Are India’s Consistent Compounders maxed out?

Saurabh Mukherjea and Rakshit Ranjan

One of the first steps we take in our research process while trying to identify a ‘Consistent Compounder’ is a 10-year or longer historical track record of consistent and healthy fundamentals. In fact, many firms in our holding portfolio and our coverage universe have delivered more than 20 years of consistency of healthy fundamentals. Such a long and consistent track record clearly means that by now most of our portfolio companies have become large in size (in terms of revenues, volumes, market share and the like).

However, in the ongoing economic slowdown, some of the common apprehensions that we come across from those who are interested in investing high quality companies for the long term are listed below.

• Relaxo Footwears manufactured and sold 18 crore (180 million) pairs of footwears in FY19 in India. Compared to this number, India’s population of 125 crore is only 7-times bigger – two thirds of which lives in rural areas. In comparison, Adidas (including Reebok) sold 40 crore (400 mn) pairs across the world in 2018! 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 crore currently (Rs 9.5 trillion). 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 percent 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’ largest retail bank after only 10 years?


• Bajaj Finance’s customer franchise has increased from 35 lakh 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 approximately Rs 40,000 crore in size. Relaxo’s revenues of only Rs 2,300 crore (approximately) i.e. less than 6 percent of the market. As much as 70 percent of the footwear industry is unorganised and the industry is likely to undergo a consistent shift from unorganised to organised 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 percent of the overall market. Relaxo is the largest organised player in the economy segment industry because its in-house 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, if Relaxo continues to sustain and enhance its competitive advantages, it should not be difficult for the firm to increase its market share from 6 percent currently to 12 percent or higher over the next 10 years. Mathematically, doubling of market share over a decade contributes 7 percent to revenue CAGR (compound annual growth rate). Alongside, if the overall footwear industry continues to grow at 10 percent 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 percent CAGR over the past decade, broadly in line with India’s nominal GDP growth rate. HDFC Bank currently has 7 percent market share in this industry and Bajaj Finance approximately 1 percent. As highlighted in our newsletter last month (click here), HDFC Bank and Bajaj Finance are among 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 volume small ticket size loans as the external environment evolves while 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 percent CAGR over the next decade, and within that if firms like HDFC Bank and Bajaj Finance double (to 12 percent) and treble (to 3 percent) their market share, respectively, the current size of these lenders won’t be an impediment to growth.

The context given in this column so far suggests that companies which have become 100 times (or more) bigger in size over the past two decades are not necessarily approaching saturation in their growth rates. This happens because of the following factors:

1. Demographic dividend: A young and large population combined with economic growth supported by rising middle class household consumption provides a long runway for growth to most sectors in India. To draw a parallel, it is true that America’s largest bank JPMorgan Chase is only 7x bigger than HDFC Bank, and only thrice as big as State Bank of India in terms of its loan book size. However, it is also true that China has four state-owned banks – ICBC, China Construction Bank Corp, Agriculture Bank of China, and Bank of China – each of these is twice as big as JPMorgan.


2. Ability to successfully expand into adjacencies over time: Page Industries started its business in India with only men’s innerwear 25 years ago – a category which is ~Rs 10,000 crore in category size currently. However, today under the same brand Jockey, Page has successfully expanded into women’s innerwear, leisurewear (outerwear), and kidswear – a total category size of over Rs 40,000 crore currently. In footwear, 20-25 years ago, Relaxo Footwears used to sell predominantly rubber hawai chappals (white flip flops with blue straps) under the brand of Relaxo. Today, the firm has diversified into sports shoes (Sparx), floaters (Sparx), premium flip flops (Flite, Bahamas) etc. Bajaj Finance was focused predominantly on consumer durable loans 8-10 years ago, today consumer durable loans contribute to no more than 10 percent of its overall loan book with the balance being diversified across home loans, business loans, personal loans etc. This ability to keep widening the basket of products while also sustaining the firm’s competitive advantages helps avoid market share related stagnation within a single product category.


3. Institutionalised systems and processes help play the small-ticket, high-volume game: A combination of large population in India and significant under-penetration of economy products in some of the most basic categories of day-to-day essentials creates a huge opportunity for a firm to scale up volumes in product categories of low ticket sizes. However, scaling up a pan-India business in such small ticket categories becomes difficult, given the heterogeneity of consumer tastes and preferences across geographies, religions, socio-economic strata; poor transportation and logistics infrastructure; demand centres which are remotely located from each other and several local unorganised competitors as incumbents. One of the most common solutions to these challenges implemented by consistent compounders has been a strong focus on institutionalising: a) IT investments in distribution and sales; b) professional empowerment of high quality talent and c) strategic decision-making through an empowered and independent board of directors.


4. A focus on product affordability via minimum price hikes: With price elasticity of demand being particularly high in low-ticket size product categories of day-to-day essentials, most Consistent Compounders minimise product price hikes while focusing on operating efficiencies to protect their profitability over time. This, combined with various other competitive advantages of these firms, ensures that there is limited room for a competitor to significantly disrupt the consistent compounder by way of ‘price wars’ by undercutting product prices. For instance, over the last couple of decades, Asian Paints has hiked product prices on a like for like basis by around 2.5 percent CAGR. Similarly, over the past 3-4 years, Dr Lal Pathlabs has not hiked prices for its diagnostics tests at all.

Companies like HDFC Bank, Bajaj Finance and Relaxo have already delivered consistently healthy growth in their fundamentals over the past decade or longer. However, given the long and consistent historical track record of these companies, some investors are concerned around saturation of the growth runway for these firms, given their large size versus global players in similar categories and their already dominant market shares.

Firms of the calibre of HDFC Bank, Bajaj Finance and Relaxo overcome these potential challenges by: a) orienting their product portfolio towards a high volume of small-ticket day-to-day essentials in a country which offers a long runway for growth in middle class household consumption and b) executing business expansion through institutionalised systems and processes, minimising product price hikes, and successfully expanding their product portfolio over time in adjacent product categories.