PMS Bazaar recently organized a webinar titled “Pricing Power Stocks & Zomato's Pricing Power Play,” which featured Mr. Siddharth Bothra, Fund Manager, Ambit Coffee Can Portfolio at Ambit Asset Management. This blog covers the important points shared in this insightful webinar.

The webinar blog covers insights from Mr. Bothra, which included the concept of pricing power in companies, highlighting key traits like the ability to raise prices, operating at or below inflation on input costs, an asset-light business model, and low debt. It explores Zomato's pricing power, Porter's analysis, and market sentiment shifts, emphasizing a move towards quality stocks, large-cap companies and navigating the market.

Key aspects covered in this webinar blog are

• Understanding pricing power in companies
• The research behind Pricing Power's success
• Zomato: A rare pricing power play
• Porter's analysis of Zomato’s competitive advantage
• Zomato’s position in quick commerce
• Understanding the shift in market sentiment
• Concentration shifting towards quality stocks
• Key catalysts driving the shift
• Navigating market challenges

Understanding Pricing Power in Companies

While the concept of pricing power is often associated with blue-chip multinational companies, Mr. Bothra emphasized that it is not exclusive to these entities. In fact, many businesses, even at early stages, can exhibit characteristics that suggest they possess strong pricing power. The key lies in identifying these traits early on, as the bulk of wealth is typically generated before a company gains widespread recognition.

According to Mr. Bothra, the characteristics of a company with pricing power include:

1.Ability to Raise Prices Above Inflation: A company that can raise the prices of its products or services at or above inflation rates without losing customer demand demonstrates strong pricing power. Companies that struggle to pass on rising input costs, often seen in cyclical industries, may not possess this power.

2.Operating at or Below Inflation on Input Costs: Companies with pricing power typically have input costs that grow at or below inflation rates. High raw material costs can limit a company’s ability to raise prices without negatively impacting demand.

3.Asset-Light Business Model: A key trait of a business with pricing power is its asset-light nature. Companies with heavy capital investments in plants or infrastructure may face pressure to operate at full capacity, which can dilute pricing power. In contrast, asset-light businesses tend to operate more efficiently, retaining their pricing advantage.

4.Low or Negligible Debt: Companies with little to no debt are in a stronger financial position, making them less vulnerable to market fluctuations. These companies are typically able to maintain stable earnings and consistent returns, making them attractive to investors.

These characteristics, Mr. Bothra notes, are essential for identifying businesses with long-term pricing power. He further explained that investors should focus on these traits rather than simply relying on a company’s reputation or its status as a blue-chip entity.

The Research Behind Pricing Power's Success

Mr. Bothra cited a research paper by Bloomberg analyst Sto titled Pricing Power Everywhere. The study analyzed companies in the U.S. from 2007 to 2023 and created an index of companies with pricing power. These companies, characterized by stable gross margins, not only delivered strong equity returns but did so with lower risk. The research showed that companies with pricing power consistently outperformed market benchmarks in various regions, including Europe and Asia-Pacific.

According to the study, portfolios constructed around pricing power stocks tend to outperform global benchmarks by delivering stable returns with less risk. This data underscores the significance of pricing power as a key factor in building resilient investment portfolios.

Zomato: A Rare Pricing Power Play

Mr. Bothra shared his analysis of Zomato, an example of a company that embodies rare pricing power. He explained that successful companies often rely on two key strategies: differentiation or being low-cost operators.

Differentiation Strategy

Differentiators, like Nestlé or Titan, focus on increasing customers’ willingness to pay more for their products by offering added value. These companies can charge premium prices because customers perceive them as superior or unique.

Low-Cost Operators

In contrast, low-cost operators like D-Mart or InterGlobe Aviation work to keep their costs below industry standards, offering lower prices to attract customers.

Zomato, according to Mr. Bothra, stands out by excelling at both strategies. It offers significant value in the food delivery space, allowing it to increase prices while retaining customer loyalty. Additionally, its scale and market position give it a unique advantage over competitors like Swiggy.

Porter's Analysis of Zomato’s Competitive Advantage

Mr. Bothra applied Porter's Five Forces analysis to Zomato's business model, highlighting the company's strong position in the market:

1.Substitute Threat: There are few substitutes for Zomato in the food delivery space. Competing platforms like Swiggy struggle to match Zomato’s efficiency and scale, giving Zomato a clear edge.

2.Threat of Entry: The food delivery industry is largely dominated by two players: Zomato and Swiggy. Zomato controls the lion's share of profits in this sector, with its market share expected to increase further in the coming years.

3.Buyer Power: Consumers in the food delivery market are fragmented, giving them little bargaining power over platforms like Zomato. Zomato’s widespread appeal ensures that it is not dependent on individual consumer preferences.

4.Cost Structure: Zomato has a unique advantage over competitors in terms of cost efficiency. Its scale allows it to control costs effectively, further solidifying its pricing power.

5.Industry Rivalry: The rivalry between Zomato and Swiggy resembles that of Pepsi and Coca-Cola, where both companies operate in a competitive yet stable environment. Their pricing strategies are aligned, which prevents them from engaging in destructive price wars.

Zomato’s Position in Quick Commerce

Mr. Bothra also touched on Zomato’s quick commerce business, which accounts for a significant portion of its overall value. Despite increasing competition from giants like Amazon and Flipkart, Zomato's early entry and strong market position give it a significant advantage in this rapidly growing sector. The convergence of quick commerce, e-commerce, and slotted delivery services is reshaping the market, and Zomato’s established brand and infrastructure position it to lead in this space as well.

Understanding the Shift in Market Sentiment

Mr. Bothra highlights that a high-risk, high-beta environment, similar to the market behavior of the 1990s and early 2000s, characterized the market sentiments between FY21 and mid-2023. This period witnessed a momentum-driven, theme-based market where short-termism ruled. However, such markets rarely sustain long-term growth, as many businesses driving the gains during this phase were not built for structural growth. In contrast, quality investors tend to focus on capital protection, prioritizing long-term investment strategies and concentrated portfolios over speculative, theme-driven approaches.

Concentration Shifting Towards Quality Stocks

The recent shift towards quality stocks is evident in the performance of large-cap companies, such as HDFC and Bharti Airtel. These companies are showing resilience, indicating a broader market shift favoring stability and long-term growth. Mr. Bothra believes this shift is accelerating, with a clear preference for companies that demonstrate strong fundamentals, irrespective of their market cap.

Key Catalysts Driving the Shift

1.Moderating Economic Growth: Mr. Bothra notes that GDP growth rates have slowed, and a sudden acceleration is unlikely. This more cautious outlook contrasts with the previous years when high growth was anticipated.

2.Supply vs. Demand: There is a noticeable increase in supply from promoters, with secondary sales and QIPs flooding the market. This supply surge has outpaced demand, raising concerns about the sustainability of recent market rallies.

3.Concentration of Market Activity: As the market moves towards more concentrated growth, Mr. Bothra points out that large-cap stocks are showing stronger performance compared to mid and small-caps, especially when considering the performance differentials in earnings growth.

4.Valuation Disparities: Valuations between large-cap and small- and mid-cap stocks are at historically high levels, which indicates that large-cap stocks may offer more value in the current market environment.

Navigating Market Challenges

Mr. Bothra advises a stock-specific approach in today’s environment. He warns that broad-based, high-beta strategies, which have dominated in recent years, may now carry significant risks. Factors such as cyclical slowdowns, high household leverage, and weak real wage growth could impact consumption patterns and broader market stability.

As the market moves into this new phase, Mr. Bothra believes that focused investments in quality companies will be key to navigating the challenges ahead. With careful attention to market trends, investors can position themselves for success in the evolving landscape.

Mr. Siddharth Bothra covered all the topics mentioned above in-depth and answered questions from the audience toward the end of the session. For more such insights on this webinar, watch the recording of this insightful session through the appended link below.

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