Motilal Oswal Financial Services

Value Migration | Thematic

Value Migration

Picking winners in disruptive times

The Indian economy is undergoing major disruptions. Passage of the GST

Amendment Bill and demonetization of high value currency notes mark the

beginning of the next phase of India’s evolution. The imminent tectonic shifts in the

economic landscape will challenge established models of doing business and coax

the emergence of business designs that are better able to satisfy customers'

priorities. In the midst of this, we launch our Thematic Strategy report,

VALUE

MIGRATION.

Through this report, we attempt to stock up on relevant tools to

identify the significant investment opportunities that will emerge from the churn,

and as Shakespeare puts it,

take the tide at the flood.

Selection of winning business models paramount to investment success

Delivering investment outperformance in stock markets is the holy grail of

investment managers. Outperforming has become an increasingly difficult task with

the ascent of passive investing. Success in investment management depends on the

interplay of multiple factors – research, discipline, patience, emotional quotient,

among others. Different approaches have worked in delivering outperformance.

What is common to all the approaches, in a nutshell, is picking a winning business

model. Picking a winning industry and then picking a winner in that winning industry

is a strong combination for achieving investment success, we reckon.

This report applies the framework of

VALUE MIGRATION,

attempts to highlight the

disproportionate returns generated by several business models, and also uncovers

several potential winners.

What is Value Migration?

Value Migration is defined by

Adrian Slywotzky,

author of the book “Value

Migration”, as a flow of economic and shareholder value away from obsolete

business models to new, more effective designs that are better able to satisfy

customers’ most important priorities. The framework tries to identify industries

where Value Migration is underway and can help pick potential winners early in the

cycle.

Value Migration

Picking winners in

disruptive times

Value Migration framework helps in picking winning business models

Through different case studies, we show that Value Migration is underway in India in

several industries. A number of businesses have benefitted from Value Migration,

delivering consistent stock returns. Businesses that have found themselves on the

wrong side of the Value Migration equation have suffered and underperformed

significantly. In this report, we have discussed in detail case studies in the Indian

investment landscape across

Banking, Auto, Consumer, Metals, Pharma, Logistics,

Telecom, Transportation, Capital Goods, and Information Technology.

These case

studies amply demonstrate the power of Value Migration in delivering consistent

business outperformance. We also highlight several potential long-term Value

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January 2017

Value Migration | Thematic

Migration winners, again, across sectors. In some case studies, we have also

highlighted global instances of Value Migration (with

references from Adrian

Slywotzky’s book)

in similar industries.

Where is your business residing in the Value Migration chain?

Typically, any business model exists in one of the three phases of Value Migration –

Value Inflow, Stability or Value Outflow. Winning business models, as the name

suggests, often find themselves in either inflow or stability phase. In the inflow

phase, the industry or business captures value from other industries or businesses

based on a superior consumer proposition. In the stability phase, the industry or

business consolidates its position. In the value outflow stage, the incumbents

witness share loss to businesses that are meeting customer needs more effectively.

The report highlights case studies pertaining to all three phases of Value Migration.

The nitty-gritties

Identifying a prevalent trend of Value Migration is half the job done. The remaining

half pertains to (a) understanding its causes, (b) fathoming the way it reflects in

financials, and (c) understanding the duration of the trend. We discuss these aspects

in detail in the report.

Common catalysts of Value Migration

Our study highlights that common causes of Value Migration in India are – cost,

technology, convenience, innovation, lower switching costs. Public Sector to Private

Sector Value Migration is a classic umbrella, encompassing several sectors –

Banking, Telecom, Aviation. This is a multi-decadal trend, in our view, and will

continue to play out. Another commonly observed trend in India is Value Migration

from the Unorganized to the Organized Segment due to evolving consumer tastes

and the increasing affordability, given rising disposable incomes and narrowing of

taxation gap (should hasten with the implementation of GST, in our view) between

unorganized and organized players. This is also a multi-year theme, which will

benefit several companies belonging to consumption-oriented industries.

Value Migration also helps to avoid debilitating business models

Evolution of technology, consumer preferences, and ever-changing competitive

landscape renders today’s winners ineffective in confronting tomorrow’s challenges.

Through few case studies in this report, we also discuss the role of Value Migration

in helping investors to avoid potential losers from the prevailing trend. We also

discuss two case studies of Reverse Value Migration, which highlight that a business

can make a comeback and drive the flow of value back towards itself even if it is a

loser during the initial stage of Value Migration.

January 2017

Value Migration | Thematic

Four interesting themes of emerging value migration

Pace of value migration in today’s times is rapid. Even before a new trend of value

migration takes shape, the newer challenger is already on the heels of emerging

winner. Interestingly, we note that unlisted players are posing strong challenge to

listed ones in several segments. The report highlights four emerging but interesting

themes on value migration which can disrupt the way businesses are done in those

respective industries. Those four themes are:

1) Automobiles: Future of transportation- Shift from product to service?

2) BFSI: Payment banks and small finance banks - Dawn of new era in financials

3) FMCG: Shift towards traditional/herbal players

4) Telecom: Disruption by new players

Snapshot of value migration case studies

S.N.

Case Study

Value Migration from Public to Private Sector

Value Migration in Two Wheelers

International Value Migration

Value Migration in Commodities

Value Outflow in Conventional Energy

Reverse Value Migration

Inter-Industry Value Migration

Industry

Banks

Insurance

Automobiles

Information Technology

Pharmaceuticals

Cement

Capital Goods

Automobiles - Two

Wheelers

Transportation [Airline]

Driver

Technology, Efficiency

Changing customer priority

Cost

R&D, Cost

Demand supply equilibrium

Preference for new energy

sources

Technology

Convenience, Cost

Source: Company, MOSL

Unique disruptions: Unlisted players posing challenges to listed ones

S.N.

Sector

Automobiles

FMCG

BFSI

Telecom

Theme

Future of personal transportation: Shift from

product to service

Value Migration from traditional FMCG to

Ayurveda/Herbal players

Payment banks and SFBs: Dawn of new era in

Financials?

The disruptor with big pockets

Unlisted players involved

Uber, Ola

Patanjali

Paytm

RJIO

Source: Company, MOSL

January 2017

Value Migration | Thematic

Value migration: Potential winners

S.N. Theme

Value Migration from Unorganized to Organized Segment

Value Migration Unleashed by Technology

Value migration due to Lifestyle Changes

Reverse Value Migration

Value Migration in Commodities

Sector

Mortgages

(Home Finance)

Jewelry

Logistics

Adhesives

Light Electricals

Telecom

Media

E - commerce

Transportation

Apparel

Diagnostics

Multiplex

Logistics

Aluminum

Winners

Repco,

Gruh Finance

Titan

Third party

logistics players

Pidilite

CG Consumer, Havells

Bharti, BHIN

Netflix, Eros, Star,

Shemaroo, Zee

Amazon, Flipkart

Indigo

Page, Arvind

Dr. Lal, SRL

PVR

Concor, GDPL

Hindalco

January 2017

Value Migration | Thematic

Value Migration

An evergreen investment framework for picking winners

Role of investment frameworks in stock-picking:

Investment frameworks are tools

& techniques that are applicable across stocks, sectors, time horizons and even

geographies. Various investment frameworks have proven handy and successful in

identifying stock ideas. Some of the successful frameworks include Economic Moats,

GARP (Growth at Reasonable price), QARP (Quality at Reasonable Price). One of the

frameworks that has delivered consistently and helped in creating investment value

is the framework of Value Migration.

What is value migration?

Adrian Slywotzky

defines value migration as a flow of economic and shareholder

value away from obsolete business models to new, more effective designs that are

better able to satisfy customers’ most important priorities. It reflects changing

customer needs that will be satisfied by new competitive offerings. Value migration

occurs when there is a disconnect between customer priorities and existing business

designs. It has several advantages; prominent amongst them being – (a) Gaining and

sustaining competitive advantage by outthinking competitors and (b) Creating new

growth drivers ahead of fading of existing growth catalysts.

Essentially, value migration has three stages:

Value inflow:

In this phase, a company or an industry captures value from other

industries or companies due to superior value proposition. The market share

and profit margins of the company or industry expand.

Stability:

In this phase, competitive equilibrium is established. Growth rates

moderate.

Value outflow:

Value starts to move away towards companies or industries

meeting evolving customer needs. In this phase, market share declines, margins

contract, and growth stops.

Value migration as an investment framework

The criticality of value migration in identifying investment opportunities is relatively

less understood, in our view. In this report, we study the framework in detail, try to

understand its role in driving investment returns, highlight several case studies, and

attempt to identify investment-worthy stocks based on this theme.

Value migration is a universal concept

From global viewpoint, value migration has been evident in the Technology (rapid

product development, shift towards new technologies), Commodities (low cost

production), and Retail (low cost distribution) industries, to name a few. From an

Indian perspective, the shift from public sector undertakings (PSUs) to the private

sector has been very evident. Value migration from the unorganized to the

organized sector as incomes and aspirations rise is underway in several industries.

January 2017

Value Migration | Thematic

Types of value migration

Value migration can manifest in several ways.



Inter-country migration:

The Indian IT and Pharmaceutical sectors have seen

value migration from western geographies owing to lower cost and niche

capabilities.



Inter-industry migration in same country:

In India, value has migrated from

Railways to Airlines, facilitated by low-cost, non-frills airlines.



Inter-company migration in same industry:

Value has migrated from the public

sector to the private sector in the Indian Banks and Telecom spaces.



One segment to another in same company:

Telecom service operators have

seen value migrating from Voice to Data.

Inter-country or inter-industry value migration is relatively rare, but wherever it

occurs, the potential for value creation is immense.

Types of value migration

Inter-country migration

The Indian IT and Pharma

sectors have seen value

migration from western

geographies owing to lower

cost and niche capabilities

Inter-industry migration in

same country

In India, value has migrated

from Railways to Airlines,

facilitated by low-cost, non-

frills airlines.

Inter-company migration

in same industry

Value has migrated from the

public sector to the private

sector in the Indian Banks and

Telecom spaces.

One segment to another in

same company

Telecom service operators have

seen value migrating from Voice

to Data.

What drives value migration?

Some important drivers of value migration are: (1) technology, (2) cost, (3)

convenience, (4) innovation, (5) easier access to funding, and (6) lower switching

costs. Each of these has led to migration of value from incumbents to new players,

creating investment opportunities along the way. By identifying such drivers early,

one can create sizable wealth.

How do you measure value migration?

From an investment perspective, value migration can be measured/captured in

terms of market capitalization, sales or profits. Value migration in terms of market

capitalization is the earliest to show, followed by sales and then by profits. The

market recognizes the potential beneficiaries of value migration much before the

reflection in financials. We discuss this in details in our case studies in the context of

value migration from public to private banks and public to private telecom

companies where we saw migration in market cap much before it manifested in

January 2017

Value Migration | Thematic

financials. In the case of unlisted players, value migration can be measured in terms

of profits, sales or market share.

How long does it take to play out?

After identifying the value migration drivers and measuring the same, the next

critical factor is assessing the duration of value migration. Through various examples

in this report, we show that value migration typically last for years/decades. Even if

one identifies a value migration case a little late, the opportunity to make outsized

investment returns is still available. For example, if one entered the value migration

trade in private banks or private telcos or even in case of Titan a little later than

when it commenced, investors would have still made good returns as these shifts

were durable and continued for years. Instances of short duration value migration

could be in technology-oriented sectors, where rapid evolution of technology results

in constant value migration away from incumbents (unless the incumbent itself

drives the value migration).

Value Migration plays:

As we highlight in this report, India is characterized by

multitude of value migration shifts given the infrastructure deficit, the rising

aspiration of its middle class population, increasing disposable incomes and hence

the desire to consume better as indeed the elevated competitive intensity in most

of the industries. The strong growth potential of the economy fosters innovation,

competition, creation of new categories and desire to wrest first mover advantage;

ultimately resulting in value migration opportunities. We apply the framework of

VM on our coverage universe and present select stocks as a potential beneficiary of

VM. Our VM ideas are

HDFC Bank, RBL, Equitas, Titan Company, Arvind, Page,

Repco Finance, Gruh Finance, Pidilite, Hindalco , Crompton Consumer, PVR, Bharti

Airtel, Indigo.

January 2017

Adrian Slywotzky

defines value migration as a flow of

economic and shareholder value away from obsolete

business models to new, more effective designs that are

better able to satisfy customers’ most important priorities. It

reflects changing customer needs that will be satisfied by

new competitive offerings. Value migration occurs when

there is a disconnect between customer priorities and

existing business designs.

Value Migration | Thematic

January 2017

Value Migration | Thematic

Value Migration – The nitty gritties

What is value migration?

The term, value migration was introduced by Adrian Slywotzky. He defines value

migration as a flow of economic and shareholder value away from obsolete business

models to new, more effective designs that are better able to satisfy customers’

most important priorities. Value migration occurs when there is a disconnect

between customer priorities and existing business designs. A universal concept, it

helps explain the big successes/failures of underlying business trends in various

markets.

Customer priorities keep changing and evolving. Businesses that identify this and

take timely or pre-emptive action end up on the right side of the customer equation.

Those that fail to do so stand on the wrong side of value migration equation, as we

shall see in this report.

Three stages of value migration

Any business model exists in one of the following three stages of value migration.

A] Value inflow:

In this phase, a company or an industry captures value from other

companies or industries due to superior value proposition. Market share and profit

margins expand for the company. Naturally, this is the most desirable phase for any

company. Early stage innovators, pioneers of new technology, companies offering

unique value proposition are the habitants of the value inflow stage. In our view, the

Indian Jewelry industry is in the value inflow phase, where value is migrating from

the unorganized sector to brands. Also, Indian Pharma industry is witnessing value

inflow, with the Chronic segment gaining at the expense of Acute. Even the Telecom

industry is seeing value inflow for its Data segment.

B] Stability:

In this phase, competitive equilibrium is established. Growth rates

moderate. Market shares also settle down and a certain comfort zone is established

for incumbents. This typically paves way for the next phase. Bulk of the business

models reside in this phase – well developed segments with limited penetration and

per capita consumption opportunities, oligopolies, and industries with regulatory

barriers. We believe the Indian IT and Pharmaceuticals industries is in stability phase

now – incremental value migration will be a function of pace of innovation and new

value propositions.

C] Value outflow:

Business value starts to move away from incumbents towards

companies meeting evolving customer needs. In this phase, market share declines,

margins contract and growth stops. Heavy competitive intensity with price wars and

battles for customer retention characterize this phase. Mature business models with

saturation, industries with stagnant innovation typically are in the value outflow

stage. The two-wheeler industry in India is witnessing incremental value migrating

towards scooters from motorcycles. In Telecom, there is value outflow from the

Voice segment and value inflow to the Data segment. In Power, there is value

outflow from conventional energy to renewables.

Value Inflow

Value

Stability

Value

Outflow

January 2017

Value Migration | Thematic

As the business model travels from value inflow to stability to value outflow,

significant value is created and then lost.

The three stages of value migration

Limited competition

High growth

High Profitability

Competitive stability

Stable market share

Stable margins

Value Inflow

Competitive intensity

Declining sales

Low profits

Value

Stability

Value

Outflow

Value migration as an investment framework

The criticality of value migration in identifying investment opportunities is relatively

less understood, in our view. From a business strategy standpoint, as competitive

intensity goes up, innovation cycles constrict, capital availability becomes easier,

product cycles shrink, and pace of evolution of technology goes up, the role of value

migration becomes even more important to understand. In this report, we look at

value migration from an investor’s perspective – we try to understand its role in

driving investment returns, highlight several case studies, and attempt to identify

investment-worthy stocks based on this theme.

Value migration is a universal concept

Value migration is a universal concept and has played out across geographies. From

global viewpoint, it has been evident in the Technology (rapid product development,

shift towards new technologies), Commodities (low cost production), and Retail (low

cost distribution) industries, to name a few. From an Indian perspective, the shift

from public sector undertakings (PSUs) to the private sector has been very evident.

Value migration from the unorganized to the organized sector as incomes and

aspirations rise is underway in several industries.

January 2017

Value Migration | Thematic

VM in global context

Value Migration –

Common Global examples

Technology led VM

VM in Indian context

VM in Commodities –

Low cost manufacturing

VM in Retailing –

Low cost distribution

Value Migration –

Indian cases

VM from Public

to private sector

VM from Unorganized

to organized

International VM

led by costs

Source: Company, MOSL

January 2017

Value Migration | Thematic

What causes value migration?

Customer priorities, an essential catalyst for value migration, change due to a

multitude of factors. Hence, there could be several drivers of value migration. Some

time-tested drivers are (1) technology, (2) cost, (3) convenience, (4) lowering of

entry barriers, (5) lower switching costs, (6) easier access to capital, and (7)

innovation.

For example, value migration from the public sector to the private sector in various

industries in India is a consequence of better technology, greater convenience,

lower costs (better value for money propositions). Combinations of these factors

have resulted in market share erosion for public sector enterprises. As private

participants gained share and scale, it enhanced their ability to invest and build the

franchise.

Snapshot of value migration case studies

S.N.

Case Study

Value Migration from Public to Private Sector

Value Migration in Two Wheelers

International Value Migration

Value Migration in Commodities

Value Outflow in Conventional Energy

Reverse Value Migration

Inter-Industry Value Migration

Industry

Banks

Insurance

Automobiles

Information Technology

Pharmaceuticals

Cement

Capital Goods

Automobiles - Two

Wheelers

Transportation [Airline]

Driver

Technology, Efficiency

Changing customer priority

Cost

R&D, Cost

Demand supply equilibrium

Preference for new energy

sources

Technology

Convenience, Cost

Source: Company, MOSL

January 2017

Value migration case studies

Value Migration | Thematic

Banking

Drivers

Technology

Efficiency

Technology

Efficiency

Cost

Value Migration from Public to Private Sector

Insurance

Value Migration from Public to Private Sector

Information Technology

International Value Migration

Pharmaceutical

International Value Migration

Capital Goods

R&D

Cost

Preference for

new energy

sources

Trust

Brand

Cost, Demand

supply

equilibrium

Convenience

Cost

Technology

Value outflow in conventional energy

Jewellery

Value Migration from Unbranded to Branded segment

Cement

Value Migration in commodities

Transportation (Airline)

Inter Industry Value Migration

Automobiles

Reverse Value Migration

January 2017

Value Migration | Thematic

Types of value migration

Value migration can manifest in several ways. It can be segregated into four broad

buckets:

Inter-company migration in same industry

Inter-country (international) migration

Inter-industry migration in same country

Inter-segment migration in same company



Inter-country or inter-industry value migration is relatively rare, but wherever it

occurs, the potential for value creation is immense. There are examples abound

of inter-company value migration in India – from public sector companies to

private sector entities, from the unorganized segment to the organized

segment.

In international value migration, the difficulty arises primarily from the fact that

only limited services are geography agnostic. Not all industries are amenable to

international value migration. Yet, there are multiple cases of international

value migration. We discuss two such cases in this report – Indian IT and Indian

Pharmaceuticals. The equation remains the same – identifying customer

needs/priorities and creating a business design that successfully addresses these

needs/priorities.

The Indian IT industry has benefited immensely from global value migration,

given its advantage of low cost skilled workforce. Over the last 20-30 years, the

Indian IT industry has built sizable scale and created several local giants. Case III

discusses the evolution of this phase.

The Indian Pharma industry represents another fine example of international

value migration induced by cost as well as niche capabilities. Unlike Indian IT,

the advantage of low cost labor played only a supportive role. Enhanced

spending on R&D and backward integration played a more important role. We

discuss this in Case IV. International value migration to Indian IT and

Pharmaceuticals.

January 2017

Value Migration | Thematic

Inter-company value migration in the same industry

Value migration from the public to the private sector has been a ubiquitous theme

in India. This has spanned across sectors and created several winners in various

industries. We highlight value migration from the public to the private sector in the

Banking and Financial Services Industry (BFSI) in this section. Other industries that

have seen value migration from the public to the private sector in India are Telecom

and Aviation. Typically, the drivers for such migration have been quality of service,

technology, and/or lack of innovation by the public sector (encumbered by

bureaucracy and attendant rules/regulations that constrict innovation and

creativity).

Case I: Value migration from public sector banks (PSBs) to

private sector banks (PBs)

Industry:

Financials – Banks and NBFCs |

Driver of VM:

Financial inclusion,

Technology, Efficiency |

Play on VM:

HDFCB, RBL, EQUITAS, BAJAJ FINANCE, PAYTM

1. What is the value migration?



Doors of value migration for the banking industry opened in 1995, and since

then, it has been a one-way journey in favor of private sector banks. Focus

on customer convenience, technology, new product introductions, and top

management continuity facilitated the migration.

Private sector banks (PBs) have gained 17-18% market share in loans and

deposits from public sector banks (PSBs) in the past two decades.

Focus on profitable growth helped PBs to get significantly higher share in

the profit pool. Share of PBs (Top-6) in overall profit pool in the system has

increased to 42% in FY15 (75%+ in FY16 due to losses of PSBs) from 16% in

FY05, as per reported data. Aggregate MCAP of PBs is at USD127b as against

USD46b for PSBs. As at the end of FY05, aggregate MCAP of PBs was

USD13.7b as against USD26.3b for PSBs.

The story of wealth creation is no different for NBFCs; their aggregate MCAP

increased from USD18b to USD64b over the last decade.

2. What phase of value migration are we in currently?



The current phase of migration is unique and threatening the entire

spectrum of financial services. New players (prepaid wallet companies,

payments banks, SFB, etc) with efficient technology, low cost acquisition,

and deep pockets are fast making in-roads in this space.

Highly profitable businesses like CASA, fee income, and monopoly over

customer transactions once the bank becomes the primary bank are under

pressure. GOI push to digitalization is likely to accelerate this phase of value

migration. For example, PAYTM has 167m customers versus HDFCB’s 365m.

PAYTM is targeting to cover 500m+ customers by the end of 2020. Post

demonetization, the pace of customer acquisition has accelerated.

Existing banks are already reacting to changes in technology platform. New

technologies like QR codes, UPI, Aadhar-enabled account opening within

January 2017

Value Migration | Thematic



minutes are increasing the level of competition and would make it

extremely difficult for inefficient players to survive in the system.

All banks have their e-wallets now and also offer credit cards to their

customers; POS business is under pressure post the onset of QR technology

and UPI. RBL Bank is building its business model on collaboration rather

than fast expanding branch network whereas, DCBB is focused on fast

expanding branch network to withstand the competition from SFBs.

After every slowdown (product or economic), NBFCs have come up with

strong business models, with niche offerings. NBFCs have been able to shift

value from the unorganized to the organized sector and from banks for

specific products.

NBFCs have created strong loyalty amongst their niche customer bases.

They have now started taking banks head-on in segments like SME and LAP

(traditional loyal customer base of banking sector). Bajaj Finance, Bharat

Financials, MMFS, SHTF, SCUF, CIFC, etc are some of the recent successful

franchises amongst NBFCs.

Some MFIs with niche business models received small finance bank (SFB)

licenses, which would not only start a shift from the unorganized to the

organized segment but also challenge the strong foothold of PSBs in SME

banking. Initial success factors are visible from players like Equitas, Ujjivan,

AU Finance, Janlaxmi, etc. The recipients of SFB licenses have an aggregate

loan book of INR346b, equivalent to ~1/3

of the loan book of Yes Bank

(more than a decade old bank).

3. What will be the catalyst for driving this value migration?



Rapidly changing technology, increasing customer education (the

government is making efforts to increase digital penetration post

demonetization), regulators’ favorable view on competition, and improving

service levels are the key factors driving this value migration.

PSBs have been unable to match the customer-friendly user interface

offered by PBs and other challengers. With the young mobile-enabled

customer base showing an increasing preference for digital solutions, PSBs

will continue to lose deposit market share.

PSBs have accumulated an unsustainable level of NPAs, resulting in

extremely low capitalization ratios (CET-1). Most PSBs have CET-1 barely

north of the regulatory minimum. This effectively means that PSBs do not

have adequate capital to fund asset growth and will need to consolidate

their balance sheets, resulting in loss of loan market share to PBs and new

competition like payments banks and small finance banks. As loan growth

opportunities reduce, PSBs will witness proportionate decline in their

deposit market share.

PSBs have already lost ~8% market share to PBs over the last decade.

4. What if this value migration plays out? Who wins and who losses?



Across the spectrum of financial services, most large private players are

likely to be the key beneficiaries of this value migration. We expect the

banking sector to grow at 14-15% – 1.3x nominal GDP growth, led by

January 2017

Value Migration | Thematic



expected increase in penetration levels. Private sector players are likely to

outgrow the sector by 5-10%. Thus, PBs could grow at 20-25%.

PBs focused on strong branch expansion (without much dent on

profitability) and diversification, having strong retail customer base and

increasing hinterland presence are likely to be key beneficiaries. . Within

PBs,

HDFCB and RBL

remain our preferred plays for this theme.

NBFCs, payments banks and SFBs are also likely to be on strong growth

trajectory. Amongst listed players, we prefer

BAJAJFIN and EQUITAS.

Among the challengers in payments banks, we see PAYTM coming up with

distributive technology that can challenge even leading PBs.

Exhibit 2: ROE (%)

Foreign Banks

15.4

45.8

41.7

42.1

43.5

14.2

13.3

11.4

7.3

10.3

11.5

PSBs

17.9

13.8

PBs

16.9

13.7

Foreign Banks

16.5

13.2

10.3

7.8

15.7

Exhibit 1: PAT market share (%)

PBs

73.7

PSBs

68.7

67.3 64.6

63.8 60.6

62.2 65.2

55.5

27.8 31.8

23.0 25.2

22.3 20.6

16.9 20.2 20.7

14.7 15.5 14.2 8.3 11.0 11.5 12.7 12.5 14.4

9.5 12.5

FY05 FY06 FY07 FY08 FY09 FY10 FY11 FY12 FY13 FY14 FY15

Source: RBI, MOSL

FY06 FY07 FY08 FY09 FY10 FY11 FY12 FY13 FY14 FY15

Source: RBI, MOSL

Exhibit 3: SA market share (%)

PBs

79.7

77.2

PSBs

75.7

Foreign banks

74.3

73.8 73.0

Exhibit 4: Market cap shift towards private banks (%)

Private Banks

PSU Banks

10.8

3.0

13.0

3.2

15.2

3.0

16.9

2.6

18.4 19.4

2.1 2.0

FY05 FY06 FY07 FY08 FY09 FY10 FY11 FY12 FY13 FY14 FY15

Source: RBI, MOSL

January 2017

Value Migration | Thematic

Case I (B): Value migration from Public (LIC) to Private sector

Insurance companies

Industry:

Financials – Insurance |

Driver of VM:

Technology, Efficiency |

Play on

VM:

HDFCLIFE

1. What is the value migration?



Private Insurance companies have rapidly gained market share post opening

up of the sector in 2000-01. Of the new individual retail business, they have

more than 50% market share. They could manage to create the market for

ULIPs, capitalizing on the need for high savings requirement.

Strength of strong and growing distribution network of parent and group

companies, trained agents (insurance being a Push product), technology,

new product addition satisfying consumer needs are some of the key factors

which drove this migration.

Most of the insurance companies are likely to list over next two years. Back

of the envelope estimate suggest top four private insurance companies

valuation of USD 25B vs. invested capital of ~USD 2B.

2. The penetration opportunity is huge



The Indian Life Insurance industry is largely underpenetrated compared to

global peers. While the share of household savings in financial assets has

increased from 31% in FY12 to 41% in FY16, the share of life insurance in

overall financial savings declined from 21% to 18% over the same time

period. Additionally, life insurance in India has largely been a

savings/investment product rather than a protection product. This is evident

from the low Sum Assured to GDP ratio of 0.6x compared to 1.0x+ for

developed market peers. Insurance density is low with per capita premium

of $43 versus global average of $662, as per a study by Swiss Re. Insurance

penetration, as percentage of GDP, is ~2.7% as compared to global average

of 3.5% and 5%+ for most developed markets. We believe drivers are in

place for structural long-term growth of the life insurance sector.

Exhibit 6: Insurance premium per capita (USD)

2,717

Exhibit 5: Insurance premium as % of GDP

12.0

8.3

7.3

3.7

3.1

2.7

2.0

1,940

1,719

688

215

178

153

1.3

Source: Company, MOSL

January 2017

Value Migration | Thematic

3. What phase of value migration are we in currently?



Post strong growth and dominance in ULIP products, private players have

started focusing on traditional high margin protection products as well.

These products as of now constitute 3-7% share in overall product mix of

companies.

Post regulatory intervention share of private players in new business

premium had come down to 37% in FY14. However, with stabilizing

distribution and product mix, share of private players has increased back to

54% as of FY16. We expect share to go up further strengthening banca

channel and increased focus on agency channel by some large players.

4. What will be the catalyst for driving this value migration?



Within Insurance space, aggressive marketing, strong and growing

distribution network of Banca partners, increasing brand acceptance and

stabilizing product mix will drive market share gains for private players. In

the new business we expect private players to have more than 60% market

share.

5. What if this value migration plays out? Who wins and who losses?



We expect insurance sector to grow at 14-15% - 1.3x of nominal GDP growth

led by expected increase in penetration levels. Private sector companies are

likely to outgrow sector by at-least 3-5% hence, private players growth is

likely to be 18-20% - depending upon the share in overall system.

Amongst Insurance companies top three private players HDFC (incl. MAX),

SBI LIFE and ICICI PRULIFE are likely to be key beneficiaries. These players

have the share of over 70% of the new business premium of private players

and they also enjoy 75% of the profits of private players.

Exhibit 8: Linked business share (New business premium) %

Private sector

42 41

LIC

Exhibit 7: Market share (RWRP basis) - %

LIC

Private sector

FY07 FY08 FY09 FY10 FY11 FY12 FY13 FY14 FY15 FY16

Source: RBI, MOSL

FY07 FY08 FY09 FY10 FY11 FY12 FY13 FY14 FY15 FY16

Source: RBI, MOSL

January 2017

Value Migration | Thematic

Case II: Value Migration in Two Wheelers: From 100cc

Motorcycles to Premium motorcycles

Indian Two Wheeler industry saw premiumization led value migration as customer

priorities shifted and resulted in significant value creation. Eicher Motor’s story of

disproportionate wealth creation in last five years is a consequence of this changing

customer priority and Eicher’s ability to nurture and serve the priority. From being

less than 5% of Hero’s market cap in 2010, Eicher’s market cap is now ~98% of

Hero’s market cap!!

Industry:

Two Wheelers|

Driver of VM:

Changing customer priorities|

Beneficiaries:

Eicher |

Potential Loser:

Bajaj Auto, Hero MotoCorp

Stylish differentiated product with improved quality addresses unmet need

of commuting in style



Domestic motorcycle volumes witnessed strong growth of 12% CAGR during

FY02-12 (FY02-07: 14.5% CAGR), creating motorcycle population ready for

replacement from FY08 onwards.

While Royal Enfield has been in market since 1955, it failed to win customers

due to higher cost, unreliable product quality and lower mileage despite being

charismatic brand. As a result, RE volumes grew by ~10% CAGR over FY02-10 (in-

line with the industry growth).

However, launch of UCE engine (2008) and RE Classic (in FY10) addressed

product quality issues and improved mileage.

This coupled with increasing affordability for RE bikes, it has benefited from

replacement demand of motorcycle sold in during FY02-07.

As a result, Royal Enfield volumes grew by ~55% CAGR over FY11-16 (v/s 5%

CAGR for 125cc segment).

Royal Enfield benefitted from differentiated positioning of its motorcycle and

enjoyed cult following of the brand due to its heritage and retro look. With

improved quality and mileage, RE’s acceptance as a replacement for basic

commuter motorcycle increased significantly.

This value migration from mainstream 2Ws to RE is reflected in market cap for

these companies – EIM’s market cap in FY10 was ~INR17b, as compared to

HMCL’s ~INR388b and BJAUT’s ~INR292b. This compares with current market

cap for EIM/HMCL/BJAUT at ~INR664b/675b/819b!

January 2017

Value Migration | Thematic

Exhibit 9: Strong growth for <125cc motorcycle during FY02-

12…

<125cc Motorcycle ('000 units)

CAGR: 1%

CAGR: 12%

1.2

1.0

0.8

0.6

0.4

0.2

0.0

Source: Company, MOSL

Exhibit 10: …coupled with improving affordability of Royal

Enfield bike…

RE Affordability Index (x) *

Exhibit 11: …drove strong demand for RE from FY11 onwards as owners of <125cc

upgraded to RE…

RE ('000 units)

CAGR: 55%

CAGR: 13%

Exhibit 12: …reflecting in continued market share gain for RE…

BAJAJ

HMCL

TVS

HMSI

Royal Enfield

FY10

24.3

58.5

6.7

6.2

0.7

FY11

26.8

54.6

7.3

0.6

FY12

25.5

55.9

6.2

7.7

0.8

FY13

24.4

53.2

5.5

11.8

1.2

FY14

19.8

51.9

5.6

15.8

FY15

16.5

6.2

16.3

FY16

17.8

52.4

6.7

4.7

Exhibit 13: …and value migration from mainstream 2W

companies to Eicher

Market Cap

(INR b)

EIM

HMCL

BJAUT

Exhibit 14: Eicher enjoyed significant premium to peers on

relative valuation multiples

Mkt Cap/Sales

(x)

8.2

4.6

2.4

2.5

2.6

1.6

2.5

1.7

2.6

1.3

8.0

EIM

9.4

6.6

3.0

1.8

2.7

1.9

3.1

2.1

3.5

2.2

HMCL

12.8

BJAUT

10.0

8.8

Source: Company, MOSL

January 2017

Value Migration | Thematic

Case III: International value migration in Indian IT sector

Industry:

Information Technology

| Driver of VM:

Cost

| Beneficiaries:

Large-cap IT

companies

From western MNCs to India-origin providers (IOPs)

India has attained a leadership position in sourcing of IT-BPM solutions, with a

market share of ~56% in 2015. Its growth story started in the 1980s, when the

industry had annual revenue of less than USD1m. It has gone on to become

USD143b in FY16. The industry now directly employs 3.7m people, contributes 9.3%

of the GDP, and accounts for over 45% of the country’s total exports. In the last

decade alone, the Indian IT industry has grown 6x in revenue terms.

Exhibit 15: Indian IT has grown 20x in last fifteen years!!

Source: Company, MOSL

1. Emergence of labor arbitrage and its evolution to offshoring



In the 1970s, Indian companies began exploiting opportunities in personnel

placement. While in the US and Europe, there was growing shortage of

engineers for the expansion of the IT industry, in India, there was an

oversupply of engineers relative to domestic demand. Indian companies

began sending engineers overseas to do software programming onsite,

mostly in the US, for billable projects.

The industry, however, matured over time and the trend moved to software

development work by Indian firms for US clients from India – offshoring.

2. Value pillars – process excellence, cost optimization and human capital

leadership



Indian IT’s global penetration saw sustained momentum in the last couple of

decades in the internet era, as the supply situation continued to play out,

laying the foundation for continued growth. The industry also ensured: [1]

world class processes in delivery, led by Mr. Narayana Murthy's Infosys, and

[2] increased flexibility for clients, which was a refreshing change from the

limited room to maneuver in clients' existing contracts.

A key factor that has helped strengthen India’s position in the global

sourcing market is its large employable talent pool. India is expected to

churn out 6.2m graduates and postgraduates in FY16.

January 2017

Value Migration | Thematic

3. Concentration of value in the hands of select large players



As the industry grew, top-tier IT companies like TCS, INFO, CTSH, WPRO and

HCLT gained disproportionate share. These five companies together account

of ~50% of the industry compared to ~37% 10 years ago. Growth was being

driven by large deals, and among the largest criteria for vendor selection

was the number of references. This led to the big getting bigger and the

mid-tier companies struggled to match, despite their base advantage.

Exhibit 16: 18% CAGR in export revenue of Indian IT over FY05-16

Indian IT exports

108

Exhibit 17:

Top-5 gained ~100bp

every

year till FY14 in the overall exports pie

YoY share gain by top-5 (bp)

270

290

350

160

110

-30

-90

-60

-80

Exhibit 18:

Headcount CAGR of 11% over FY06-16

Professionals employed ('000)

3052

3290

3485

3688

1293

1621

1962

2196

2300

2541

2775

FY06

FY07

FY08

FY09

FY10

FY11

FY12

FY13

FY14

FY15

FY16

Source: Nasscom

January 2017

Value Migration | Thematic

Global Computing: Three-phase value migration in IBM

Value migrated from business models built around mainframes and minicomputer

systems to business models built around (a) workstations and PCs, and (b) elements

of computing functionality valued by customers – processor chips, operating

systems, low cost distribution, communications software and systems integration.

Change in customer priorities drove value from giants like IBM and DEC to the likes

of Intel, Microsoft, Novell and EDS, among others.

Exhibit 19: Value migration in the US Computing industry

Tabulation

Computing (IBM)

Integrated business design (DEC)

Specized business design (Microsoft, Intel,

Compaq, Dell, HP etc.)

In the open architecture era of personal computers, integrated computing

companies like IBM and DEC could not hold on to their customers. Over time, both

the institutional and individual customers deserted the integrated business design,

as open architecture provided more choices for basic hardware, software, support

and peripherals. Specialist service providers gained market share, generating cash

and raising capital for future growth targets. Companies like Microsoft, Intel,

Compaq and Novell created tens of billions of dollars in market value.

Exhibit 20: IBM saw value migrating towards specialized payers from mid-80s onward

(index stock price )

IBM

Microsoft

Intel

HP Inc

1,798

958

100

270

Source: Company, MOSL

January 2017

Value Migration | Thematic

Amazon’s disruption of the traditional providers of Tech stack

The meteoric rise:

AWS launched in 2006 and is forecast to surpass the $10 billion

revenue mark on its 10th anniversary next year. By comparison, it took nine years

for Google to hit $10 billion and 10 years for Facebook. Oracle and Microsoft each

took 23 and 22 years, respectively, to pass the $10 billion milestone. Measured by

revenues, AWS is approximately 6x larger than its biggest rival Microsoft Azure and

is arguably the greatest disruptive force in the entire enterprise technology market

today.

How it got there:

Amazon has been able to leverage the e-commerce business’s

massive investments in datacenters around the globe, and in essence fund the

development of AWS out of the company’s e-commerce operations. AWS is highly

profitable: [1] partly as a result of operating at much larger scale than any

competitor by a mile, [2] partly through its mastery of datacenter design and

provisioning, and user experience design, and [3] partly through its rapid and

relentless pace of innovation. Amazon is to cloud as has been the case of Google in

ad-based search, Oracle in relational databases, Microsoft in Windows and Office,

SAP in client/server ERP, Cisco in network switches and routers, and IBM in

mainframe computers.

The waning relevance of traditional players:

Traditional incumbents such as HP,

IBM, Cisco, Dell, and EMC (now acquired by Dell) are all trying to stem the decline of

their traditional businesses and get onto the cloud in a meaningful way. The shift

from mainframe to client/server caused the downfall of major companies such as

DEC, Data General, McCormick & Dodge and many others. In contrast, the shift from

the on-premise perpetual license culture and business model to the consumption

model is far more challenging for incumbents to deal with. This dramatic set of

changes is unlikely to take place without its share of shakes and tremors, as we’re

seeing with the struggles that IBM, HP, and Dell are experiencing.

Amazon’s exponential pace of value creation

Exhibit 21: Amazon’s revenues grew 10x in nine

years

Revenue USD Bn

107

Exhibit 22: Value

creation

by Amazon

400

300

200

100

Historical market cap (USD)

360

Source: Company, Bloomberg

January 2017

Value Migration | Thematic

Case-IV: International value migration to Indian Pharmaceutical

sector

Industry:

Pharma |

Driver of VM:

Cost, R&D |

Beneficiaries:

Select Pharma

companies

1. Indian pharma companies expanding presence in US generics market

US generics have been at the forefront of growth for Indian companies. The US is

the world’s largest generics market (>USD65b) and India has been a key beneficiary

of ‘genricization’ of the US pharma market over the last decade. Indian companies

have increased their market share in US generics from 16% in 2008 to 22-25% (total

prescriptions – TRx), still leaving scope for further inroads. Indian companies have

benefited from a wave of patent expirations in the last 5-7 years as well as a

favorable base, resulting in 25-30% growth over FY09-16.

2. Increase in R&D spend and ANDA filings key growth driver for Indian

Pharma

The share of ANDA approvals/annum for Indian pharma companies has increased

from mid-single digits in early 2000 to >40%. Apart from this, enhanced thrust on

R&D has been a key contributor to growth. Total R&D investment from key Indian

generic companies has increased from ~5% of sales in 2010 to 8-10%.

3. Strong backward integration and cost arbitrage key facilitators

Production costs for generic drug makers in India are 65% less than in the US and

50% less than in Europe. Also, due to the low-cost advantage, India is also quickly

becoming an attractive destination for clinical trials. Apart from this, strong

backward integration places Indian players favorably to address the likely pricing

pressure from channel consolidation in the US (at distributor level).

4. Inorganic route adopted to add capabilities

Owing to the complexity involved in development, the gestation period for acquiring

certain skillsets/capabilities in complex generics has become longer. Several Indian

companies have adopted the inorganic expansion route, identifying assets or

companies that have a differentiating technology or portfolio. Interestingly, most of

these acquisitions earlier used to be low ticket size (sub-USD200m). However, in the

recent past, bigger companies like Sun, Cipla and Lupin have entered into large

ticket size acquisitions to gain scale and enhance product mix.

5. Focus on complex generics to enable sustainable growth

Indian pharma companies have been cognizant of (a) reduced number of new

generics opportunities due to tapering of patent expirations for small molecules,

and (b) expanded scale of operations, rendering incremental growth challenging.

Over the last 3-5 years, most of their incremental R&D efforts have been towards

complex generics opportunities such as injectables, oral contraceptives,

transdermals, and NDDS-based products. Complex generics account for ~50% of the

US generics market, exhibiting 2x the growth rate compared to the overall market

growth rate. However, Indian companies derive only 15-20% of their current US

sales from these product segments. Incrementally, we expect over 40% of sales to

emanate from differentiated products or complex generics, which would help Indian

January 2017

Value Migration | Thematic

companies to grow at a healthy pace and improve their profitability. We believe

SUNP, LPC, DRRD, and ARBP are best positioned to tap growth in these niches or

complex generics.

Exhibit 23: Contribution of US to total sales increasing consistently

33%

27%

18%

17%

19%

22%

33%

34%

FY09

FY10

FY11

FY12

FY13

FY14

FY15

FY16

Exhibit 24: Rising share of Indian players in US generics market

US generic market (USD b)

Mkt Share of leading Indian Cos (%)

4.5

FY06

4.7

FY07

5.6

FY08

5.2

FY09

6.8

FY10

8.4

9.5

10.3

10.5

11.5

FY11

FY12

FY13

FY14

FY15

FY16

Exhibit 25: Increase in R&D spend by key Indian companies driving growth in US

>10-12%

8.5

5.5

5.8

5.6

6.0

6.9

7.5

FY10

FY11

FY12

FY13

FY14

FY15

FY16

FY17-18

January 2017

Value Migration | Thematic

How do you measure value migration?



In his book, Value Migration, Adrian Slywotzky points out that value flows into

and out of business designs. A key approach to measure that flow of value, he

suggests, is price-to-sales ratio (market cap/trailing 12 months’ revenue). A ratio

greater than two suggests value inflow phase, a ratio between one and two

suggests stability phase, and a ratio lower than one indicates value outflow

stage.

The ratio allows one to measure and compare value migration in several ways:



Value migration between companies in an industry



Value migration between companies in different industries

Estimating value migration for companies with multiple business models is trickier.

How does value migration manifest?

Our analysis of past instances of value migration suggests that value migration in

terms of market capitalization is the earliest to show, followed by sales and then by

profits. The market recognizes the potential beneficiaries of value migration much

before reflection in financials. When value migrated from public sector banks to

private sector banks, the rate at which the market capitalization of private sector

banks expanded was much higher than the rate of growth in their profits in the

earlier years (Exhibit 29).

Exhibit 26: While market cap shifted in favor of private sector banks in FY07, profit, NII and income salience remain in favor

of public sector banks (excluding FY16)

Private Banks

PSU Banks

Private Banks PAT share (%)

PSU Banks PAT share (%)

Private Banks NII share (%)

PSU Banks NII share (%)

PSU Banks total income share (%)

Private Banks total income share (%)

January 2017

Value Migration | Thematic

Exhibit 27: Gap between Sun Pharma’s and Glaxo’s market cap started widening in FY06; similar trend in profits became

evident later in FY08

Sun Mkt Cap (INRb)

Glaxo Mkt Cap (INRb)

2,117

1,972

34.8

18.2

194

322

2.4

1.0

7.7

5.5

13.5

5.6

5.8 5.0

3.6

PAT (RHS) INRb

Glxo PAT (INRb)

52.8

47.1

1,188

458

203

5.1

Similarly, in the case of value migration in Telecom, the rate of growth of market cap

for private players was much higher than the rate of growth of profits (Exhibit 25

,26). Bharti Airtel, the key beneficiary of value migration, reported losses even while

the shift in market cap was underway. In the IT sector too, when outsourcing was in

its embryonic stages, growth of market cap of IT players was way ahead of profit

delivery.

Exhibit 28: Market cap: Bharti’s marketcap crossed MTNL in

FY07 (INR b)….

Bharti market cap (INR b)

MTNL market cap (RHS) INR b

1568

116

1447

782

287

383

Exhibit 29: ..while profits overtook only in FY09 (INR b)

Bharti PAT (INR b)

MTNL PAT (INR b) RHS

1188

1184

-2

-26

Source: Company, MOSL

The same trend was observed in Batteries industry. Value migration towards Amara

Raja was reflected in the market capitalization first. As shown in Exhibit 27 and 28,

value migration in terms of market capitalization towards Amara Raja started

conclusively in FY13 and it crossed the market cap of Exide in FY15 whereas profits

of Amara Raja are yet to cross Exide. Gap between profits and market caps of Amara

Raja and Exide has been consistently narrowing in the last ten years.

January 2017

Value Migration | Thematic

Exhibit 30: AMRJs share in market cap ovrtook Exide in FY13

AMRJ's share in combined Mcap (%)

EXID's share in combined Mcap (%)

Exhibit 31: However profits yet to cross Exide’s profits

AMRJ's share in combined PAT (%)

EXID's share in combined PAT (%)

12 16

Source: MOSL, Company

The above examples in Banks, Pharma, Telecom and Batteries industries underscore

an important point. Once the trend of value migration is detected, the market

moves very swiftly and rewards the potential beneficiaries much before the benefits

are actually reflected in financials.

January 2017

Value Migration | Thematic

How do you detect value migration?



Early identification of value migration trends helps in maximizing the investment

gains. Naturally, this leads to a critical question – how does one detect value

migration early?

Detecting value migration is difficult even for a company/management totally

involved in running its business and driving strategies. In the value inflow phase,

most of the organization’s energies and resources are concentrated towards

meeting consumer demand. In the stability phase, complacency creeps in and

prevents early detection of migration. Lastly, in the value outflow phase, the

focus is on preventing losses.

The initial phases of value migration are quite subtle, gradual, and hence,

difficult to understand. Also, when value migration is driven by new competition

(and not the incumbents), it is difficult to detect. For example, in the Two

Wheeler industry, Eicher’s Royal Enfield did not create any concern initially, as it

was not a traditional competitor. The impact became evident only after few

quarters/years of tangible market share gain by Eicher Motors.

Nonetheless, early detection of migration provides an edge in gaining early

exposure to potential winners as well as avoids players on the wrong side of the

equation.

Some of the factors which can help investors in earlier detection of value migration,

in our view, are:

A] Market share movements

provide a very strong signal of value migration.

Consistent share gain trends are usually a harbinger of bigger trends at work. E.g.

Indigo’s consistent market share expansion in Airlines, Private Bank’s share gain in

savings deposits or Eicher’s rising equities in premium two wheeler space all

underscore a distinct value migration shift in the underlying businesses.

B] Innovation leadership

is another metric to identify potential beneficiaries of

value migration. Players that drive innovation and create new categories/sub-

categories enjoy tremendous first mover advantages and trigger value migration. In

Decorative Paints, Asian Paints is well- entrenched as an industry leader, with 55-

56% market share. However, it is innovation leadership that has cemented its

position as industry leader and ensured continued share gains over the years

(gained 1,500bp market share in ~15 years). It has been a pioneer in introducing

several new practices in the industry – tinting machines, home solutions, color ideas

etc. Similarly, Shree Cements switched to petcoke as preferred fuel about a decade

ago, a trend which the rest of the industry has adopted in only last 2-3 years.

Incrementally Shree cement is graduating to Waste Heat recovery for its power

requirement in order to reduce its power and fuel cost.

C] Customer satisfaction scores,

while subjective, can act as a good starting point to

understand whether customers are happy. Declining satisfaction scores should alert

investors about impending value migration. Value migration in Public Sector Banks

January 2017

Value Migration | Thematic

and Public Sector Telecom companies in India was triggered by dissatisfaction with

the incumbents’ services when the industry was witnessing rapid changes triggered

by private players.

D] Policy changes:

In a regulated industry (Aviation, Power, etc) changes in policy

provide a trigger for value migration. While these are difficult to anticipate, close

monitoring assumes critical importance in detecting any migration trends. Broad

policy changes like GST implementation will hasten value migration from the

unorganized to the organized sector.

The key question that now arises is, how does value migration manifest in the case

of unlisted players? In our view, one should look at market share movement. Market

share data is typically readily available with industry syndicates or the media. More

often than not, gains in market share are followed by gains in profitability.

January 2017

Value Migration | Thematic

Duration of Value Migration

How much value is created depends on the duration of value migration – the longer

the value inflow stage, the greater the value creation. Typically, once the value

migration begins, it lasts for several years, even decades. Duration of value

migration is a function of three factors:

Strength of the value migration driver

Ability of the incumbent to innovate and meet ever-changing consumer

needs/priorities

Sustainability of the competitive advantage

The stronger the driver, the longer the value migration continues. In the IT sector,

for instance, the driver of value migration is low cost and a skilled workforce,

advantages of which have long shelf life. The value migration has sustained for

decades and the drivers haven’t yet faded.

Through various examples in this report, we show that value migration lasts for

years/decades. Even if one identifies a case of value migration a little late, the

opportunity to make outsized investment returns might still be available. The value

migration in the Indian Banking and Jewelry is still underway, despite having already

lasted for over a decade. Of course, the earlier one identifies the value migration,

the larger is the opportunity to earn outsized returns.

Instances of short-duration value migration could be in technology-oriented sectors,

where rapid evolution of technology results in constant value migration away from

incumbents (unless the incumbent itself drives the value migration).

In this report, we highlight the case of value migration in the Jewelry industry, which

began over a decade ago, but is still in the works, as the share of organized players is

still low. There are several more such examples – migration towards generics in

Pharma, from PSU to private sector banks and migration in cement industry.

January 2017

Value Migration | Thematic

Value Migration in Cement

Value migration has happened even in the commodity sectors. Change in

manufacturing process necessitated by various considerations (cost, speed to

market, technology evolution) has driven value migration. Companies exhibiting

nimble-footedness in adapting to technological changes have reaped benefits from

such value migration while those not capitalizing on such changes have lost out. We

highlight one such example from the Indian Cement sector.

Case-VII: Value migration in Cement towards Shree Cement

Industry: Cement | Driver of VM:

Cost, Supply demand equilibrium

| Play on

VM:

Shree Cement

1. What was the value migration in Shree Cement?



Value creation:

Shree’s market cap has increased by 16.5x over FY06-FY16

far outpacing the marketcap accretion by its peers. Ultratech has been

second best where in its market cap has increased by 10x over the same

period. Ramco and Ambuja have seen market cap increasing by 3.6x and

3.1x over the same period with ACC being the laggard where in its market

cap has increased by only 1.65x in last decade.

Superior volume growth:

Shree cements volume has increased at CAGR of

19% over FY06-FY16 led by aggressive capacity addition and market share

gains. The combined volume of other top 4 players increased at CAGR of 8%

over the same period with ACC, Ambuja and Ramco registering volume

growth at CAGR of 6%,5% and 4% respectively. Ultratech’s volume increased

at CAGR of 12% over FY06-FY16.

Strong operational performance:

Shree cements EBITDA has increased at

CAGR of 23% over FY06-FY16 led by volume growth and margin expansion

as against ACC and Ambuja cements EBITDA which increased at CAGR of 8%

and 5% respectively over the same period.

2. What drove the value migration?



Capacity ahead of Industry:

Shree cement’s capacity increased at 21% CAGR

over FY06-FY16 to 27mt at present as against industry capacity increased at

10% CAGR over the same period.

Localized operations:

Shree cement supplies 80% of its total cement

capacity from only two mother clinker units thus making it extremely cost

competitive compared to other peers.

Asset creation at lower cost:

Shree cement’s cost of setting up a capacity is

~30-40% lower than industry standards because of its efficient design,

standardization of plants and superior execution.

Efficient methods of production:

Shree cement way back in 2006 had

adopted 100% usage of alternate fuel for its kilns as it was cheaper by ~30-

40% compared to conventional sources of fuel. Other players transitioned to

alternate fuel in meaningful manner only in FY12-FY13.

January 2017

Value Migration | Thematic



Aggressive pricing in newer markets:

Shree cement in order to garner

higher market share in newer markets resorts to pricing its products at

discount. Despite lower pricing Shree cements profitability and return ratios

are far superior to peers due to cost competitiveness and efficient asset

creation.

3. Shree’s preparedness for next leap?



Pan India presence:

Shree cement is transforming itself from being a

regional player to PAN India by adding capacity in East and south markets

over next 2-3 years.

Scaling capacity:

Shree cement is likely to add ~10mt of capacity over next

2-3 years which constitutes ~25-30% of India’s total capacity addition. This

will enable it to gain market share on a sustained basis.

Exhibit 32: % share of SCRM of the total market cap has

increased 3x in 10years

Shree

Ramco

Ambuja

Ultratech

2006

2016

Source: Company, MOSL

ACC

Exhibit 33: Added capacity(mt) without hurting B/S

Cpacity addition (mt)

-13

-14

-13

-12

0.3

-19

-41

-67

Net Debt (RHS, INR b)

Source: Company, MOSL

Exhibit 34: Market cap (Rebased to 100) of cement

companies

2006

2016

Exhibit 35: Shree’s market cap as a % of other cement

companies

2006

2016

1006

1648

364

100

Shree

100

Ramco

100

Ambuja

318

100

Ultratech

100

165

196

416

117

Shree as % ACC

ACC

Shree as %

Ramco

Shree as %

ACEM

Shree as %

UTCEM

Source: Company, MOSL

January 2017

Value Migration | Thematic

Exhibit 36: Trend in RoIC(%)

RoIC(%)

Source: Company, MOSL

Global value migration in commodities

In the US, value migrated from integrated steel mills to four different business

designs, including to different industries like Aluminum and Plastics.

The integrated business model of US Steel companies generated material value in

the 1950s and 1960s. Integrated mills enjoyed bargaining power, as their customers

had no alternative to domestic supplies. Through vertical integration, the mills

achieved low unit costs at higher utilization rates. The success of this model blinded

steel producers and they did not worry about any non-traditional competitors.

Meanwhile, Japanese steelmakers were gaining some traction in the US. However,

the heavy tariffs on higher quality steel nullified the Japanese price advantage and

the grip of US integrated mills on automotive players remained firm. The Japanese

steelmakers were able to offer lower prices despite high transport cost, as they

focused on reducing cost at every stage of the supply chain (large-scale shipping, ore

costs, coal costs, adopting new production process to cut costs).This gave Japanese

mills 30% cost advantage vis-à-vis their US competitors, helping them to offset

transport costs. By early 70s, Japanese production was bridging the gap with

American production rapidly. The Japanese adopted a new production process,

continuous casting, which eliminated ingot making and reduced costs significantly.

They then aggressively converted their capacities to continuous casting.

Also, in the US, mini-mills were gaining traction with construction companies. They

offered competitive prices on low-end bar steel (rebar) due to unique advantages of

their business model – used electric arc furnaces meant lower investment, rural

locations helped cut labor costs by 30-40%, overheads were low, proximity to

construction areas cut transport time and cost. Since mini-mills were small,

integrated steel companies did not take their threat seriously. Nucor was rapidly

emerging in the mini-mills arena.

Integrated steel companies found more competition from alternate materials like

Aluminum and Plastics. In cans, the relative ease of using aluminum appealed to

manufacturers. Aluminum makers focused their resources on driving steel out of the

beer can market and achieved success. Value migration from integrated steel

business design to aluminum-based business design was gaining pace. By late the

January 2017

Value Migration | Thematic

60s 20% of the beer cans were made of aluminum. This number went up to 50% by

1973.

The oil shock of 1973 pushed up gasoline prices, creating demand for fuel-efficient

vehicles. Plastic manufacturers detected the change in consumer priorities towards

fuel-efficiency and reacted quickly. Plastics began to compete with steel by the end

of the decade. Plastics gained because of light weight, rust resistance, and lower

factory retooling costs. Use of plastics reduced body weight and increased fuel

efficiency. Big steel players did not take the threat of plastics seriously.

Thus, value migrated from integrated steel mills towards four different directions:

Japanese mills, US mini-mills, aluminum producers, and plastic makers.

What is also interesting to note is the way Nucor managed to reinvent its business

model when it detected a threat to its mini-mills, which worked well in the 70s and

the early 80s. But it faced challenges, as competition had increased and prices of its

raw material, scrap, were rising rapidly. Nucor realized the shifting equation and

redesigned its model – built iron carbide plant to lower dependence on scrap,

expanded product lines, and included upmarket flat-rolled steel products. This

enabled it to pull back from the value outflow stage to the value inflow stage.

Exhibit 37: Four-phase VM in US steel industry in 70s and 80s

Aluminum

Plastic

Integrated Steel

Mill in USA

Low cost

Foreign

mills

Minimills

Source: Value Migration by Adrian Slywotzsky

January 2017

Value Migration | Thematic

Value outflow led by emerging preference for new

sources of energy

Value outflow happens when

business value starts to move away from current

business design towards others meeting evolving customer needs. In this phase,

market share declines, margins contract and growth stops.

Companies that lag on the innovation curve or ignore the evolving market trends

tend to be at the receiving end of the value outflow stage. At times, complacency

blinds an organization to the evolving threats. Such threats or new trends build up

with time and assume bigger proportions. By the time the organization realizes it is

in the value outflow phase and takes corrective actions, the competition has upped

the ante.

We discuss the case of BHEL, which is experiencing value outflow due to the shift

from conventional energy to renewable sources.

Case-IX: Value Migration: Shift from conventional energy to

renewables

Industry:

Capital Goods |

Driver of VM:

From Conventional Power to Renewables|

Play on VM:

Negative for BHEL

1. What’s the potential value migration?



To meet its target under the Conference of the Parties (COP21) Agreement

on Climate Change by 2030, the Government of India targets to increase

renewables capacity to 30% of total generation. For the medium term, the

stated target is to increase renewables capacity from the current 43GW to

175GW (100GW solar and 75GW wind) in FY22.

2. What phase of value migration are we in currently?



In the last two years, the Indian government has increased focused on

renewables. 7GW of renewable capacity was added in FY16 – the highest

ever in a year. The target for FY17 is more ambitious – 10-12GW of solar and

4GW of wind capacity, implying renewable capacity addition of 14-15GW,

higher than the thermal capacity addition target. The government intends to

maintain this pace over the next few years, spelling doom for thermal

capacity addition in the country.

3. What will be the catalyst driving this value migration?



To promote renewable power generation, the government warrants strict

adherence to the implementation of the RPO and RGO obligations. Under

the renewable purchase obligation (RPO), state electricity regulatory

commissions (SERCs) are obligated by law to buy a certain percentage of

electricity from renewable energy sources. The guidelines issued in 2010 by

Central Electricity Regulatory Commission (CERC) recommended a

January 2017

Value Migration | Thematic



standardized RPO target of 5% in every state, with linear increase of 1%

annually till 2020 to achieve the NAPCC target of 15%.

The Power Ministry plans to amend the Electricity Act to introduce

renewable generation obligation (RGO), whereby conventional power plant

developers would be obligated to generate ~10% power from renewable

energy sources. Successful inclusion and implementation of the RGO norms

can help the wind market to expand from 2.3GW in FY16 to 4-5GW per

annum in the medium term.

4. What if this value migration plays out?



Focus on renewable energy sector will dent incremental thermal capacity

addition. Current capacity utilization for thermal plants stands at 54%. In our

view, even if the current capacity utilization is increased to 60% over FY18-

22, with the additional renewable/thermal power capacity expected to

come up during the period, India would remain power surplus. This does

away with the need to order new thermal capacity over the next 2-3 years.

From a power generation equipment perspective, BHEL, market leader in

the thermal fuel fired market, would be a key loser. It derives ~85% of its

revenue from coal-fired plants, which are in a structural decline.

Exhibit 38: India’s installed capacity shifting to renewables

Hydel

12%

13%

12%

Thermal

14%

Nuclear

16%

17%

Renewables

18%

19%

20%

21%

68%

71%

70%

69%

68%

67%

66%

18%

FY13

17%

FY14

15%

FY15

14%

FY16

13%

FY17E

13%

FY18E

12%

FY19E

12%

FY20E

11%

FY21

11%

FY22

Exhibit 39: Base power deficit to remain negative, as existing Exhibit 40: Improvement in capacity utilization of thermal

capacity sufficient

power plants to take care of incremental demand

10.0%

5.0%

0.0%

-5.0%

Base Deficit(%)

100%

80%

60%

40%

20%

Hydel

Thermal

Nuclear

Renewables

January 2017

Value Migration | Thematic

Over capacity in BTG and a resultant fall in pricing and margins for BHEL.

The BTG

industry has been facing an over capacity over the past 5 years – total industry

capacity is upwards of 20GW while industry level ordering has fallen to 10GW during

FY12-16. This has led to severe pricing pressures with BHEL taking the lead to cut

prices to retain its market leadership. While it has been able to sustain market share

at ~74-75%, this has come at the cost of margins. Gross margins which have

averaged 44-45% over the past decade (FY05-FY15) have fallen to 37% in FY16 – a

sharp dip of 700bps.

Exhibit 41: Gross margins of Bhel on a downward trend (%)

47.4

44.5

44.8

46.1

40.3

42.1

46.6

42.9

43.5

42.4

43.9

37.0

January 2017

Value Migration | Thematic

Reverse Value Migration

Possible to wrest “Value” back

After discussing the concept of value migration as an investment framework and

highlighting several drivers/examples in the previous section, we now look at the

possibility of reverse value migration in this section. In simplistic terms, reverse

value migration can be defined as the flow of value back to the point of its

emanation. For example, if value has migrated from industry A to industry B, then

reverse value migration is the flow of value back to industry A.

Customer priorities keep changing, which poses challenges to incumbents. However,

we believe incumbents do not have to lose the game of value capture/migration as

such priority shifts also open up significant opportunities. With a responsive

business design, incumbents can sustain their positioning in the market and create

new value proposition that addresses changing priorities.

Thus, value migration is relocation of underlying value – rather than disappearing of

value – to product/business design, which helps address changing customer

priorities.

Reverse value migration highlights that it is possible to wrest back value after

initially having been at the receiving end of the value migration process. However, it

requires combination of factors to work, prominent among them being the ability to

drive relevance of the product segment back in customers’ mind after having

suffered in the first phase of value migration. Second, we believe it also requires

innovation skills to bring a product back to the center stage and ensure customer

satisfaction.

Indian two-wheeler Industry is the most prominent exponent of reverse value

migration, where we saw the flow of value from scooters to motorcycles and now

back to scooters. Another case of reverse value migration is being witnessed in the

transportation sector, where the value first migrated from road to rail to then again

to road. However, it is now migrating back to rail as constraints are being addressed.

Here, we discuss the case study of reverse value migration in the Indian two-

wheeler industry.

January 2017

Value Migration | Thematic

Case-X: Reverse Value Migration: From Scooters to Motorcycles

to Scooters

Industry:

Two Wheelers|

Driver of VM:

Technology|

Beneficiaries:

TVS, HMSI |

Potential Loser:

Hero MotoCorp

Value Migration: From Scooters to Motorcycles to Scooters



Indian two-wheeler industry has evolved over the last four decades, with value

migrating from geared scooters to motorcycles, and now to automatic scooters,

driven by changing customer preferences and availability of new products.

Geared scooters dominated 1960s to mid-1990s due to low cost, high mileage

and low maintenance as compared to then available motorcycles, reflecting in

~14% CAGR in scooter volumes. However, higher economic growth and

urbanization saw increasing dominance of four-stroke fuel-efficient, sturdy

motorcycles from Japanese players with features/specs meeting customers’

changing priorities. This resulted in a rapid decline in demand for geared

scooters with preference shifting to motorcycle and automatic scooters. Bajaj

Chetak’s (synonym for geared scooters in India) production was stopped in

2005.

While Japanese players launched reliable and fuel efficient four-stroke

technology in 1985, it took almost 10 years and an oil shock for them to find

acceptance among Indian consumers. Indian motorcycle industry grew at ~22%

CAGR from FY93-FY08, overtaking scooters in FY2000. Motorcycles benefited

from value migration away from scooters, as customers’ priorities were on

better mileage, superior quality (product and ride) and aesthetics.

Automatic scooters have been in the market since mid-1980s (Kinetic DX, Bajaj

Sunny, etc.) and grew at ~14% CAGR from FY93-FY03. However, automatic

scooters gained traction with the launch of Honda Activa, the first four-stroke

automatic scooter, in 2001. Automatic scooters started gaining acceptance,

especially in urban markets, driven by narrowing fuel efficiency gap,

improvement in urban roads and unisex appeal. Indian automatic scooter

industry grew at ~22% CAGR over FY08-FY13.

Exhibit 42: Changing customer priorities drove value flow from scooters (geared) and

mopeds to motorcycles from 1990s to mid-2000s

100%

75%

50%

25%

Motorcycle

Scooter

Source: Company, MOSL

January 2017

Value Migration | Thematic

Exhibit 43: Changing consumer priorities drive value migration in 2W industry

Exhibit 44: Value migration from Geared Scooters to Motorcycles to now towards Automatic Scooters

100

Motorcycle

Geared Scooters

Automatic Scooters

Geared Scooters

ceased to exist

post 2008

Source: Company, MOSL

Hero MotoCorp: Structural value migration or cyclical impact?



Executive 100cc segment (~56% of HMCL’s volumes) is witnessing potential

value outflow towards a) scooters, b) premium and c) economy segment,

reflecting in ~9.5% CAGR decline in the segment volumes over FY14-16. We

believe that part of outflow toward economy segment is also due to two

consecutive poor monsoon seasons, which should get corrected in FY17/18.

HMCL has been trying to gain market share in scooters through two new

launches in 2HFY16, which has helped it to gain lost market share. However, it is

still much behind market leader HMSI.

It has successfully captured value outflow toward executive 125cc segment, as

reflected in ~16pp market share gain in this segment since FY14 (~23% CAGR in

January 2017

Value Migration | Thematic



volumes). However, it has seen virtual wipe-off of market share in premium

segment (>150cc), with ~16pp loss in market share to ~3.3% since FY12.

We recently downgraded stock to

Neutral,

as despite factoring in strong volume

growth (8.5%/11.5% in FY17/18), stable EBITDA margins (at 16.5% for FY18E)

and resultant strong EPS growth (~18% in FY18E), valuations at ~18.9x/16.1x

FY17E/18E appear fairly valued considering it would lose excise benefit from

FY19. We have a target price of INR3,666 (18x FY18E EPS adjusted for loss of

excise benefit— at ~15% premium to LPA).

Exhibit 45: Executive segment: Structural value migration or cyclical impact?

Source: Company, MOSL

January 2017

Value Migration | Thematic

Value migration driven by Unlisted players

Unique business models of unlisted players posing a threat to incumbents

We have discussed various themes on value migration in the preceding section –

themes which have been in play for some time and also themes which are expected

to play out in the future.

In this section, we attempt to highlight themes which are yet to gain significant

traction and are still in embryonic stages relative to themes we have discussed in

earlier sections. The common thread around these themes is the challengers are

unlisted and are posing threats to incumbents. Nonetheless, these are trends which

are disruptive in nature and have the potential to cause serious dislocation in the

existing order of things. Needless to say, it will take time to play out and maybe

create new winners or dislocate existing winners. Giving the rapid change of pace in

technological evolution, the trends in today’s age are rather short lived. Even before

a new trend takes shape and its success is judged, it is threatened by a newer trend

and has to start worrying about its survival. In essence, the pace of value migration

is rapid in today’s world. In the past, value migration was about meeting unmet

needs of consumers. Today it is about creating needs which doesn’t exist. In this

section, we discuss four interesting themes which, in our view, will create disruption

going forward and challenge the existing frameworks of businesses. These themes

need not necessarily be a play on stocks but nonetheless will have an impact on the

way of doing business.

Exhibit 46:

Unique

disruptions

: Unlisted players posing challenges to listed ones

S.N.

Sector

Automobiles

FMCG

BFSI

Telecom

Theme

Future of personal transportation: Shift from product to service

Value Migration from traditional FMCG to Ayurveda/Herbal players

Payment banks and SFBs: Dawn of new era in Financials?

The disruptor with big pockets

Unlisted players involved

Uber, Ola

Patanjali

Paytm

RJIO

Source: Company, MOSL

Theme 1: Future of personal transportation: Shift from product to service?



Introduction of shared mobility services like Uber and Ola have brought about a

revolution in the transportation industry. These taxi aggregators developed a

smartphone app that allows users to hail private cars for travel, as well as

allowing drivers to earn money from picking up rides in over 425 cities in 72

countries worldwide.

While new generation taxis had been making in-roads in India since 2008 in

form of radio-taxis like Meru, EasyCabs, TabCabs etc, these services were

primarily targeting users of normal taxis. These radio-taxis were expensive than

normal taxis and owned car. Value migration from normal taxis to radio-taxis

had just begun around 2009-10, emergence of shared mobility service like Ola,

Uber disrupted both radio-cabs and normal service due to cost and

convenience.

Three major drivers for shared mobility services:



Price:

It offers chauffer driven rides at a great price, cheaper than regular

taxis as well as owned car.

January 2017

Value Migration | Thematic



Convenience:

It is convenient (using app), easy to use and having multiple

payment options.



Quality and Safety:

Cars operated under shared mobility services are well-

maintained. Also, one can track her journey along with details of the drivers

and the car.

While these shared mobility apps have disrupted normal taxi business, it has

potential to influence car buying patterns (if not eliminating need to own a car).

Currently shared mobility accounts for <4% of all miles driven globally. UberX is

almost 50% cheaper than owning a car in city like New York. Autonomous cars

might be 40% cheaper UberX and 70% cheaper than owning car!

Similarly in India, Ola/Uber offers one of the cheapest mode 4W transportation.

More importantly, these services offer local solutions for the India markets like

Uber Moto, Ola Shuttle, UberPool, Ola Corporate, Ola Autos etc.

The ease, convenience and luxury provided by these services without having the

hassle of driving in congested roads and worrying about the parking their cars at

a lower cost have made people reconsider their plans of owning a car.

Potential drivers of faster adaption of shared mobility apps in India



Road congestion:

With four Indian cities featuring in top10 congested cities

in the world, self-driving is increasingly painful in the top-10 India cities.



Poor public transportation:

Urban public transportation infrastructure

hasn’t kept pace with urbanization, putting more pressure on the road

networks.



Regulations:

Increasing pollution levels in tier-1 cities would force

regulators to adopt strict measures to curb pollution (for eg Delhi/NCR has

witnessed several measures like ban on 10yrs/15yrs diesel/petrol vehicle,

odd-even policy, Green levy on diesel vehicle above 2ltrs etc). These kinds of

regulatory oversight could end up scaring first time buyers (over 40% for the

industry).



Ride sharing:

Ride sharing services from Ola/Uber drives down costs for

user, congestion on the road and curtails pollution.



Autonomous vehicle:

Autonomous vehicle can bring down cost of shared

mobility services by upto 20% in India, widening cost advantage for these

services.

What could be potential impact of shared mobility services on Auto/Auto Ancs



Given India’s low penetration of car, and convenience and aspiration of

owning a car would weigh over rationality, shared mobility apps wouldn’t

impact demand for car significantly in the medium term. In fact, in the

medium term car sales could see boost from additional demand from these

service providers.



We don’t expect demand from First Time Buyers getting impacted

meaningfully, though on margin few such buyers might defer their

purchase.



However, increasing usage of these services would put at risk car demand

from replacement (~28%) and 2

car buyer (~27%).



While demand for cars in India would not decline, pace of growth in the long

term would be lower than what was estimated prior to emergence of

shared mobility. Hence, the challenge for OEM would be to produce car

which are unique, aspirational and yet affordable.



January 2017

Value Migration | Thematic

More importantly, these services could have bigger influence on car

ownership patterns in the global markets. In US, age of young people with

driver’s licenses has been steadily decreasing. In 2014, 77% of 20 to 24-year-

olds had driver’s licenses (v/s 92% in 1983). As per one survey, a millennial

today is 30% less likely to buy a car than someone from the previous

generation.



Lower pace of growth in India and in global markets would influence auto

component suppliers who are focused on PV OEM segment viz Motherson

Sumi, Mahindra CIE, Bosch (which could also be impacted by shift towards

Electric Vehicles) etc.



"The age of access is here. There is going to be increasing number of people

who would want access to transportation and not own object of

transportation. Today, one lives in a world where the Olas and Ubers of the

world are stating that a person doesn't need to own a car, for them

transportation is commodity.“

Mr Anand Mahindra, M&M

Exhibit 47: Shared mobility trumps owned car in per Km cost

12.3

14.0

15.5

2nd Car

Exhibit 48: High share of First Time Buyer (% of Maruti’s

sales)

First Time

Buyer

Replacemen

Exhibit 49: Policies adopted by various countries and cities around the world to reduce car

ownership and usage

Source: World Resource Institute

January 2017

Value Migration | Thematic

Theme 2: Value Migration from traditional FMCG to Ayurveda/Herbal

players [Patanjali Ayurved]

Industry:

FMCG

| Driver of VM:

Niche positioning and cost

| Beneficiaries:

Patanjali

and broader Naturals space

Patanjali – the disrupter

Indian FMCG industry has seen the emergence of a new unconventional player

which has made rapid strides in the last 4-5 years and is now the most commonly

discussed threat for the business models of incumbent FMCG players.

Patanjali, founded by Baba Ramdev (Yoga guru) as a pharmacy store in 1997, flew

below the radar of industry incumbents for the first fifteen years and then over the

next four years its revenues went up 10x. The conventional wisdom of entrenched

FMCG players having established an unbreakable moat of distribution reach coupled

with brand strength through decades of presence has been challenged by Patanjali.

Exhibit 50: Patanjali’s niche positioning based on Ayurveda has been its key USP

What is Patanjali’s secret sauce?

So what explains Patanjali’s success? What has driven the value migration from

traditional FMCG players towards Patanjali which resulted in sharp spurt in revenues

from INR 4.5b in FY12 to INR 50b in FY16?



In our view, the single biggest factor which drove value towards Patanjali was its

success in making Ayurveda mainstream. It smartly capitalized on the

consumer’s acceptance of Ayurveda/Herbal/Natural products driven by health

and lifestyle considerations. Core competence of Patanjali lies in manufacturing

products with Ayurveda positioning and making it available to consumers

through its vast network of Patanjali Chikitsalayas at a price discount of 15-30%

vs. existing products. The product basket of Patanjali expanded rapidly with

presence from Food to Grocery, Home Care, and Personal Care. It successfully

January 2017

Value Migration | Thematic



identified the need of consumers and fulfilled the same by creating a product

basket with strong Ayurveda lineage.

It also leveraged the brand Patanjali, popularized by Baba Ramdev through his

Yoga camps. The umbrella branding helped it save money on advertising and

promotions vs. other FMCG players and pass on the savings to customers

through reduced prices.

Having gained significant size, it has then focused on widening its reach by

expanding the distribution network and making its products available in mom

and pop outlets.

Last but not the least, it also benefitted from its positioning as a “Swadesi

(domestic) player” with an explicitly avowed goal of replacing MNC’s.

Thus, combination of positioning, brand equity, distribution reach and Swadesi

angle helped Patanjali establish its presence and pose a meaningful threat to

several FMCG players.

Exhibit 51: Patanjali product basket spans several categories

Patanjali in numbers

Patanjali’s revenue jumped from INR4.5b in FY12 to INR50b (reportedly) in FY16.

There was a particularly sharp spurt from INR20b in FY15, partly because its

products started becoming available not just in 10,000-odd franchisee-run small

chikitsalayas

(100-300sf health centers) but also across leading modern retail chains

like Big Bazaar, Reliance Retail and Star Bazaar. It has dedicated shelves to exhibit its

products in these stores.

Exhibit 52: The exponential rise in Patanjali’s revenues; up 10x in four years

Revenue (INR b)

Growth (%)

149.3

87.4

42.9

FY11

FY12

FY13

40.3

FY14

68.4

FY15

FY16

January 2017

Value Migration | Thematic

Exhibit 53: Diversified category basket

Cosmetics

Revenue mix (%)

21.5

12.4

15.6

10.7

15.8

Exhibit 54: Profits up 5x in three years

Profit (INR b)

Profit margin (%)

Hair care

Dental

products

Food

Toiletries

0.7

Healthcare

FY11

0.6

FY12

0.9

FY13

1.9

FY14

3.2

FY15

The game is not over yet

Over the next few years, Patanjali intends to focus on six areas: natural medicine,

natural cosmetics, natural dairy products and food, natural cattle feed and feed

supplements, bio-fertilizers and bio-pesticides, and natural indigenous seeds. It

intends to quadruple revenue to INR200b by FY20. It has three factories currently

and it plans to set up six more in the next few years.

Challenges in the offing

Limited distribution, stock-outs, and capacity expansion could pose challenges.

Patanjali’s products only reach ~200k outlets compared to the 6-7m outlets reached

by larger FMCG players like Hindustan Unilever, ITC and P&G, and 3-4m outlets

reached by mid- tier FMCG players.

Exhibit 55: Patanjali’s distribution reach

Distribution type

Distributors

Company owned outlets

Mega-marts

Distribution reach

4,000

10,000

100

January 2017

Value Migration | Thematic

Low-cost Retail revolution in USA and Europe in the 80s

The disruption caused by Patanjali in India finds an uncanny parallel in the Retail

industry in the US and Europe in the 1970s and 1980s. Wal-Mart in USA and Aldi in

Europe, benefitted by satisfying the customer priority of low cost and convenient

shopping experience.

Wal-Mart

Wal-Mart took advantage of the shifting priority of American consumers towards

cost consciousness and hassle-free shopping in an environment where customers

were pressed for time and money in an era of declining purchasing power for

middle-income families (1970-1990). It capitalized on these trends by providing low

cost access to a wide range of branded goods. It built big stores, where scale and

volumes enabled it to offer lower prices than traditional stores. The sheer

availability of multiple categories of goods ensured a better shopping experience

and saved consumers’ time.

Wal-Mart’s focus on logistics, purchasing and flexibility to evolve its business model

to match changing customer priorities reshaped the landscape of the Retail industry.

Traditional retailers like Sears and JC Penney bore the brunt of stagnation even as

Wal-Mart prospered.

Exhibit 56: Walmart expanded the gap with rest of the retailers

500

400

300

200

100

135

157

Walmart Mcap (indexed)

410

JC Penny Mcap (indexed)

399

316

Source: Company, Bloomberg

Aldi

In Europe, in the 1970s and the 1980s, traditional grocery/food shops were facing

the challenge of economic obsolescence from hypermarkets. Hypermarkets created

value by satisfying the new customer priorities of low cost and convenient one-stop

shopping experience.

Aldi offered acceptable quality food staples at rock bottom prices. Variety offered

was limited but emphasis was on convenience. Unlike hypermarkets, Aldi stores are

small with no-frills furniture and primarily located in cities. It offered limited variety

of non-perishable, fast moving staples (high inventory turnover). It had strong

controls on overheads, with employees performing multiple duties. Customer

service was minimal, which helped control labor cost. Advertising was mostly word-

of-mouth. All this resulted in average sales per employee hour being 35% higher

than supermarkets.

January 2017

Value Migration | Thematic

Theme 3: Payment banks and SFBs: Dawn of new era in Financials



After two decades of new private banks entering the banking system, RBI and

GOI announced a new set of financial services companies, namely Small Finance

Banks (SFB) and Payments Banks. With no legacy issues, focus on cost reduction

with the use of technology and an established customer base in most cases,

both these categories are likely to be strong competition, in a decades to come,

for incumbents especially state owned banks.

Of the 10 players who received the SFB license, 8 are NBFC-MFIs. Upon

conversion to SFB, their focus will be on diversification, especially into the SME

business done by banks. At the same time, they would look to reduce cost of

funding by building a strong CASA franchise over the medium term, with most

customers being the MFI customers they serve. As such, they will compete with

large banks not only on loans but also on deposits. They will look into tapping

the vast areas of unbanked or under-banked population at sustainable costs

with the use of technology.

Payment banks licensees come from a variety of sectors. Most companies

already have a large customer base in place and are likely to pose a big threat to

incumbents. For example, Airtel (250m+), Vodafone (200m+), Idea (175m+) and

One97 Communication (Paytm, 100m+) already have a large customer base in

place. As such, the cost of acquiring a new customer will be minimal, hence,

payment banks should be able to maintain profitability. For example, if Airtel

were to raise INR1,000 in deposits per customer, it would translate into INR250b

of low-cost deposits at minimal acquisition cost. In addition, since payment

banks are not allowed to lend, their primary focus would be on fee income. This

would pose a threat to private and public sector peers with a large share of

retail fees.

State owned banks have already lost market share in traditional lines of

business to private sector banks. With lower efficiency compared with peers and

development of a corporate bond market, we expect spreads to remain under

pressure. Bank will have to focus on niche business and high cross sell to

maintain respectable ROEs. Companies with higher share of retail business and

ability to cross sell will be able capture higher share in growing profit pool.

Private banks (ability to cross sell, no legacy issues), SFBs (diversification,

creating niche for themselves) and payment banks (companies with high

customer base, focus on fee income, low cost distribution) are well placed to

capture this opportunity. State owned banks market share loss is likely to

accelerate whereas, NBFCs will continuously need to innovate to maintain to

keep the growth rate healthy.

January 2017

Value Migration | Thematic

Exhibit 58: Airtel and Vodafone customer base is higher

than/equal to largest bank in the country – Payment bank

license can leverage on this customer base

250

No of debit cards outstanding/user base

200 203

175

100

Exhibit 57: Digital and cards likely to be a key source of

payment in India

Card

Digital

Other paper

cash

2025

Source: BCG

2005

2010

2020

2015

Source: MOSL

Exhibit 59: Mobile banking transaction value overtook traditional banking channels in FY16

(INR B)

ECS

Debit Card PoS

Mobile Banking

490

282

309

243

149

142

199

135

IMPS

625

Source: MOSL

Exhibit 60: Incumbents have the cost advantage over infrastructure heavy banks

Cost of a customer transaction across channels

Channel transaction cost

Branch

ATM

Call center

Offline BC model

Online BC model

Internet

Mobile

Cost (INR/txn)

40 to 50

13 to 17

8 to 10

4 to 6

2 to 4

0.2 to 0.5

< 0.2

Source: MOSL

January 2017

Value Migration | Thematic

Theme 4: RJIO: The disruptor with BIG pocket in Indian Telecom industry

How has the technology development brought by a new player changed the

industry landscape?



The telecom market has been at the forefront of value migration from voice/low

speed data to high speed 4g data, accelerated by the launch of new operator –

RJio. India has typically lagged developed market by 8-10 years for technology

advancement viz., 2g launched towards 2000s, 3g launched towards 2010.

However, RJio’s 4g launch has triggered a reduction in this cycle to about 4-5

years. As the Indian telecom market moves towards high speed data, the

ecosystem development has accelerated to create the right user experience.

The ecosystem led by smartphone base, data network, pricing and digital

content have accelerated to support RJio led data growth. The smart phone

base has reached about 280-300mn, nearly 30% of the overall active subscriber

base. Broadband coverage has reached 55% of the 2g coverage. Smartphone

content has also improved drastically, with large part of the entertainment,

utility, news and banking services provided online. The key driver to all these

factors is the data pricing which has been reduced to about INR 12/mb by RJio, a

fall of over 60-70% compared to the data pricing four years back.



We expect RJio to drive overall data subscriber penetration of over 50% in the next

1-2 years. RJio’s aggressive marketing of value added digital entertainment services

like movies, videos, and other applications like Mobile banking should promote data

usage across consumers. We expect the data to drive growth for the next five years

with over 40% traffic growth and 30% revenue growth.

Exhibit 61: Telecom

Industry

Snapshot: 2017 resembles 2002 period

2001-02

Voice

Network Coverage

New Operator

Launch

Pricing

Subscriber

penetration

Traffic growth

Usage/sub

Profit and ROCE

Five years

Post 2002

2016-17

Data

Next five years…



(RCOM)















(RJIO)











2017 resembles 2002 –

Can new operator and

price decline, trigger

data traffic led growth

and profitability

January 2017

Value Migration | Thematic

Application of value migration framework

Picking the winners

Having discussed the concept of value migration and its nuances as well as brief case

studies of several VM examples, we now proceed to apply the concept of VM to

identify investment plays.

As we highlight in this report, India is characterized by multitude of value migration

shifts, given the infrastructure deficit, rising aspirations of its middle-class

population, increasing disposable incomes and hence the desire to consume better

and indeed the elevated competitive intensity in most of the industries. The strong

growth potential of the economy fosters innovation, competition, creation of new

categories and desire to wrest first-mover advantage, ultimately resulting in value

migration opportunities.

Some of the VM opportunities highlighted in this section have been in play already;

some are at nascent stage, while others have shown partial demonstration.

However, common thread across the ideas highlighted in this section is – Value

Migration at work!

Value migration as a tool to identify solid and compounding franchises

We expounded on the various facets of value migration in this report. We believe it

serves as a great tool to identify potential winners in our universe from a three-year

perspective. As discussed in this report, value migration is underway in several

sectors, and in a market like India – which is characterized by resourceful

entrepreneurs, evolving technologies and its material implications for various

sectors, under-penetration and low per capita consumption across categories – the

process of value migration is unending, in our view. Beneficiaries of value migration

will be able to exhibit sustainable earnings outperformance, given the competitive

advantages they possess.

Anticipating value migration in various spaces and combining it with traditional

investment approach provides us with a set of stock ideas. In this section, we apply

the framework of value migration and identify some of the potential winners based

on our understanding of this tool.

Varied sources of value migration

Our hunt for VM beneficiaries in our coverage universe has revealed several sources

of value migration. Some of the key sources of VM, in our view, stem from

technological changes, change in consumption habits, change in lifestyle habits of

consumers, infrastructure development and reforms undertaken by policymakers in

various fields.

Common characteristics of VM beneficiaries

Our extensive analysis of VM thesis suggests that players that benefit from VM tend

to have certain common traits. Naturally, the DNA of VM winner will be significantly

different vs. also-ran, me-too players. Some of the common traits of VM winners

are:

a) Leaders in the respective space; b) innovation as key organization focus

area; c) healthy cash flow dynamics; and d) nimble footedness in adapting to

change if they are not leading the change.

January 2017

Value Migration | Thematic

Exhibit 62: Value migration: potential winners

S.N.

Theme

Value Migration from Unorganized to Organized Segment

Value Migration Unleashed by Technology

Value migration due to Lifestyle changes

Reverse Value Migration

Value Migration in Commodities

Sector

Mortgages (Home Finance)

Jewelry

Logistics

Adhesives

Light Electricals

Telecom

Media

E - commerce

Transportation

Apparel

Diagnostics

Multiplex

Logistics

Aluminum

Winners

Repco, Gruh Finance

Titan

Third party logistics players

Pidilite

CG Consumer, Havells

Bharti, BHIN

Netflix, Eros, Star, Shemaroo, Zee

Amazon, Flipkart

Indigo

Page, Arvind

Dr. Lal, SRL

PVR

Concor, GDPL

Hindalco

We apply the framework of VM in our coverage universe and present select stocks

as potential beneficiaries of VM.

We select VM winners based on our analysis of various Value Migration trends

unfolding in India. We believe combination of De-monetization and GST will

accelerate the

shift from unorganized to organized

sector across various consumer

facing sectors in India. Rising cost of doing business for unorganized players,

enhanced compliance requirements, broadening of tax net and better monitoring

mechanisms are some of the factors which will pose significant challenges to

unorganized players in our view. This should, in our view, drive the shift towards

organized segment. We highlight our potential winners in Mortgage, Jewelry,

Adhesives, Consumer Electricals and Logistics space.

Second theme we pick is the value migration unleashed by

Technology.

Rapid

changing technology is not allowing incumbents to breathe easy. While this theme

can encompass many sectors, we highlight winners from Telecom, Media and E-

commerce space in this section.

Lifestyle changes

are also driving value migration in several spaces. Changing

consumer habits, rising aspirations and bulging middle class are some of the

underlying catalysts responsible for these changes. This forms the bedrock of third

theme. Here, we highlight winners from Transportation, Apparels, Multiplex and

Diagnostics space.

While listed players comprise the majority of our Value Migration winners, we have

not refrained from highlighting the unlisted winners.

Our VM winner ideas are

HDFC Bank, RBL, Equitas, Repco Finance, Gruh Finance,

Pidilite, Titan Company, Page, Arvind, Crompton Consumer, PVR, Hindalco, Indigo,

Bharti Airtel.

January 2017

Value Migration | Thematic

Value migration from unorganized to organized segment

A theme spanning multiple sectors; GST and Demonetization to hasten the

shift



As incomes rise and aspirations take shape, customers’ choice/preference shifts

toward branded/organized goods. Various categories and sectors in India have

high salience of unorganized sector (paints, batteries, jewelry, electrical goods,

adhesives, processed foods, etc.). We believe value migration from unorganized

to organized trade is a very durable and long-term shift, which can span for

decades and create material value for organized players over a period of time.

Implementation of GST and Demonetization will aid the shift from unorganized

traded towards organized segment in the medium to long term. As the cost of

doing business goes up for un-organized trade (coming into the tax net) their

price competitiveness vis-à-vis organized trade will shrink, in our view.

We highlight three sectors where this theme will be prevalent.

Mortgages (Home Finance):

India with a population of 1.3b, with over 250m

households, has an acute shortage of housing with 50m new housing

requirement. Favourable demographics, rising income, increasing urbanization,

strong support from government/regulator, puts the mortgage finance space in

sweet spot. Mortgage finance sector has seen phenomenal growth in last 15

years. The outstanding housing loan of HFCs at the start of 2000 was INR253b

and SCBs were INR183b with a total of INR438b. The same has grown

exponentially to over INR 14t combined for banks and HFCs. i.e. 14% of banking

system. While the growth during last 1.5 decades has been driven by top 10

cities, incremental growth will be driven by geographical penetration in tier II,

tier III cities. Over 50% of HFCs’ disbursements are concentrated in three states,

indicating large untapped potential in the country. Top 10 cities contribute

~45% of disbursements.

Jewelry:

Indian Jewelry sector is characterized by the presence of thousands of

un-organized, regional and mom & pop jewelers. The wide prevalence of under-

caratage and rising aspirations of Indian consumers has ensured a decisive and

durable shift towards organized trade. The government has imposed several

restrictions on cash purchase of jewelry with mandatory PAN card requirement,

imposition of excise duty et al. De-monetization coupled with implementation of

GST augurs quite well from the perspective of branded organized players like

Titan, in our view. These two big reforms will increase the cost of doing business

for un-organized trade.

Logistics:

Indian Logistics industry is typified by high fragmentation,

inefficiencies and complexity. Implementation of GST will drive consolidation in

warehousing space and a shift from unorganized to organized sector.

Manufacturing and sourcing decisions which are currently dependent on tax

considerations will henceforth be driven by supply chain perspectives. GST will

drive outsourcing in the Logistics industry and benefit the third party logistics

providers, in our view.

January 2017

Value Migration | Thematic

Case-III: Value Migration in Housing Finance: From Unorganized/

Untapped to Organized

Industry:

NBFCs

| Driver of VM:

Unorganized/Untapped to Organized

|Play on VM:

RHFL, GRUH FINANCE

1. What’s the potential value migration?



Housing shortage was estimated at 18.8m units in urban India and at 44m

units in rural areas. Even if 22m houses (50% of required houses) need

funding with average ticket size of INR0.6m, this could be an INR9t+

opportunity over the next decade.

Self-employed segment accounts for 34% of the workforce, but ~10% of

loans. Banks and HFCs have ignored self-employed segment in tier II and tier

III areas due to difficulty in credit appraisal, lack of proper documents, KYC

checks and NPL volatility.

While growth in the past 1.5 decades has been driven by top 10 cities,

incremental growth will be driven by geographical penetration in tier II and

III cities. New growth segments have emerged like self-employed segment

(1/3 of India’s workforce).

2. What phase of value migration are we in currently?



Current landscape of mortgage penetration indicates huge concentrated

geographical presence for both banks and HFCs.

Top 5 states contribute ~60% of banks’ outstanding home loans; the

concentration is even more in case of HFCs, with top 5 states contributing

~70% of disbursements.

The trend is no different when looked into districts/cities concentration—

top 10 cities constitute 43% of banks’ outstanding books.

3. What will be the catalyst for driving this value migration?



Young population:

India has one of the youngest populations among major

counties, with median age at 26 years. Moreover, the average age of owning

a house, which stood at +45 years in 2000 (as the major source of funding

was personal savings), has now gone down to 34 years and is expected to go

down further.

Increasing urbanization:

Despite a steady increase in urbanization, India’s

urban population stands at 31%, which is far lesser than other developing

countries.

Increasing penetration of housing finance:

Finance penetration in urban

areas stood at 35% and is expected to grow to 50% in next 5-7 years. On the

other hand, finance penetration is lower in rural areas at 9%, primarily due

to inadequate lender branches because of higher cost of operations,

absence of large salaried class and challenges in valuing collateral in rural

areas. These low levels of penetration provide massive opportunity, in our

view.

January 2017

Value Migration | Thematic

4. Government and regulatory support and expanding pie



‘Housing for All’ by 2022 and 100 smart cities:

As part of its focus toward

affordable housing, the government has planned for 20m new housing units

in 500 towns and cities in seven years in partnership with the private sector.

100 smart cities will also be developed over the next decade.

Lower risk weights:

RBI/NHB has reduced risk weights for lending below

INR7.5m to 35% from earlier 50%. This measure will help to significantly

lower capital consumption.

NHB refinance:

The Government of India via NHB offers refinance to entities

offering lower ticket size loans to low-income group customers. This is a big

incentive for companies to cater to this segment.

5. What if this value migration plays out? Who wins and who loses?



Value migration from unorganized to organized in housing finance space

would drive faster loan growth of over 30% for players targeting the

untapped segment, as against 18% overall mortgage growth.

Moreover, focusing on this segment has dual benefits: a) Access to cheaper

refinance from NHB which helps reduce cost of funds. b) Since there is

virtually no competition in this segment and the pie is huge, companies

operating in this segment enjoy better pricing power.

We find Repco and Gruh Finance as a clear beneficiary of the same.

Exhibit 63: Self-employed workforce is 34%; share in loans is ~10%. Salaried workforce is

16% but gets 90% of institutional credit

Salaried

16%

Casual labour

50%

Self employed

34%

Source: Company, MOSL

Exhibit 64: Acute housing shortage

Factors

No. of households without houses - 2012

No. of temporary houses - 2012

Shortage due to congestion - 2012

Shortage due to obsolescence - 2012

Additional housing shortage arising between 2012-2016

Total housing shortage

Total housing shortage (m)

Average cost of rural house (INR m)

Loan-to-value ratio

Average loan per house (INR m)

Total financing requirement (INR b)

Shortage (million)

4.2

20.2

11.3

7.5

0.6

43.7

21.9

0.6

70%

0.42

9,177

January 2017

Value Migration | Thematic

Exhibit 66: Repco has highest proportion of self-employed

customers among peers

Salaried (%)

Self Employed (%)

Exhibit 65: Top 10 cities form 43% of mortgage loan book

Mumbai

10%

Bangalore

Delhi

Pune

4% Chennai

Hyderabad 4%

Thane

Ahmedabad Kolkata 2%

Source: Company, MOSL

53.9

55.9

55.1

53.5

53.1

55.0

56.8

58.8

Rest

57%

46.1

44.1

FY10

44.9

46.5

46.9

45.0

43.2

FY15

41.2

FY16

FY09

FY11

FY12

FY13

FY14

Source: Company, MOSL

January 2017

Value Migration | Thematic

Value migration in Indian Jewelry sector

Case-VI: Durable Value Migration: Unbranded to branded

Jewelry

Industry:

Specialty Retail |

Driver of VM:

Un-organized to Organized shift|

Beneficiaries:

Titan

Jewelry industry has seen massive value migration towards branded

players in last 15 years



The Indian Gems & Jewelry market is largely unorganized, with over 0.5m small

players, but the market has been seeing a shift towards organized branded

retailing in the last few years.

In the last decade and half, value has been migrating from the unorganized

trade towards branded players. India’s organized jewelry market has been

growing at 30-40% annually compared to 10% growth for the overall Gems &

Jewelry sector. The share of the organized sector in the Jewelry market has

grown substantially from 10% in 2008-09 to 22% in 2014-15.

Growth in the organized market was led by regional chains, whose share grew

from 7% in 2008-09 to 17% in 2014-15. The share of national chains grew from

3% to 5%.

The migration towards branded players can largely be attributed to changes in

consumer preferences, driven by higher aspirations, rising disposable incomes,

and widely prevalent under-caratage in the unorganized segment.

Tanishq

has led value migration in the sector



Titan launched its jewelry division,

Tanishq

in 1996, with a range of jewelry and

ornate watches for the European and American markets. However, as demand

in the West declined due to slow economic growth followed by recession,

Tanishq

changed its business model and began focusing primarily on the Indian

jewelry market, which was primarily unorganized, highly localized, and had no

concept of branded jewelry. There were ~0.2m jewelers in India in the late

1990s.

Since then, Titan has pioneered the Branded Jewelry concept in India, and has

created a sizable leadership presence in the Jewelry segment, leveraging on its

Tata

brand equity. Competition exists in the segments, but Titan has continued

to gain market share. The following are the key elements that contributed

significantly to Titan’s value migration journey in the segment:

Change in product positioning:

After realizing that it had gone wrong in

terms of product offering in the initial stages,

Tanishq

changed its brand

positioning from that of a westernized offering to an Indian traditional

branded jeweler.

Gaining trust through purity:

There was no organized player in the jewelry

business in India before Titan’s

Tanishq

first set shop. Directly pitted against

traditional jewelers offering similar ornaments,

Tanishq

decided to address

the issue of gold purity to gain consumers’ trust. In 1999, it introduced the

January 2017

Value Migration | Thematic

concept of karatmeters in its retail stores to give consumers a more

trustworthy method to test the purity of gold than the traditional

touchstone method. This enabled it to finally make a dent in the consumers’

long-standing relationships with their traditional jewelers.

Delivering value:

In 2000,

Tanishq

decided to have standard gold prices

across its showrooms throughout the country.

Tanishq

had set up an ultra-

modern, large-scale manufacturing unit in Hosur, Tamil Nadu, which helped

it to charge the same price across the country.

Creating brand:

Titan has been creating brands over the years,

Tanishq

being the biggest. It caters to India’s mid-and-premium jewelry market, with

a large footprint of 200+ stores pan-India (including two

Zoya

stores) spread

across 111 towns.

Expect migration towards branded players to continue



The jewelry market growth in India will largely be led by retail branded players –

the share of the organized segment in the overall Gems & Jewelry market is

expected to be 35% over the next few years, given the urbanization trends and

the emergence of online players. The regulatory clampdown on Black Money

and introduction of stringent norms for cash purchase of jewelry has already

hurt the un-organized trade in the last 18 months. De-monetization coupled

with GST will hasten the shift towards organized players in our view as cost of

doing business goes up for un-organized trade. The greater the compliance

imposed on regional/un-organized trade, the more favorable the dynamics for

the shift towards organized segment, in our view.

The shift from unorganized to organized players will be further supported by

recent regulations: (1) levy of 1% excise duty on gold jewelry, (2) mandatory

hallmarking, and (3) quoting of PAN for jewelry purchases of over INR200k.

Exhibit 67: Share of organized segment has grown from 10%

in 2008-09 to 22% in 2014-15

Exhibit 68: Tanishq leads the listed jewelry pack

2008-09 (%)

2014-15 (%)

Tanishq

PC Jeweller

Net Sales (INR b)

Unorganised Gems and

Jewellery market

Source: Company, MOSL

3 4

FY08

6 7

FY09

10 9

FY10

FY11

FY12

TBZ

Organised Gems and Jewellery

market

FY13

FY14

FY15

Source: Company, MOSL

January 2017

Value Migration | Thematic

Exhibit 69: Titan’s market cap expanded at 41% CAGR

Market Cap (INR B)

301

Exhibit 70: Market opportunity for Titan, going forward

Market Size (INR b)

1,500

300

FY06

FY16

Source: Company, MOSL

High Value Diamond Jewellery

Wedding Jewellery

Source: Company, MOSL

January 2017

Value Migration | Thematic

Indian Logistics industry – Emergence of third party

logstics providers

Industry:

Logistics |

Driver of VM:

GST|

Beneficiaries:

Third party logistics players



India logistics spend (as a % of GDP) is 12-14% as against ~8% in developed

countries. This high cost is led by complex fragmented structure and high

inefficiencies (infrastructure and policy) in the system.

Third party logistics (3PL) services is an important factor to improve efficiencies

– and we believe this will happen post GST as there will be economic incentive

to do so.

Shift to 3PL will be driven by (a) economics, (b) time savings and (c) better

compliance for new technology platform.

3PL will promote hub-and-spoke model; business to shift from unorganized

to organized sector



Consolidation of warehouses:

GST presents an opportunity for industry players

to consolidate their warehouses and set up larger facilities, which will bring in

supply chain efficiencies.

Re-evaluation of sourcing and manufacturing decisions:

Among other factors,

sourcing and manufacturing decisions are presently dependent on indirect tax

considerations. In the GST regime, due to fungibility of credits, these decisions

shall be made from a supply chain perspective.

3PL providers typically specialise in integrated operation, warehousing and

transportation services that can be scaled and customised based on market

conditions and the demands and delivery service requirements for their

products and materials.

Exhibit 72: GST will promote hub and spoke model leading

to higher outsourcing

Exhibit 71: Warehousing demand in India expected to grow

at 9% CAGR, implying addition of 520msf of addition (msf)

Manufacturing

EXIM*

1,003

238

681

1,096

269

736

Consumption

Total

1,198

304

1,310

344

107

1,440

CAGR

386

115

13%

CAGR

918

211

631

795

858

939

2014

2015

2016

2017

2018

2019

Source: Company, MOSL

January 2017

Value Migration | Thematic

Exhibit 73: Evolution of 3PL Market

Domination:

Full global / national supply chain management

and control

Innovation:

Deep supply chain ownership and improvement

proposition

Adoption of Customers:

Industry focus and end-to-end

logistics service capability

Beginnings of 3PL:

Limited value addition, cargo control and

asset ownership

Exposure to Global Models:

Bringing in global models and

technology paradigms

Limited Innovation:

Multimodal transport solutions and

warehousing

Achievement of Scale:

Companies growing regional / national

presence

Basic Logistics Need Fulfilment:

FTL trucking and godowns

Source: Industry, MOSL

Exhibit 74: Share of 3PL Logistic market

Share of 3PL Logistics Market

80%

57%

40%

Japan

Europe

India

Source: Company, MOSL

January 2017

Value Migration | Thematic

Case-V: Pidilite Industries: Shift from commoditized to branded,

innovation addresses unmet needs

Industry:

Adhesives and Sealants|

Driver of VM:

From Unorganized/ Unbranded to

Organized/Branded

| Play on VM: Pidilite

What’s the potential value migration?

In the adhesives and sealants businesses, value is migrating from

small/local/unorganized/unbranded players to Pidilite.

What phase of value migration are we in currently?



We reckon that around half of the adhesives market and more than half of the

sealants market is unorganized/unbranded, which offers ample room for

growth. Pidilite has over 70% share of the organized adhesives segment, with no

significant competitor even in the unorganized segment. Smaller branded

competitors include Jivanjor (Jubilant Group) and Araldite (Huntsman).

Since 1959, Pidilite has been successfully creating and expanding categories via

innovation. Two-thirds of its sales are derived from products and innovations

pioneered by the company in India. Its dominant brands in the adhesives and

sealants segments include Fevicol, M-Seal and Fevikwik.

What is the catalyst driving this value migration? How will Pidilite benefit?



Three macro factors driving growth are:



Urbanization: Around 40% of India’s population is expected to live in cities

by 2030, up from 30% in 2008. Driven by urbanization and pick-up in GDP,

the construction industry is expected record an 11% CAGR over the next six

years, as against 9% between FY12 and FY15. Urbanization will drive strong

demand for construction chemicals like adhesives and sealants for use in

furniture and waterproofing.



GST implementation is expected to lead to better efficiencies, and faster

shift from unorganized to organized players.



Increasing use of adhesives in new sectors: From nuts and bolts, the

automobile industry is moving toward adhesives. Also, instead of sutures

and stiches, the medical industry is moving toward adhesives. We believe

such developments are opening up large markets for adhesive/sealant

players.

While macro factors contribute to growth, Pidilite is likely to be a key

beneficiary of value migration from unorganized to organized players due to its:



In-house R&D



Innovative and clutter-breaking advertising



Focus on products that have low cost of usage but are extremely critical to

edifice or procedure.



By far the widest network of 60,000 dealers in the country.



Strong relationships with carpenters, plumbers and distributors, who have

been sustained and nurtured for generations.

January 2017

Value Migration | Thematic

What if the value migration plays out, who wins and who loses?

Pidilite will get an increasing share of the rapidly increasing pie as its moats help

take market share away not only from unorganized players but also smaller branded

players.

Exhibit 75: 40% of India’s population expected to live in Exhibit 76: Construction industry expected to grow at 11%

urban areas by 2030

over FY15-21

Urban Population (m)

Urbanization rate (%)

220

1991

290

2001

340

2008

590

2030

Exhibit 77: Volume growth superior to peers

Volume growth (%)

14.3

12.8

11.4

8.9

Exhibit 78: Sales CAGR of 19.2% in the past 10 years

Net Sales (INR b)

35.7 37.1

20.2 18.3

17.9 15.9

Change (%)

16.0

8.0

10.4

12.2 10.8

9.3 12.7 17.4 20.1 22.2 26.7 31.6 37.3 43.2 48.4 53.7

FY12

FY13

FY14

FY15

FY16

Exhibit 79: Gross margins have shown healthy improvement… Exhibit 80: …as have EBITDA margins

Gross Margin (%)

48.7

46.0

43.8

45.3

42.1

51.8

EBITDA Margin (%)

22.0

16.7

14.5

18.2 17.9

15.5

10.9

17.2

47.4

45.9 45.3

44.9

16.3

16.3 16.0

January 2017

Value Migration | Thematic

Case-VI: Shift from unorganized to organized sector in light

electrical on account of GST

Industry:

Consumer Electricals

| Driver of VM:

GST driven shift towards organized

segment|

Play on VM: Crompton Greaves Consumer, Havells

1. What’s the potential value migration?



The Government of India seems committed to replace all indirect

taxes levied on goods and services by the center and the states with a

common GST by April 2017. With GST implementation, it is anticipated that

the tax base will be comprehensive as all goods and services will be taxable

with minimum exemptions.

In India, there is significant presence of unorganized segment in Light

Electricals. We estimate that in FY16, unorganized segment constituted

~25% of overall industry sales, though down from ~40% in FY10. This

primarily constitutes cheap imports from China and local players that

typically do not pay taxes and are outside the ambit of tax authorities.

2. What phase of value migration are we in currently?



Constitutional amendment bill has been passed by the Lower as well as

Upper houses. The GST bill needs to be ratified by at least 15 state

legislatures out of 29 before the President notifies GST Council, which will

decide new tax rate and other issues. The central government has set a

deadline of April, 2017 for its rollout.

3. What will be the catalyst for driving this value migration?



Successful implementation of GST from April 2017 would bring unorganized

players under the tax ambit, which will help to substantially narrow down

the price differential between organized and unorganized segments.

4. What if this value migration plays out?



GST implementation is expected to narrow the large indirect tax differential

between organized and unorganized players. This would be achieved by

ensuring better compliance and enforcement by:

1. Reducing threshold limit for exemption from indirect taxes to INR1m

under GST from INR15m under the current excise duty regime.

2. Tracking the flow of GST credit in the entire value chain using

technology platforms.

3. Ensuring availability of seamless input credit.

4. Reducing overall effective tax rates.

As a result of GST, unorganized sector is expected to come under the ambit

of taxes and therefore the price difference between organized and

unorganized segments would reduce substantially. This would, in turn, lead

to a shift in consumer preference from unorganized to organized sector.

While this shift has already been going on over past few years, GST would

act as a catalyst to accelerate this change.

Key beneficiaries of this shift in Light Electricals space are Havells, Crompton

Consumer Electricals, V Guard and Bajaj Electricals.

January 2017

Value Migration | Thematic

Exhibit 81: Measures that will lead to shift of trade from unorganized to organized

segment

Exhibit 82: Unorganized players as % of overall category sales for light electricals

Description

Fans

Lighting

Pumps

Domestic Switchgear

Industrial Switchgear

Switches

FY06

60%

75%

55%

60%

40%

75%

FY10

40%

60%

45%

20%

30%

50%

FY15

25%

40%

30%

<5%

20-25%

30%

Source: Havells, Frost, Industry, MOSLe

January 2017

Value Migration | Thematic

Value migration unleashed by Technology

Disruptive value migration

Technology is one of the most common catalysts of value migration. Various

industries have seen significant value accretion (depletion) owing to changes in

underlying technology. The pace of disruption across sectors has increased manifold

resulting in massive churn in the winners/losers. We expect several winners to

emerge going forward driven by Technology led Value Migration in Banking,

Telecom, Media and e-commerce sectors. We discuss them in details in this section.

The Indian telecom space has seen explosion of data, which has caused some shift

away from voice toward data. Though growth in data has slowed down in recent

quarters, from a trend perspective this shift is well and truly underway.

Case-IX: Telecom – from voice to data

Industry:

Telecom

| Driver of VM:

Voice to Data

| Play on VM: Telcos: BHARTI,

BHIN

1. What’s the potential value migration?



FY17-22 marks ‘The Ultimate Disruption’ in the USD29b Indian telecom

market. Historically, voice revenues have dominated the business models of

telcos, with data being an ancillary offering. Currently, ~77% of Indian

telcos’ revenues are derived from voice segment. With expectation of a 2%

CAGR decline of voice revenues over FY17-22E and data revenue growth of

~31% over the aforementioned period, overall industry is likely to grow at

9%.

Incremental data revenue should be ~INR1,254b, while incremental industry

revenue is pegged at INR1113b over FY17-22E, implying incremental data

contribution of over 110% of incremental industry wireless revenues.

While smaller operators face virtual extinction given their inadequacy in

terms of data spectrum, even the top-3 incumbents need to significantly

change their current business design as changing consumer communication

preferences increasingly push the value from voice to data.

2. What phase of value migration are we in currently?



While data user base is expected to treble from ~324m in FY16 to ~1.04b in

FY22E, traffic growth would be supported by 3G becoming the default

access technology for mobile data compared to 2G currently (average data

usage by a 3G user is 0.8-1GB per monthly, ~2x of a 2G data user).

While only 132m out of the 324m wireless data users are on broadband

(largely 3G) currently, mobile broadband (3G+4G) users will constitute bulk

of the 1.04b data user base by FY22E. Data user penetration is expected to

increase from ~31% in FY16 to ~81% in FY22E, with mobile broadband users

expected to dominate the user mix (mobile broadband penetration in FY16

was ~31%).

January 2017

Value Migration | Thematic



Share of data revenue has grown from 13.7% in FY15 to 17.5% in FY16. Data

revenue is expected to grow 3x from INR337b in FY16 to over INR1t in

FY22E, contributing ~57% of the estimated USD47b telecom industry

revenue by FY22E.

3. What will be the catalyst for driving this value migration?



The entry of a deep-pocketed new-bee Reliance Jio has forced incumbents

to aggressively roll out data networks and re-align their business

design/networks from being traditionally tailored for voice to increasingly

cater to explosive data demand as data climbs up the consumer priorities

list for communication and as market value of telcos increasingly gets linked

to data growth.

Affordable (sub-INR4000) VoLTE-enabled smartphone penetration is only

de-bottlenecking the device barrier for consumers.

The threat from OTT voice, which is expected to get increasingly competitive

as data realization per MB drops from current levels, can significantly

disrupt the voice market and the entry of a non-voice legacy operator like

Reliance Jio is only going to accelerate VoIP.

4. What if this value migration plays out? Who wins and who loses?



Companies with superior spectrum and fiber portfolio will be well

positioned to capture maximum value in the changing telecom landscape.

Bharti Airtel and Reliance Jio have invested the highest in spectrum and

fiber assets, and this should hold them in good stead as the business design

moves from ensuring ubiquitous voice network coverage to offering true

broadband data service.

Bharti has the highest investment in data spectrum among all operators,

with data spectrum spanning 900MHz, 1,800MHz, 2,100MHz and 2,300MHz

bands. 98% of Bharti’s footprint (all circles except Kerala) is covered with

2100 3G spectrum. In addition, Bharti would be using 900MHz spectrum in

select circles for 3G. Bharti is the only other large operator except Reliance

JIO to have a significant 2300 MHz band 4G footprint; it also covers 62% of

its revenue footprint with 4G 1800 band spectrum.

Reliance JIO has the most comprehensive 4G spectrum portfolio spanning

across 800, 1800, and 2300MHz spectrum bands. It has the second highest

investment in data spectrum

Among the tower companies, BHIN – the market leader enjoying 40%+ of

the Indian telecom tower base – is well placed to play the data capex cycle

as the urgency to roll out networks among telcos is palpable.

January 2017

Value Migration | Thematic

Exhibit 84: India wireless: Incremental voice v/s data

revenue

Incremental data revenue

Incremental voice revenue

276

3139

FY20

111

FY14

119

FY15

128

FY19E

FY20E

201

308

262

Exhibit 83: Telecom industry revenue mix

Non-data VAS revenue (As % of rev)

Data revenue (As % of rev)

Voice (As % of rev)

1491

1640

1822

FY15

1946 2203

FY16

FY17

2523

FY18

2862

FY19

FY16E

FY17E

FY18E

FY13

FY14

Source: MOSL

Source:, MOSL

Exhibit 85: Industry wireless revenue split (%)

Non-voice Non-VAS rev

Data Rev

Voice Rev

Gross wireless rev

604

1488

2178

854

1466

2406

1124

1440

2652

Exhibit 86: FY15-18E incremental wireless revenue analysis

2202

1412

1413

2912

1683

1386

3156

1822

-163

-10

3851

250

1476

1822

FY15

337

1494

1927

FY16

428

1523

2043

FY17E FY18E FY19E FY20E FY21E FY22E

Source: MOSL

Exhibit 87: Data penetration and share (%)

Data Penetration

Data rev (% of wireless rev)

Exhibit 88: Growth trend in voice and data

Voice

30.9

Data

31.5

FY15

FY16

1.6

-1.9

FY15-17E

FY17-22E

Source: MOSL

FY17E FY18E FY19E FY20E FY21E FY22E

Source: MOSL

January 2017

Value Migration | Thematic

Value migration in Media: Content shift from physical to digital

Internet ecosystem evolving

Internet usage has evolved from large devices like PCs and laptops to handheld

devices. Smartphones have revolutionized the use of internet. Telco’s growing data

network penetration, currently standing at 55% has played a pivotal role in

supporting the growth of internet usage on the go. Additionally, smartphone

penetration at about 30% of active subscribers has further accelerated data usage

on handheld devices.

Usage on small devices to change consumption pattern

Content consumption patterns are changing. The television has traditionally served

as the primary screen for consumers while other screens (tablets, mobile phones,

etc) have remained secondary. This is changing. Soon, size will not matter –

consumer preference is shifting to multiple screens of varying sizes that work

seamlessly together. For media firms, this has substantial implications. Firstly, TV,

film and print companies need to enable linear content on digital formats. Secondly,

all linear content does not work seamlessly on all digital formats. Thus, different

formats need to be integrated to address the digital Indian. Thirdly, existing media

companies will face competition not from their traditional TV and print peers, but

from any content creating company.

Smartphones and tablets have taken a large share of consumers’ time, substituting

the time towards newspapers and TV. This has forced many media companies to

shift towards digital platforms. Going forward, the market will be bifurcated

between content creator and distributor, where content would be king. Content

creators, content aggregators as well as content distribution platforms may co-exist

in the value chain to serve the consumer.

Demand for differentiated/niche content increasing

India’s content viewership has transcended from one channel (Doordarshan) to

three Hindi GEC channels to six major Hindi GEC channels to movies and regional

channels and several more genres over the past two decades. As content viewership

further fragments, the need for differentiated/niche content will only increase and

economics will dictate the mode/platform for content delivery.

Pull platforms to satiate neglected long-tail/niche content demand

The biggest shortcoming of linear programming is its inability to cater to the long-

tail/niche content demand due to unfavorable economics. This need gap is

increasingly being filled by pull platforms such as YouTube, DailyMotion, Spuul,

Google Play, BigFlix, etc. The mobile phone (“second screen”) is increasingly

becoming the preferred mode for content delivery. Mobile video viewership in India

is expected to grow from 0.06 Exabytes in 2015 to 1.2 Exabytes (source: CISCO VNI)

and will account for 72% of mobile data traffic by 2020, up from 38-42% in 2015.

January 2017

Value Migration | Thematic

Increasing “individual escapist” psyche among Indians encouraging mobile

content consumption

While no immediate cannibalization of TV viewership is expected, as seen in other

mature markets, the time spent online is expected to increase manifold in India as

well. The use of mobile devices for content consumption is a direct manifestation of

increasing personal escapism. A 2014-Deloitte study suggests that ~45% of Indians

are expected to increase their content consumption on mobiles/tablets in CY20

from ~17% in CY14.

DNA (device, network and access) getting smarter – a much-needed enabler

While bandwidth constraints remain, with average broadband speed being

~2.5mbps in India. Just about 14% of broadband connections have speeds of

>4mbps – this is the lowest amongst APAC nations. India’s digital infrastructure is

set for an overhaul, with the impending 4G network rollouts by major telcos. The

smartphone base has reached 280m-300m, nearly 30% of the overall active

subscriber base and is expected to reach ~690m in FY20. Trends in key emerging

markets (China, South Africa, Brazil) suggest that at 25-35% smartphone penetration

levels, data growth more than doubles YoY; a lion’s share of this growth is expected

to be video-led for India. Broadband coverage has reached 55% of 2G coverage, data

prices have dropped 60-70% over FY12-16 following RJIO’s entry, and smartphone

prices have breached the sub-USD50 price point. All these are much-needed

enablers for the online video consumption story.

Burgeoning digital/mobile ad budgets a testimony to online video

explosion

As consumers have increasingly become platform-agnostic for their content

consumption, the digital/mobile screen seems set to gain critical mass and serve as

a great tool to increase the reach efficiency of advertisements through cross-

platform advertising. This is reflected in the ever burgeoning digital/mobile ad

budgets of advertisers. Digital ad spends grew at a CAGR of 43% to INR60b over

CY10-15 and are expected to grow at ~33% to INR255b over FY15-20 (from 33% of

TV ad spends in CY15 to ~70% of TV ad spends). Mobile ad spends are expected to

grow at a CAGR of ~62% from INR9b in CY15 to INR102b in CY20. A lion’s share of

these spends is expected to be on online video advertisements.

Broadcasters’ OTT launches a hedge against audience exodus

A slew of OTT platform launches, some by major broadcasters (HotStar, Spuul,

Netflix, Muvizz, Hooq, Eros Now, Box TV, Sony Liv, Yupp TV, Ditto TV, Ogle, Hungama

play, Amazon Prime, Viacom18’s Voot, ALT) over the last two years also validates

the shift in consumer preferences from appointment-based viewing to time-shifted

viewing. Due to this, syndication revenues for film libraries are expected to increase.

IP-based content owners to benefit, as content consumption shifts from

“push” to “pull” platforms

Relevant genres from a content consumption standpoint in India can be bracketed

as Hindi GEC, Hindi Movies, Sports, Regional, News, Niche. As content consumption

increasingly shifts online, IP-content such as movies, which has relatively sticky

viewership, could see a surge in takers.

January 2017

Value Migration | Thematic

Exhibit 89: Global viewership increased from 1/3rd to 2/3rd

of TV viewership over FY12-16

Monthly Digital Video Viewers (INR b)

Monthly Traditional TV Viewers (INR b)

Dig Viewers as % of TV viewers

53.0%

35.1%

1.06

0.4

FY12

0.6

FY13

1.08

0.6

FY14

1.1

0.7

FY15

1.14

0.7

FY16

1.11

0.7

FY17E

1.1

56.9%

58.0%

62.7%

Exhibit 90: Mobile outpaces desktop in daily time spent per

viewer

-via desktop/non-mobile devices (min)

-via mobile devices (min)

66.6%

20.1

24.3

23.4

25.6

27.3

27.6

FY12

10.5

FY13

15.7

FY14

22.5

FY15

30.4

38.3

FY16

FY17E

Source: Company, MOSL

Exhibit 91: India: Digital ad spends to grow at 33% CAGR

over CY15-20E

Digital ad spends (INR b)

35%

40%

35%

YoY

Exhibit 92: India Mobile ad spends to grow at over 11x over

CY15-20E

Mobile ad spends (INR b)

80%

75%

62%

52%

46%

YoY

30%

28%

60.1

CY15

81.1

CY16E

113.6

CY17E

153.3

CY18E

199.3

CY19E

255.2

CY20E

CY15

16.2

CY16E

28.4

CY17E

CY18E

69.8

CY19E

102.1

CY20E

Source:

www.eMarketer.com

Source:

www.eMarketer.com

Exhibit 93: Within the digital ad spends, Video ad spends ballooning

Social Media

Display

Video

Mobile

FY12

34%

10%

41%

FY13

FY14

FY15

38%

30%

29%

13%

18%

29%

23%

17%

12%

17%

10%

14%

16%

Source:

www.eMarketer.com

January 2017

Value Migration | Thematic

Exhibit 96: South

Africa:

Data

consumption more than doubles post

FY13

Monthly Data Consumption

(Pb/month)

Smartphone penetration (% of

population)

34%

12%

18%

23%

43%

Exhibit 94: China: Data consumption

more than doubles post FY12

Monthly Data Consumption

(Pb/month)

Smartphone penetration (% of

population)

47%

37%

14%

19%

26%

13%

10%

171

FY09 FY10 FY11 FY12 FY13 FY14

Source: Deloitte

FY09 FY10 FY11 FY12 FY13 FY14

Source: Deloitte

FY09 FY10 FY11 FY12 FY13 FY14

Source: Deloitte

Exhibit 97:

Video consumption to increasingly shift from appointment-based viewing to on-demand viewing

Source: MOSL

January 2017

Value Migration | Thematic

E-commerce: Demonetization boost; proliferation of

digital payment augurs well

E-commerce has gained rapid strides in India in the last four years. Rising penetration of

smartphones, convenience of shopping from the comfort of home (or office), explosion of

choices for customers, non-stop customer offers/lower prices and aggressive investments

by incumbent players have led to strong growth in the e-commerce industry.

Government’s de-monetization initiative will also herald a new phase with greater

encouragement and incentives for digital payments. E-commerce industry is an obvious

beneficiary of the thrust towards greater digital payments, in our view.

Cash on Delivery had its logic in Nascent industry…

Demonetization has adversely affected the CoD business for the industry which

drove ~70% of the transactions. The main factor behind opting for CoD was paying

once the order is delivered, given the risk of returns in cases of damaged goods,

counterfeits and prolonged delivery timelines. However, E-commerce companies

such as Amazon and Snapdeal among others have introduced alternatives. Snapdeal

launched ‘wallet on delivery’ through FreeCharge last month. Amazon halted its CoD

for a couple of days following demonetization. It resumed the service two days later

while also training its agents to help customers who opt for card payments at the

time of delivery. Electronic payments at doorstep went up by a factor of 10x in the

span of two days – a clear indication that customers are able to adapt to electronic

payment methods, by assisting people shift to making payments electronically

online. While an impediment in the short term, this will likely be a blessing in

disguise in the long run for the industry, for which CoD was a necessary evil

considering the cash-driven economy. Digital payments is way more efficient for the

companies.

… But now even tier-II and tier-II may well realign

While cash indeed is the lifeblood of the ecosystem as we move down the tiers, and

impact on businesses in these segments may be higher, the move by the Central

government will hasten the process of financial inclusion in the markets outside of

metros. At Shopclues (more dependent on lower tier cities), CoD business dropped

30% post demonetization, while prepaid orders went up by 15-20%.

January 2017

Value Migration | Thematic

Exhibit 98: Indian Ecommerce market has grown 42 CAGR in

last six years

India Ecommerce (INR b)

2110

Exhibit 99: Online travel and Etail account for lion’s share of

the market

4.2

2.1

3.0

CY15 segmental (%)

Online travel

30.0

Etail

Financial Service

60.8

Matrimony &

Classifieds

Source: IAMAI, MOSL

1257

473

533

815

263

351

Source: IAMAI, MOSL

Short term pain for long term gain

While it boosts sales of online companies, it obstructs their cash flows and makes it

difficult to scale operations. There are several additional costs involved with this

payment method and the risk of returns and thefts with this form of payment are

higher. This should help e-commerce companies to reduce overhead costs and other

risks associated with the COD model. The challenge over the near-to-medium term

is that only a small percentage (12%) of the population owns Credit or Debit cards.

The boost in combination with GST

Tax laws in India have failed the e-commerce sector by not providing enough clarity

/ guidelines on taxation for typical e-commerce sector transactions like e-wallet,

cash-on-delivery, gift vouchers, drop-shipment (direct delivery of goods from the e-

commerce company vendor to the customer) etc. Clarity for E-commerce industry

continued to remain elusive for charging either VAT/CST or Service tax, depending

on categorizing their offerings into goods or services. Both VAT and service tax

authorities exercise right over such digital transactions leading to disputes and

never-ending litigations. GST could hold the key to unlock the issues faced by the e-

commerce sector. Combine the efficiency of digital payments with the benefits from

GST for the sector, the nascent industry may be shifting gears from small steps from

big leaps.

January 2017

Value Migration | Thematic

Value migration due to lifestyle changes

Change in consumption habits driving value migration

When consumers’ disposable income rises in emerging economies, the propensity to

spend it on discretionary goods goes up. Lifestyle changes which follow the

emerging income patterns create natural winners in various industries. Rising

incomes, coupled with changing aspirations, have fuelled an uptick in consumption

across discretionary and non-discretionary segments. This is driving value migration

in consumer-oriented industries like Airlines, Apparels, Healthcare and Movie

Exhibition. We discuss some of the potential winners in details in this section.

Inter-industry value migration in Transport industry

Inter-industry value migration, while rare, is typically initiated by factors like cost,

technology, and convenience. In India, the Transport industry has seen value

migration from Railways to Airlines and from Roads to Railways. Within the Airlines

industry, value has migrated from full-service carriers to low cost careers.

Case-VIII: Value migration from Railways to Airlines

Industry:

Transportation|

Driver of VM:

Cost, Convenience|

Beneficiaries:

Indigo

Value Migration:

Rail to Air

Railways, given the lack of options had a monopoly in the long-distance domestic

travel in India despite issues of seat availability and travel time. The situation started

to change after India’s economic liberalization in 1991 which also subsequently

opened the Aviation sector for private players. Within no time, the availability and

increasing affordability of air travel led to incremental passenger shift from rail to

air. This was further accelerated by the entry of no-frills low coast carriers (LCC’s).

Thus the combination of “need + availability + affordability” is playing an important

role in rail to air value migration.

Shift from rail to air travel led by convenience and economics



In India, rail used to be the preferred mode of transport for long distance travel

due to economics, comfort and non-availability of the air travel option.

Air travel has emerged as an option in the last decade, with the emergence of

private airlines, which offer significant comfort/time advantage over rail.

Increase in disposable incomes, living standards and value of time have raised

demand for air travel for both business and tourism in India.

Shift from rail travel to air travel is being driven by (a) capacity constraints of

Indian Railways (tickets need to be booked 2-3 months in advance), and (b)

comparable fares. Air travel costs have remained nearly stable due to

competition and are now falling due to lower ATF prices.

While economics will be the key driving factor for air travel, other factors like

increased business travel, increasing disposable income, higher share of earning

population (time-pressed) will continue to drive this shift, in our view.

January 2017

Value Migration | Thematic

Indigo best placed to capitalize on this trend



InterGlobe Aviation, operating the

IndiGo

brand, is the market leader by a

distance in domestic aviation with 40% share and still gaining. It is set to

comfortably ride the domestic passenger CAGR of 12% over the next decade,

potentially making India the 3

largest aviation market in the world.

IndiGo

is the only airline in India to be profitable for the last eight years and we

believe this sustainable advantage is due to its unique fleet strategy, which

significantly reduces its aircraft ownership cost and makes it the lowest-cost

operator.

Exhibit 101: Price based discounting to protect share

Exhibit 100: Indigo’s positioning vis-à-vis competition

Exhibit 102: Passengers carried by Indian railways have been

growing at 4% CAGR since FY06

Passenger carried by railways (million)

Exhibit 103: Domestic air passengers have grown at 12%

CAGR since FY06

Passenger carried by airways (million)

FY06 FY07 FY08 FY09 FY10 FY11 FY12 FY13 FY14 FY15

Source: Indian Railways, MOSL

FY06 FY07 FY08 FY09 FY10 FY11 FY12 FY13 FY14 FY15

Source: DGCA, MOSL

January 2017

Value Migration | Thematic

Exhibit 104: LCCs ticket prices comparable to train tickets

New Delhi to Mumbai (Price in INR)

Normal train

Fastest train

4,745

3,870

2,255

1,560

595

LCC

Normal Train

Fastest Train

LCC

Source: Industry, MOSL

2,860

2,080

3,200

Exhibit 105: Air travel saves significant time

New Delhi to Mumbai (Travel time in hours)

Source: Indian Railways, MOSL

Shift from full service carriers to low cost carriers



Due to lower fares, within airlines, market share began shifting towards low cost

carriers. This shift was more evident in developing economies, where

passengers are more price-sensitive. Difference in market shares between the

developing South-East Asian countries and the developed North-East Asian

countries (Japan, Korea, etc.) highlights this trend.

Exhibit 107: IndiGo the only domestic airline profitable for

last 7 years

FY09

IndiGo

Yes

FY10

Yes

FY11

Yes

FY12

Yes

FY13

Yes

FY14

Yes

FY15

Yes

Exhibit 106: In line with the global trend, value is migrating

to LCCs even in India

Low cost carriers

Full service carriers

60%

54%

50%

39%

37%

38%

SpiceJet

Jet Airways

41%

FY10

46%

FY11

50%

FY12

61%

63%

62%

GoAir

Air India

FY13

FY14

FY15

Kingfisher

Ceased Operations

Source: Company, MOSL

Source: DGCA, CAPA, Company, MOSL

Exhibit 108: Comparing RASK less CASK (ex-fuel) – Indigo has superior profitability track record even versus global LCCs (USc)

2010

2011

2012

2013

2014

Average

Southwest

Spirit

Easyjet

CebuAir

Westjet

Allegiant

IndiGo

Source: MOSL, Company

January 2017

Value Migration | Thematic

Upheaval in US airline industry; migration towards low cost

carriers

In the 18 years to 1978, when the US Airline industry was regulated, the operating

revenue of 11 national carriers had grown from <USD10b to USD30b. However,

profits did not grow commensurately.

On intra-state routes, several small airlines (Southwest, etc.) operated a low cost

business model and passed the savings to consumers. Prices were low enough to

compete with other modes of transport (trains, buses). Leisure and price-sensitive

corporate travellers preferred these local airlines.

As the airline deregulation took place in 1978, competitive intensity shot up. Players

fought for attractive routes. Larger players that operated via hub-and-spoke

business design and used big planes achieved some cost savings, but still had a high

cost structure overall.

On the other hand, smaller players that had lower cost structures and competed on

price had flexibility. Southwest Airlines was the leader among low cost carriers. It

benefitted from its formula of ‘low fares no frills’ approach. It was one of the few

profitable carriers in the US. This business model satisfied the customer priority.

For national carriers, the route competition had intensified and it led to some

carriers giving up services between several city pairs. Price wars began when new

players entered the transcontinental market, leading to losses. When jet fuel prices

doubled in 1979-80, major airlines fell into financial troubles.

A new airline emerged to take on Southwest and beat it at its own game. However,

it succumbed. The airline, People Express, drove fares lower and concentrated on

vacationers and price-sensitive travelers. Cost structure was thriftier than

Southwest. However, People Express started floundering after initial success (it had

revenue of USD1b by 1985). It expanded rapidly, resulting in chaos (inefficient traffic

handling, delayed flights, crowded terminals). It even expanded into the strong

markets of national carriers like United and American. They reacted by undercutting

People Express. To further compound problems, People Express bought expensive

Boeing planes. Eventually, faced with higher debt, it merged with Texas Air.

Major airlines nonetheless continued its business design, investing in new routes.

This resulted in similar actions by various players and added debt to the balance

sheets. Demand was not sufficient to justify investment in new planes. Higher fixed

costs drove major carriers towards price competition. All of this resulted in

operating margins of major carriers correcting drastically from ~6% in 1978 to -2.5%

in 1990. As profitability pressure increased, several steps followed – acquisitions,

bankruptcy, differentiated initiatives like frequent flyer programs.

However, the troubles of major airlines were aiding the growth of Southwest, which

stuck to its business model. It maintained its low cost business model and expanded

judiciously. It targeted markets where competition from major carriers would not

hurt profitability and built leadership positions in those markets. Several major

carriers later tried to mimic Southwest’s business model.

January 2017

Value Migration | Thematic

Case-VIII: Value Migration in the Indian Apparel industry

Industry:

Apparel

| Driver of VM:

From Unbranded to branded

| Play on VM:

Positive for Arvind, Page Industries and Aditya Birla Fashion and Retail Limited

1. What’s the potential value migration?



India’s apparel market (which contributes 5.5% of India’s GDP) stood at

USD41b in 2013 which is expected to grow to USD64b by 2018 and USD102b

by 2023 implying a CAGR of 9% over 2013-23. The growth will be driven by

increase in both per capita consumption as well as the average spends on

apparel.

The growing reach beyond the major urban centers and the development of

alternative retail channels like e-commerce and omni concept will continue

to drive the growth of the branded apparel category.

2. What phase of value migration are we currently?



The Indian apparel retail landscape is currently at an evolutionary phase,

with radical changes occurring in apparel retailing and distribution. Apparel

constitutes 28% of organized retail market which is expected to grow at 18%

CAGR over next 5 years which implies higher pace of growth for branded

apparel market compared to overall apparel market CAGR of 9%.

Currently, menswear is the biggest segment within the apparel market;

however, kidswear and womenswear are growing more rapidly. It is

estimated that, within another decade, the womenswear category will catch

up with menswear, in terms of size. The share of Menswear is expected to

decline from 42% in 2013 to 39% in 2023 while share of Womenswear and

Childrenswear increase from 38% to 39% and 20% to 22% respectively from

2013 to 2023.

The innerwear segment is only 8.1% of the apparel industry but is the

fastest growing segment at ~11 CAGR in the past 15 years and is expected to

grow 13% CAGR between 2013-2023. 48% of the segment is still

unorganized while even within the organized innerwear segment only 20%

~is the premium and fashion segment.

3. What will be the catalyst for driving this value migration?



With the disruptive growth of direct selling, home shopping, and e-tailing

channels, the fashion and lifestyle segment is witnessing a shift away from

traditional channels towards alternative retailing avenues which is also

leading to a shift from unbranded to branded. Additionally, acceptance of

Private Labels is growing rapidly owing to their affordable prices and

reasonable quality.

The rapid penetration of Internet-supporting devices is contributing

immensely to the growth of alternative retail.

These catalysts boost growth that is already being driven by rising incomes,

favourable demographics, higher urbanization and greater awareness of

fashion through media and distribution expansion by the top fashion

brands.

January 2017

Value Migration | Thematic

4. What if this value migration plays out?



Arvind, Page Industries and ABFRL with dominant brand franchises will be

the big beneficiaries.

Exhibit 110: Discretionary spends to drive growth

Exhibit 109: Rapid penetration of internet enabled device

Users internet enabling device

PC/Laptop Users

Mobile phone users

Smartphone users

Tablet users

2013

402

2023E

226

675

607

Source: Company, MOSL

Exhibit 111: Healthy growth rates expected in various sub-segments of Apparel category

10 year expected growth CAGR (2013-23) (%)

Menswear

Womenswear

Boyswear

Girlswear

Innerwear

Source: Company, MOSL

Exhibit 112: Branded innerwear is likely to show rapid growth Exhibit 113: ...as half of the market is still unorganized

Innerwear market (INR b)

595.4

322.1

177.5

Unorgaized,

Organized,

2013

2018E

2023E

Source: Company, MOSL

January 2017

Value Migration | Thematic

Value Migration in Indian Diagnostic Services

Industry: Diagnostic Sevices| Driver of VM:

Lifestyle changes|

Play on VM:

Dr. Lal

Pathlabs, SRL

1. What’s the potential value migration?



Based on industry estimates, India’s diagnostics market was valued at

USD6b in FY2015. It is expected to exhibit a 15% CAGR over next five years

to reach USD12b by FY2020, despite unavailability of certain high-end tests

in India.

The diagnostic landscape in India is highly fragmented with Institutional

diagnostic chains having market share of only 6-7% of total market (Dr Lal,

SRL, metropolis, etc.).

Share of institutional chain network will continue to improve in the Indian

diagnostic market which was historically dominated by standalone and

hospital based centers.

According to Crisil, institutional diagnostic chains is set to deliver revenue

growth of ~19% CAGR between FY15-18E (vs industry growth of ~15%) on

the back of technological advancement, robust balance sheet and increase

in evidence based treatment.

2. What phase of value migration are we currently?



Institutional diagnostic chains have outpaced local diagnostic service

providers on the back of better brand recognition, rich test mix, and

improving affordability/ awareness.

Having said that, local and regional players still account for more than 90%

of total market. This is primarily because of weak regulatory environment.

Though we have witnessed, multiple steps taken by the Government in the

Pharma segment over the last 5 years, diagnostic services have not come

under regulatory gamut yet. We believe regulations regarding quality

assurance/ control (whenever it comes) will provide a critical advantage to

the institutional players against local service providers.

3. What will be the catalyst for driving this value migration?



Factors such as an underpenetrated Indian healthcare market, rising income

levels and increasing health awareness among consumers provide existing

players with ample opportunities of growth.

Rising proportion of geriatric population (60+ years), increasing incidence of

lifestyle-related diseases, growth in medical tourism and increasing

penetration of health insurance in the country also significantly boost

demand for diagnostic services.

The overall market for wellness and preventive diagnostics was estimated at

6%-8% of the total diagnostic services market in 2014-2015. The preventive

healthcare market is poised to grow faster than the diagnostic industry

owing to increased health insurance coverage. As per CRISIL estimates, this

segment is expected to grow to INR48b in FY18 from INR26.4b in FY15,

implying CAGR of 23%-25%.

January 2017

Value Migration | Thematic

4. What if this value migration plays out? Who wins and who losses?



Share of institutional chain network (which currently stands at just 6% of

total market) will continue to improve in the Indian diagnostic market which

was historically dominated by standalone and hospital based centers.

According to Crisil, institutional diagnostic chains is set to deliver revenue

growth of ~19% CAGR between FY15-18E (vs industry growth of ~15%) on

the back of technological advancement, robust balance sheet and increase

in evidence based treatment.

We believe large institutional players like Dr Lal and SRL are poised to

capitalize on strong inherent demand and shift from unorganized to

institutional segment.

Exhibit 115: Diagnostic services industry to grow at 15%

CAGR over FY15-20E

Diagnostic Services Market size (USD b)

12.1

7.9

9.1

10.5

Exhibit 114: Diagnostic market is still highly fragmented

6.0

6.9

2014-15

Source: AIOCD, MOSL

2015-16

2016-17

2017-18

2018-19

2019-20

Source: AIOCD, MOSL

Exhibit 116: Diagnostic presence relatively under penetrated

No. of diagnostic labs per million population

418

Exhibit 117: Geriatric population increasing at faster rate

than rest of the population

11%

20%

27%

35%

14%

21%

29%

2011E

15 - 29 years

15%

21%

28%

27%

2016P

30 - 44 years

11%

16%

23%

26%

25%

2021P

13%

16%

24%

23%

2026P

60+ years

Brazil

India

Source: AIOCD, MOSL

2001

0 - 14 years

45 - 59 years

Source: AIOCD, MOSL

January 2017

Value Migration | Thematic

Case-VII: Value migration from single screen to multiplex

Industry:

Movie Exhibition

| Driver of VM:

Unorganized to Organized

| Play on VM:

PVR

The movie exhibition industry has seen a shift in trend from single-screen theatres

to multiplexes. Despite multiplexes forming just ~21% of total screens in India, their

share in net box office collections value-wise stands at 70%. There are close to 1,800

multiplex screens. On an industry level, ~100-150 screens are added in multiplexes

annually, which is one-third of the pace at which single screens are closing down. On

the other hand, the number of single screens has declined to 7,600 from 9,000

around five years back. With near saturation in several metropolitan and tier-I

markets, the focus is now shifting to the next 40 cities, which are experiencing rapid

urbanization and greater economic growth.

Industry offers large untapped opportunity

India’s screen density (screens per million population), per capita frequency and per

capita spend on movies are way below the global average, indicating ample

headroom for growth. Screen penetration in India stands at 8 per million, versus 31

per million in China and 125 per million in the US. The biggest Bollywood release of

2015, Bajrangi Bhaijaan (which saw domestic collection of more than INR3b), was

viewed across 4,200 screens by merely 2% of the total Indian population.

Multiplexes are likely to be the key beneficiary of this potential, as unviable cost

dynamics and unfavorable tax regime have forced many single-screen theatres to

shut down or convert to multi-screen properties.

Single screens facing challenging times

Single screens are facing challenging times. The number of single screens reduced

from ~8,700 in 2010 to ~7,700 in 2014, with multiplex screens doubling from ~888

to ~1,700 during the same period. Multiplexes have key advantages over single

screens with respect to better infrastructure and overall movie going experience,

namely (a) picture quality, (b) surround sound systems, (c) air conditioning, (d)

parking spaces, (e) quality of food and beverages and (f) online ticketing to enhance

consumer convenience and curb black marketing.

Exhibit 118: Mix between single-screen and multiplexes

Single Screen

1,350

1,500

Multiplexes

1,630

1,780

Single Screen

19%

Multiplexes

8,685

8,451

8,002

7,674

81%

2012

2013

2014

2015

January 2017

Value Migration | Thematic

Exhibit 119: Screen penetration in India is a fraction of even developing countries

Screen/m population

125



Location of the screen/multiplex plays an important role in determining

footfalls, ATPs and SPHs, given that there is no content differentiation across

peers. PVR being the pioneer and largest player in the business is benefiting

from its premium positioning. Given heavy capex requirements (INR20-

25m/screen), the industry is largely consolidated in nature with top four players

controlling 70% of total multiplex screens. The top players are thus aggressively

adding screens and looking for inorganic growth opportunities.

PVR has guided for screen additions of 50-60 annually, and also plans to reach

1,000 screens in the next few years. Growth in same screens is expected to be

led by ATP and SPH, as the occupancy rate generally peaks out at 33-35%.

Exhibit 120: PVR is India’s largest multiplex chain

524

420

341

215

PVR

Inox

Cinepolis

Carnival

DT Cinemas

January 2017

Value Migration | Thematic

Reverse Value Migration in Logistics industry



Reverse value migration is driven by changes implemented by losers of the value

migration trend. When those changes satisfy customer priorities again and make

economic sense, value migrates back to where it belonged initially.

In the earlier sections, we discussed reverse value migration prevalent in the

two-wheeler industry (from motorcycles to scooters). We notice a similar VM

that is underway in freight transportation.

Case-X: Rail to Road; expected to reverse from road to rail

Industry:

LOGISTISCS|

Driver of VM: Dedicated Freight Corridor | Play on VM:

Concor; GDPL

1. What was the value migration?



Rail to road: Share of rail in freight transportation has declined from ~70% in

1970s, 60% in 1980s to ~30% now.

Despite being an efficient mode of transport, rail lost freight transportation

market share to roads, led by (a) high railway freight (due to cross-

subsidization of passenger tickets); (b) unreliable schedule of freight trains

(passenger train get first right of railway use); and (c) poor last-mile

connectivity (lack of coordination in infrastructure development).

This has added to India’s logistics cost share in GDP at 14%, versus

international benchmark of 8-10%.

2. What will change now?



Indian government has recognized the burden of road transport on the

economy and initiated construction of dedicated rail freight corridor.

While the plan is to have a quadrilateral dedicated freight corridor

connecting four corners of India, currently it is building two corridors -

connecting Delhi to Mumbai in West India and Kolkata in East India.

Dedicated freight corridor promises to be a ‘game changer’ for improving

competitiveness of Indian manufacturing. DFC plans to run freight trains in

India on time tables. Travel time for goods transportation between Mumbai

and Delhi would decline from 60 hours currently to just 18 hours.

These rail freight corridors are expected to complete by 2019 and, with the

right haulage charge, will help to partially bring freight traffic back from

road to rail.

3. What if this value migration plays out? Who wins and who loses?



Direct beneficiaries of this value migration from road to rail will be container

train operators (CTO) – Container Corporation (CCRI IN) and Gateway

Distriparks (GDPL IN), which have 75% and ~10% market share, respectively.

CTOs would benefit from higher asset utilization, cost savings and time

savings, leading to higher volumes and profitability.

January 2017

Value Migration | Thematic

Exhibit 121: Rail has lost significant market share to road in last few decades

100

FY51

FY71

FY81

FY91

FY00

FY05

FY12

Source: NTDPC

Railway

Road

Exhibit 122: Dedicated freight corridors will connect Delhi to Mumbai and Kolkata

Source: DFCCIL

Exhibit 123: Share of rail in freight transport significantly lags other countries

66%

51%

65%

44%

32%

44%

Australia

Canada

China

Russia

USA

India

Source: World Bank; NTPDC; EXIM Bank; 2012

January 2017

Value Migration | Thematic

Case-XI: Value Migration: From Steel to Aluminum

Industry:

Aluminum |

Driver of VM:

Substitution of Steel |

Play on VM:

Hindalco

What is the potential value migration?

Aluminum is increasingly becoming a metal of choice for automakers. By using

aluminum – which has a superior weight-to-strength ratio – as a substitute for steel,

weight of a vehicle can be reduced by as much as 50%, which in turn helps lower

fuel consumption and CO2 emission.

According to Duckers, the use of aluminum in vehicles will increase from ~175kg in

2015 to more than 225kg by 2025. This implies that aluminum demand from autos

will more than triple from ~11mt in 2015 to ~35mt by 2025. Aluminum is now also

the preferred metal in sheet work. Demand for auto grade rolled products is

estimated to increase exponentially from ~1-1.5mt currently to ~8mt by 2025.

What phase of value migration are we in currently?

Aluminum is the youngest metal whose use started only ~100 years ago. Auto

manufacturers started using this metal in heat exchangers in 1980s, and then in

wheels and engines in 1990s. Aluminum was largely used in cast parts until recently,

and we note that the substitution of steel by aluminum in body sheet work began in

2010. Novelis began the development work many years before that with the

introduction of technologies like fusion. Fords’ F-150, Jaguar and Land Rover are the

early adopters, thus marking the beginning of a new wave of substitution.

What will be the catalyst for driving this value migration?

Regulations in the US (such as Corporate Average Fuel Economy, or CAFE) and

Europe on reducing CO2 emission are driving automakers’ relentless focus on

improving fuel efficiency in vehicles. CAFE requires fuel efficiency to increase from

27.5mpg in 2010 to 54.5mpg by 2025, ~5% improvement annually.

Aluminum has advantage v/s steel as it (a) has superior weight-to-strength ratio, (b)

has better handling and metallurgy, (c) is safer as it can absorb more energy and (d)

has better corrosion resistance and surface quality. Therefore, we believe the

substitution will also spread to midsize and smaller vehicles.

What if this value migration plays out? Who wins and who loses?

Hindalco is the biggest beneficiary, in our view. Hindalco’s subsidiary Novelis has

been leading the steel sheet substation in close association with auto makers in the

US and Europe. The share of high-margin auto grade sheets in its product mix has

increased from low-single-digits few years ago to 16% in FY16. The share is likely to

increase further to 25% over the coming few years to meet exponential growth in

demand for which capacity has already been created.

Hindalco’s primary smelting business too has become highly cost competitive. Cost

of production has moved into first quartile of the global cost curve. Hindalco has

now turned free cash flow positive after a hiatus of 10 years, which will drive de-

leveraging and equity value. Free cash flow to market cap yield is very attractive.

January 2017

Value Migration | Thematic

Exhibit 124: Aluminum use in automobiles

Source: MOSL, Hydro

Exhibit 125: Global aluminum auto use

Aluminum use in light vehicles - mt

Exhibit 126: Rolled aluminum product auto use

Aluminum use in light vehicles - mt

Expon. (Aluminum use in light vehicles - mt)

8.1

4.9

8.7

11.4

14.8

1.3

0.5

2012

2015

2020

2025

Source: MOSL

2012

1999

2015

2025

Source: MOSL

Exhibit 127: Rolled products’ use in light vehicles to grow exponentially

Rolled product content per vehicle - kg

2012

2015

2020

2025

Source: MOSL, Company

January 2017

Value Migration | Thematic

Exhibit 128: Regulations are driving automakers’ relentless focus on improving fuel

efficiency

Source: MOSL, Hydro

Body and closure parts

represented ~11% of

aluminum used in autos in

US, as against more than

50% share in case of all-

aluminum F-150 truck.

Exhibit 129: Rolled products share of aluminum components used in autos in US

Rolled products (body and closure parts) share of aluminum use in autos

2015

F-150

Source: MOSL, Company

Exhibit 130: Auto product share in product mix for Novelis

Share in product mix

Kt (RHS)

724

568

468

366

170

FY12

261

FY14

12%

FY15

15%

FY16

18%

FY17E

22%

FY18E

25%

FY19E

823

Source: MOSL, Company

January 2017

Value Migration | Thematic

Abbreviations used in the report

PBs:

Private Sector Banks

PSBs:

Public sector banks

SFB:

Small Finance Banks

HFC:

Housing Finance Companies

BFSI:

Banking, Financial Sector and Insurance

IOPs:

India-origin providers

RPO:

renewable purchase obligation

RGO:

renewable generation obligation

CERC:

Central electricity regulatory commission

SERC:

State electricity regulatory commission

BTG:

Boiler Turbine Generator

FMCG:

Fast moving consumer goods

PSU:

Public Sector Undertaking

RBI:

Reserve Bank of India

NHB:

National Housing Board

3PL:

Third Party Logistics

VoLTE:

Voice over Long-Term Evolution

VoIP:

Voice over Internet Protocol

CoD:

Cash on Delivery

LCC:

low coast carriers

DFC:

Dedicated Freight Corridor

CTO:

container train operators

January 2017

THEMATIC/SECTOR GALLERY

Value Migration | Thematic

NOTES

January 2017

Value Migration | Thematic

NOTES

January 2017

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Value Migration | Thematic

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report. To enhance transparency, MOSt has incorporated a Disclosure of Interest Statement in this document. This should, however, not be treated as endorsement of the views expressed in the report.

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SEBI pursuant to a complaint from client Shri C.R. Mohanraj alleging unauthorized trading, issued a letter dated 29th April 2014 to MOSL notifying appointment of an Adjudicating Officer as per SEBI regulations to hold inquiry and

adjudge violation of SEBI Regulations; MOSL replied to the Show Cause Notice whereby SEBI granted us an opportunity of Inspection of Documents. Since all the documents requested by us were not covered we have requested to

SEBI vide our letter dated June 23, 2015 to provide pending list of documents for inspection.

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Served as an officer, director or employee

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Regional Disclosures (outside India)

This report is not directed or intended for distribution to or use by any person or entity resident in a state, country or any jurisdiction, where such distribution, publication, availability or use would be contrary to law, regulation or which

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For Hong Kong:

This report is distributed in Hong Kong by Motilal Oswal capital Markets (Hong Kong) Private Limited, a licensed corporation (CE AYY-301) licensed and regulated by the Hong Kong Securities and Futures

Commission (SFC) pursuant to the Securities and Futures Ordinance (Chapter 571 of the Laws of Hong Kong) “SFO”. As per SEBI (Research Analyst Regulations) 2014 Motilal Oswal Securities (SEBI Reg No. INH000000412) has

an agreement with Motilal Oswal capital Markets (Hong Kong) Private Limited for distribution of research report in Kong Kong. This report is intended for distribution only to “Professional Investors” as defined in Part I of Schedule 1 to

SFO. Any investment or investment activity to which this document relates is only available to professional investor and will be engaged only with professional investors.” Nothing here is an offer or solicitation of these securities,

products and services in any jurisdiction where their offer or sale is not qualified or exempt from registration. The Indian Analyst(s) who compile this report is/are not located in Hong Kong & are not conducting Research Analysis in

Hong Kong.

Motilal Oswal Securities Limited (MOSL) is not a registered broker - dealer under the U.S. Securities Exchange Act of 1934, as amended (the"1934 act") and under applicable state laws in the United States. In addition MOSL is not a

registered investment adviser under the U.S. Investment Advisers Act of 1940, as amended (the "Advisers Act" and together with the 1934 Act, the "Acts), and under applicable state laws in the United States. Accordingly, in the

absence of specific exemption under the Acts, any brokerage and investment services provided by MOSL, including the products and services described herein are not available to or intended for U.S. persons.

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document must not be acted on or relied on by persons who are not major institutional investors. Any investment or investment activity to which this document relates is only available to major institutional investors and will be

engaged in only with major institutional investors. In reliance on the exemption from registration provided by Rule 15a-6 of the U.S. Securities Exchange Act of 1934, as amended (the "Exchange Act") and interpretations thereof by

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Securities International Private Limited. ("MOSIPL"). Any business interaction pursuant to this report will have to be executed within the provisions of this chaperoning agreement.

The Research Analysts contributing to the report may not be registered /qualified as research analyst with FINRA. Such research analyst may not be associated persons of the U.S. registered broker-dealer, MOSIPL, and therefore,

may not be subject to NASD rule 2711 and NYSE Rule 472 restrictions on communication with a subject company, public appearances and trading securities held by a research analyst account.

For Singapore

Motilal Oswal Capital Markets Singapore Pte Limited is acting as an exempt financial advisor under section 23(1)(f) of the Financial Advisers Act(FAA) read with regulation 17(1)(d) of the Financial Advisors Regulations and is a

subsidiary of Motilal Oswal Securities Limited in India. This research is distributed in Singapore by Motilal Oswal Capital Markets Singapore Pte Limited and it is only directed in Singapore to accredited investors, as defined in the

Financial Advisers Regulations and the Securities and Futures Act (Chapter 289), as amended from time to time.

In respect of any matter arising from or in connection with the research you could contact the following representatives of Motilal Oswal Capital Markets Singapore Pte Limited:

Varun Kumar

Varun.kumar@motilaloswal.com

Contact : (+65) 68189232

Office Address:21 (Suite 31),16 Collyer Quay,Singapore 04931

For U.S

Motilal Oswal Securities Ltd

January 2017

Motilal Oswal Tower, Level 9, Sayani Road, Prabhadevi, Mumbai 400 025

Phone: +91 22 3982 5500 E-mail: reports@motilaloswal.com

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