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Maintaining The Moat

Mahesh Patil, Head-Equities, Birla Sun Life believes that a company can maintain it’s moat by redeploying profits

Mahesh Patil
Head-Equities, Domestic Assets,Birla Sun Life AMC

On advantages of a moat
Companies with economic moats are able to withstand competitive pressures for a longer time period. Ultimately these competitive advantages get reflected in the company’s financials. They enjoy better return on capital employed, higher margins and better free cash flows.

On assessing how sustainable a moat is
Check how much lead the company enjoys. If the lead is overwhelming, it is likely to last for a longer time.
If a company has a competitive advantage at present, which gives it above-average returns, check whether it is using that window to lower costs, upgrade technology, and thus create further entry barriers for rivals.
Track management’s actions. See how much the company has invested over the years in developing its brands. FMCG companies especially must spend a lot on brand building.
If the company’s moat arises from technology, does it invest a certain percentage of its sales on research and development so that it keeps coming up with innovations? What a leader does with its cash flows is very important.

On moats that have got eroded
BHEL manufactures power generation equipment. Earlier, it was the only supplier of large power equipment and had a dominant market share. Most of the orders used to go to it by default. So it enjoyed high growth and good margins. But then competition became a reality. Once its overwhelming domination was lost, the stock also got de-rated.
In the Hindi broadcasting space, Zee used to be a dominant player with high TRP ratings. But when the policy was changed allowing new players to come in, Zee lost market share to Colours and Sony.
HUL’s stock has not gone anywhere in the last 10 years. It had the distribution reach, but it did not proactively make the requisite investments in creating new brands, developing new categories, and broad-basing its overall portfolio. That left it susceptible to competition.