Thematic | Value Migration Value Migration Please refer our report published on January 2017 Value Migration 2.0: Digging deeper, exploring more themes Pace of migration accelerating in BFSI and Jewelry In our Theme Report on Value Migration published in January 2017, we had dwelt upon the importance of staying with winning business models in ultra-disruptive times. India is indeed witnessing a phase of heightened disruption over the last three years, with transformational and game-changing reforms like GST, RERA, IBC (Insolvency and Bankruptcy resolutions), and Demonetization, driving underlying changes in the way businesses operate and create value for stakeholders. To recap, along with various nitty-gritties of Value Migration, we had highlighted 26 case studies in our report, which touched upon cases where (a) Value Migration is already prevalent and has left a trail of winners/losers, and (b) Value Migration can drive changes in the ensuing decade. We had also discussed the disruptions caused by unlisted players and consequent challenges they posed to the listed ones. In this sequel, we look at the progress/updates on some of the cases already highlighted and also dwell on two interesting new themes of Value Migration. Recap: 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 happens in three stages: [A] 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. [B] Stability: In this phase, competitive equilibrium is established. Growth rates moderate. [C] 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. BFSI – pace of Value Migration accelerating Value Migration from public sector (PSU) to private sector banks is one of the most prominent themes underway today. While the thesis has been playing out right and has many more legs to go, it is the pace of migration that has surprised us positively. We believe while the corporate banking sector in India has been under tremendous pressure over the past few years, the private sector banks are likely to emerge even stronger, while PSU banks will continue to face challenges on capitalization and growth. We further note that private sector banks have done a phenomenal job in building their liability franchise (strong traction in CASA mix) using both digital capabilities and rapidly expanding branch network. PSU banks’ market share loss has accelerated and we expect the trend to continue. Overall, there is a long way to go for PSU to private sector banks Value Migration and digitization will drive the trend further, in our view. Gautam Duggad – Research analyst ([email protected]); +91 22 6129 1522 Bharat Arora – Research analyst ([email protected]); +91 22 3982 5410 14Investors May 2018 are advised to refer through important disclosures made at the last page of the Research Report. 1 Motilal Oswal research is available on www.motilaloswal.com/Institutional-Equities, Bloomberg, Thomson Reuters, Factset and S&P Capital. Thematic | Value Migration Information Technology – staring at Phase-3 of Value Migration? For the best part of the last decade, the Indian IT services industry basked in the glory of low-cost talent, offering services 40-60% cheaper, with admirable flexibility to their global clients. It was the answer to large developed market clients’ need to optimize their IT spending. Championed by local and MNC peers alike, the model stabilized, and then, growth rates began to wane. Fast forward to today’s era – clients’ spending pattern has moved to the duality of: [1] optimizing IT spends on existing programs further by use of cloud, automation, AI, RPA and SaaS technologies; and [2] investing these savings towards their digital transformation. As a result of the above, the pie of bread-and-butter services for the industry has been directly hit, and the new services that provide growth opportunity are not moving the needle as much, thanks to low base. Besides, the new models are significantly deviant from status quo, requiring companies to embrace bold moves such as cannibalizing existing streams of cash generation, resetting to a lower profitability (at least in the interim) and actively chasing acquisitions. In this context, we witness the three phases of Value Migration, starting from value inflow benefiting the regime of low cost sourcing route to IT spending optimization to value outflow towards models built on the combination of automation, cloud and digital technologies. Oil & Gas: Green metamorphosis – Value Migration from Oil to Gas In the last few years, rising pollution has been at the forefront of the policy making and judicial activism in India. The focus on increasing penetration of gas becomes all the more important considering that in the latest study of the World Health Organization (WHO), half of the 20 most polluted cities globally are Indian. Policy initiatives in exploration and production (E&P) like Hydrocarbon Exploration Licensing Policy (HELP), Open Acreage Licensing Policy (OALP), premium pricing for gas production from difficult fields, and National Data Repository among others are expected to boost domestic gas production by ~10% YoY for the next 3-4 years. With enabling policies, increase in gas supply and improvement in pipeline infrastructure, broadly, the whole gas sector is expected to benefit – producers, importers, transmission companies and city gas distribution companies (CGDs). Consumer: Jewelry – massive Value Migration unfolding; multiple tailwinds conspire to augment the trend Opportunity for branded jewelers in an era of demonetization/formalization of the economy and Titan being the key beneficiary was one of the high-conviction themes we had focused upon as a part of long term Value Migration opportunities. Since then, additional growth drivers have emerged – GST implementation, which has further tilted the balance in favor of organized trade, rigorous provisions under PMLA, and credit squeeze for unorganized trade as fallout of the Nirav Modi scam. This is over and above the initiatives undertaken by company – aggressive expansion plans, focus on wedding jewelry portfolio. Titan has already been witnessing healthy 14 May 2018 2 Thematic | Value Migration market share expansion away from the unorganized trade and has delivered strong performance over the last 18 months on revenue as well as profitability front. From a longer-term perspective, the management has guided for strong ~20% five-year revenue CAGR in its jewelry division. In our view, the Value Migration opportunity in the jewelry industry remains immense, given the size of the industry and Titan, as the only pan-national branded jewelry player, is at the forefront to capture this long-term opportunity. Exhibit 1: Synopsis of Value Migration case-studies S.N. Industry Value migration thesis Remarks Winners/Losers 1 BFSI PSU Banks to Private Banks The pace of migration has accelerated HDFC BANK, IndusInd, KMB 2 IT Legacy models to Digital Entering Phase 3 of Value Migration Large-cap IT 3 O&G Oil to Gas Policy thrust - multiple winners IGL, Gujarat Gas, MGL 4 CONSUMER - Jewelry Unorganized to Organized Rapid market share gains for organized plays Titan Source: Company, MOSL 14 May 2018 3 Thematic | Value Migration BFSI – Pace of value migration accelerating Value migration from public sector banks – long way to go; digitization and superior customer service to further drive the trend In our first theme report, we had highlighted how the shift away from public sector banks to more agile, competitive and customer friendly private sector banks can happen over the next few years. While the thesis has been playing out right and has many more legs to go, it is the pace of migration that has surprised us positively. We believe that while the corporate banking sector in India has been under tremendous pressure over past few years, the private sector banks are likely to emerge even stronger, while public sector banks will continue to face challenges on capitalization and growth. We further note that private sector banks have done a phenomenal job in building their liability franchise (strong traction in CASA mix), using both digital capabilities and rapidly expanding branch network. This has enabled them to offer attractive lending rates, and thus, gain market share across most lending products. Private sector banks have significantly strengthened their liability franchise; cross-sell abilities further driving business growth Till a few years ago, private sector banks, with the exception of Axis Bank, HDFC Bank and ICICI Bank, had lower CASA ratio than their public sector peers. However, over the last three years, private sector banks have invested heavily in technology and have come up with a wide variety of innovative products in assets and liabilities as well as enhanced transactional abilities. With a wider customer base, private sector banks have used their cross-sell capabilities