted basis.

Why is the volatility of returns for emerging brand high?

The higher volatility of emerging brands is explained by high failure rate of making it as an established brand. While Infosys made the successful transition to an established brand from that of an emerging one, there are countless examples of brands that skipped the ‘Established brand’ stage to move directly towards being a ‘Fading brand’. This could have disastrous implications for investors.

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EmergingBrand

Established Brand

Fading Brand

Turn around

or Demise?

FY20

FY18

FY19

Turn Turn Taround

or Demise?

FY20

Source of Data : Internal Analysis of Axis AMC, Ambit Capital

Disclaimer: This note has been prepared only for information purpose. While reasonable care has been taken in its preparation, this communication does not purport to be a complete description or advice on the securities, markets, investment philosophy or developments referred to herein. Axis AMC does not warrant its accuracy, completeness or results. To the extent permitted by law, Axis AMC or its officer, employees or agents may have bought or sold the securities mentioned in this communication or may do so in future. This report is not an offer or solicitation of an offer to buy or sell any securities mentioned herein. The data used in this material is obtained by Axis AMC from the sources which it considers reliable. Axis AMC disclaims all liabilities, losses and damages arising out of the use of this information. Investors are requested to consult their financial, tax and other advisors before taking any investment decision(s). The AMC reserves the right to make modifications and alterations to this statement as may be required from time to time. This document should not be treated as research report. The companies/ securities mentioned in this report are only for the purpose of explaining the concept/investment rationale and should not be construed as recommendations by Axis AMC

INVESTMENT IMPLICATIONS

• Emerging, Established and turn-around phases of life-cycle of a brand are the most profitable phases of the life-cycle of the brand from an investors’ perspective.

• Emerging brands offer higher return opportunity for investors in absolute terms, but it is accompanied with higher risk as well.

• Higher volatility of emerging brands is also reflective of the extremely high risk of failure. In other words, emerging brands can potentially skip the ‘established’ stage. Hence, a portfolio of emerging brands only carries significant capital risk for investors.

• Established brands offer higher return opportunity for investors on a risk-adjusted basis as the volatility, reflective of the business risk is relatively lower. Hence, we reckon that established brands have a strong case for themselves in investors’ portfolios.

While this study was conducted with the benefit of hind-sight, we apply similar principles on a forward-looking basis, in our PMS offering ‘Brand Equity Portfolio’. Notably, about 50% of our portfolio is invested in emerging brands, while established brands comprise the rest of our portfolio.