In India, Bosch Limited, the Indian arm of Germany’s Bosch Group, offers a good example of a technology-based moat.
Bosch’s economic moat arises from its superior technology. It has access to the latest and tested technologies from its parent. These technologies provide it with a strong competitive edge. In the auto components space, Bosch enjoys competitive advantage especially in the fuel injection equipment division. The company commands a market share of over 81 per cent in this segment and is the major supplier to most original equipment manufacturers (OEMs). This creates an almost monopoly-like situation for Bosch.
High switching cost
Players in the fuel injection systems (FIS) industry enjoy high pricing power as OEMs involve the FIS player right from the research and development (R&D) stage. Once a vehicle’s FIS system is developed, the OEM generally sticks to that player or system for the entire life cycle of the vehicle. Hence, Bosch will continue to remain a preferred vendor to its OEMs.
A dominant market position imparts pricing flexibility to the company which results in better bargaining power. Moreover, this is a consolidated industry with only a few players having the required technology and orientation towards innovative research. Hence, the FIS industry enjoys high entry barriers. This translates into higher margins for Bosch in the auto component segment.
Riding on healthy margins for years has produced stellar returns for the company over the years. Over the last 10 years, it has registered an average return on capital employed of 32.9 per cent and return on equity of 24.2 per cent.
Can the moat be breached?
The segments in which Bosch operates are susceptible to technological upgradation and innovation. If any of its competitors launches new and more innovative products at cost-effective prices, it could well take away Bosch’s leadership. But no such threat is apparent in the near future.
Bosch is investing in capacity expansion which will be undertaken in a phased manner. Its cumulative capex over the next three years is expected to be around Rs 2,500 crore.
The prevailing price to earnings ratio (P/E) of 21.37 is at only a 5 per cent discount to the median P/E of 22.39. The stock’s P/E has corrected by 8 per cent over the past six months (since we first wrote about this stock). In the last calender year, when the Sensex has lost over 20 per cent, Bosch’s share has stood out as a strong defensive. Though the stock price has not moved much, earnings have been rising steadily, and that has led to a contraction in the P/E multiple.
The stock currently has a price-earnings to growth (PEG) ratio of 1.04, compared to 1.1 six months earlier.
Price to book value of 4.86 and enterprise value to sales ratio of 2.7 are also close to their five-year averages.
Buy this stock on dips in a staggered manner, with an investment horizon of three to five years.