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How Disruption Affects 'Safe Stocks'

Jul 2, 2016

In this issue:
» Stalled projects could be a real challenge to GDP growth
» Should you be bothered about 'Brexit'?
» A breather for global markets
» ....and more!
00:00
Sarvajeet Bodas, Research analyst

Back in 2000, when we shifted our house, my father immediately applied for a new telephone line. Back then, mobile phones were not so common. Landline connectivity was on the must-have list. I remember, my father following-up with the MTNL office for the landline and the local operator-engineer in my area who actually installed the phone line. To have a smooth-functioning phone line, one had to give 'Chai-Paani' to the local operator.

But times were changing. Mobile phones slowly started to replace fixed landlines. I remember Reliance came out with its classic white phone with the blue light. Then we had Nokia phones with their famous models. Many private operators such as Airtel, Orange (now Vodafone), Reliance Communications, and Loop Mobile successfully entered the high-potential Indian telecom market.

That was the scene in 2000-08. But in the background, something else was happening. As landline phones lost their significance to mobile phones, some telecom companies benefitted tremendously. But so-called 'monopoly' MTNL was crushed by the trend.

The company's revenue started to fall on the one hand and costs were increasing on the other. The impact was visible in its financial statement. Losses were mounting. A debt-free company with good cash balance back in early 2000 now had huge debt on its balance sheet. In the process, MTNL's market capitalisation eroded 88%.

This is how disruption can shake a company upside-down. The slow response to changing trends, the inability to keep costs under control, and inefficient operations compared to the private telecom operators led to the downfall of a monopoly.

The famous marketing guru, Al Ries, writes in his book, War in the Boardroom, 'The biggest mistake of logical management types is their failure to see the rise of a new category. They seem to believe that categories are firmly fixed and a new one seldom arises.'

This is just one example. The world is awash in technologies that are transforming the social and physical landscape in which we live. These disruptions have reoriented consumers, businesses, and the markets in ways few could have anticipated just a few years ago.

Take the recent example of Gillette in the US market. It is one of the top brands in the world, dominating the razor market. The company created a moat around its business by way of product quality, innovation, and strong brand recall. The company has a very good business model - the so-called razor-and-blades business model.

For decades, Gillette sold its razor handles for a small price, but charged much more for the blade cartridges that must be replaced after several shaves. This locks the consumer into the manufacturer's platform and allows the company to sell proprietary consumables at a high profit margin.

Say an upstart wanted to break this dominance. Imagine the kind of investment it would require. The new company would have to 'burn' money to create brand awareness. Not to mention create a repertoire of excellent products to match the product depth of Gillette. Not an easy job.

For many investors, Gillette is a must-have in the portfolio. It has solid business fundamentals, offers good returns, and keeps competitors at bay.

But wait...

As they say, the only thing constant in life is change. And change is happening in the razor and shaving market.

The upstart is Dollar Shave Club, which is disrupting the traditional shaving industry by providing innovative solutions. The company offers a monthly subscription service and delivers razor blades every month. It also offers additional grooming products for home delivery.

Guess what - with this innovative approach, in just three years, the company has chipped away at Gillette's dominance to grab 8% of the US$3 billion US market for razors and blades. This startup has forced Gillette to start a similar service. But Gillette's me-too strategy will only serve to cannibalise their existing sales and eat away at their margins.

It will be interesting to see what happens in this space, which was not long ago considered dull and strangely uncompetitive.

The bottomline is disruptions can affect 'safe' companies too.

Pagers, wrist watches, home telephones, Walkmen, Yellow Pages, travel and insurance agents, and restaurant guides were all victims of disruption. Exponential change is already remaking the investment map and more shape-shifting is likely in store. The need for agility remains constant, and the companies who remain flexible will be sustainable and relevant for the long term.

For any investor, it is important to be on the lookout for signs that the Titanic has started to sink.

Have you lost money in supposedly safe companies due to disruptive changes in technology? Let us know your comments or share your views in the Equitymaster Club.


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03:00 Chart of the day

One of the biggest drivers for a sustainable recovery in the Indian economy is a revival in capex cycle. When the Modi government came to power, a lot was expected from it to get this process going. So after two years of Modi government, where do we stand?

If the chart is anything to go by, we are still some way off before the capex cycle really kicks off. There are two legs to more capital expenditure. One is investment in new projects. The other is speeding up stalled projects. According to CMIE, stalled projects have greater chances of getting back on track. But there seems to be not much headway here. Since June 2015, stalled projects in absolute terms have only increased every quarter.

The other problem is that the private sector is much more impacted by this. As it is, the sector is reeling because of excess capacity. So there has not been much incentive to invest. Plus, it has not helped that stalled projects continue to remain stuck. There are several reasons why stalled projects have not taken off. Land acquisition problems, lack of environmental clearances, raw material and fuel supply problems, lack of funds to name a few. Clearly, if a lot of red-tape is done away with it will go a long way in giving the much needed shot in the arm to the capex cycle.

Stalled Projects: The Pipeline Remains Blocked


03:45

Britain's exit from the European Union continues to hit the headlines. As per an article on Firstpost, the International Monetary Fund (IMF) is of the view that the repercussions of this decision will not be limited to just UK or EU nations...but the impact will be global. There is a lot of uncertainty regarding the future relationship and terms of business agreements with UK and global countries. Further, according to IMF spokesperson Gerry Rice, policy makers will have to take decisive policies if the financial markets come under pressures due to this uncertainty.

The consequences of Brexit are yet to be seen. But such headwinds could lead to volatility in the stock markets. So how should investors deal with such events?

We believe that such volatile periods could be the best time to invest in fundamentally strong companies. All one needs to do is to focus on earnings' profile of the company.

To make your job easy, we have already done the math. Based on our calculations, we believe there is an upside of about 70% in the earnings of top Indian businesses. Which means the Sensex could be perched as high as 40,000 in three to four years.

And the time to act on stocks that could lead this earnings surge is now.

Download our special report - Sensex 40,000: 4 Stocks to Profit from the Coming Stock Market Wave -to make the most of this rare opportunity.

04:15

After the mayhem in global financial markets in the previous week over concerns on Britain leaving European Union, this week was a quite a breather as the global markets recovered.

Stock markets in UK ended the week higher by 7%. The stock markets rallied on the hope that the central bank of England will pump fresh stimulus into the economy in the coming months. The stock markets in France and Germany too ended the week higher by 4.1% and 2.3% respectively.

Asian markets too recovered during the week. Further, weak inflation and lukewarm business sentiment are raising expectations that the Bank of Japan will have to act again to shore up inflation. This coupled with global factors led to stock markets in Japan ending the week higher by 4.9%. While, stock markets in Singapore and China too ended the week higher by 4.1% and 2.7% respectively.

Back home in India, the BSE Sensex ended the week higher by 2.8%. During the week, the Union Cabinet approved the recommendations of the Seventh Pay Commission. The commission had recommended an overall increase of 23.6% in the salary of the central government employees and the pensions of those who have retired from central government jobs. The move is expected to deliver a potential boost to private consumption demand and economic activity.

Performance During the Week Ended 24th June, 2016

04:50 Weekend investment mantra

"Risk comes from not knowing what you're doing" - Warren Buffett

This edition of The 5 Minute WrapUp is authored by Sarvajeet Bodas (Research Analyst).

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3 Responses to "How Disruption Affects 'Safe Stocks'"

Vipul Jasani

Jul 5, 2016

Hi,

The example given is not appropriate. Killing MTNL is conspiracy to benefit private players. This is not only my beleif but also employees of MTNL!!! However no one will talk openly as it can not be proved.

Thanks,
Vipul.

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Ravi shah

Jul 2, 2016

Mr Sarvajeet,Disruptions can turn the company upside down but few can challenge and disrupt EQM with such working hosesty Mr Dayal has instilled in a institution. Your Clients feel safe that there will be no paid job here and the safe stocks suggested by EQM will not destroy your image and goodwill.Of course I lost money in Opto circuit,jp asso.,etc.

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Muthuswamy N

Jul 2, 2016

This is why the saying "survival of the fittesst' In Management fittest means the most flexible! Today there is need for manufacturing dance to the tune of the market, leave alone Even a small competition needs this kind of manufacturing flexibility, which traditionally is lethargic to quick changes.

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