Wednesday, December 12, 2012

Continuing Customer Businesses and Stock-picking

We discussed product characteristics of a consumer business, consumption pattern and what role it can play in stock investing in the last post. Taking the theme forward, this time we look at continuing customer businesses and their role in stock-picking. You must have observed that there are many businesses that do not toil that hard to get a large chunk of their customers, those customers are already there, and it’s only for the net incremental customers they focus their energies. Are you wondering what do I mean?
Let’s look at this dimension of assessing business advantage a little more closely.
1.      Housing Finance Companies – These are businesses where customers are continuing y-o-y and generate revenues for the company for a long time. Take example of a Gruh Finance. It gives loans for 10 years or longer. Once a customer is acquired, he/she is a source of income for Gruh for the next decade or so. No more investments needed in retaining this customer, except of course the right customer service & home loan rates. Isn’t it a great business to be in? Theoretically speaking, one can move his loan from one HFC to another, but that number is not so large. Compare this with a Videocon manufacturing TV sets or a Whirlpool doing refrigerators that has to toil hard, against all competitors, to acquire every single customer every year.
2.     OEM suppliers – In businesses like auto ancillaries and other OEM suppliers, we have companies with an assured customer and offtake. Take example of Motherson Sumi, Amtek Auto, Suprajit Engineering etc. In that sense, they have customer continuity with large auto companies or  industrial giant supply chains. The downside is however in their bargaining power. Supplier companies are the price-takers and at times, struggle to protect their margins. Having said that, there can be quite a few that enjoy premium positioning in their supplies, quality control and delivery schedules.
3.      Rating agencies – Here is a business where the companies stick with a particular rating agency (CRISIL, ICRA, CARE, Fitch), and then you have annual surveillance to get the rating refreshed. There are numerous instances when after many years of rating association, a particular rating agency “stopped” understanding their business model in a favourable light and the company goes for a new rating agency. Still, it’s a fairly stable business insofar as continuing customers are concerned with little investment involved in customer retention.
4.     Cable & Telecom operators – In theory, you are a fairly stable revenue generator for your cable TV operator (Dish TV, Tata sky, Sun TV, Hathway or whoever you’re with) or your telecom operator (Airtel, RCom, Idea etc) over a period of time. In reality, however, there is fair bit of switching occurring in these segments due to consumer preferences, cost considerations, service standards, package offerings and so on.
5.     Tollway companies – These sound great from continuing customer perspective. Daily commuters have to pay to cross that road or bridge. It’s a different matter that in Indian markets, two of the better known names in this business are having a rough weather – Noida Tollbridge for uncertainty over its concession agreement terms, PILs filed against toll hike and IRB Infra over corporate governance issues.
6.     Habit forming businesses – I could have done without including these businesses here. The category title I have given is also not very accurate. But customers keep coming back to cigarettes, tobacco & liquor companies, however bad their products may be from health point of view.

There can be many more ideas where customer continuity is far more assured than normal businesses. Obviously, this cannot be the sole criterion of stock-picking. A good combo of business & financial factors coupled with this aspect of investing can make a lot of sense and create enormous shareholder value over a period of time. Do share your stock ideas and themes that look attractive from customer continuity perspective.

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