What is Moat? Why it is Important for the Business? All You Need to Know!7 min read
In this article, we will be discussing Moat of the business, why it is important for the business, and what are the types of Moats. So, Let’s get started!
What is Moat?
- Moat is a distinct advantage that a company has over all its competitors
- This distinct advantage helps the company to protect its market share & profitability & thrive through the competition.
- This distinct advantage is often difficult to mimic or break through for the peers of the company.
- Low-Cost Operating Expenses, Extensive Data, Technology, Patents, High Acquisition/Switching Costs, and Extremely High Entry Barriers are some examples of Moat.
- The bigger the moat of the company, the harder it is for the competition to breach through the company
Basic Dimensions of Moats:
Moat can be classified into 2 types:
1) Wide Moat:
- Wide Moat is those Moats which is possessed by the company for a much longer period.
- Example: A Technological advantage of a company that is difficult for the other companies to emulate.
2) Deep Moat:
- They are those Moats that enable the company to large amount of money in a very shorter period.
- For Example, any company which is having high competitive advantages in a large addressable market.
Classification of some of the Moats concerning strength type
1) Low-Cost Production:
- Low-Cost Production Moat is having such a competitive advantage which enables the company to provide goods and services at a much lower rate.
- In the case of a Low-Cost Production Moat, Divis Labs has an important moat of low-cost production due to the backward integration of its operations.
- Divis Labs has been sitting at a very strong EBITDA margin as compared to other pharma companies
- Backward Integration of raw materials has been a strong moat for Divis Labs. This means that the company manufactures the raw materials required for the production of its goods.
- This has led to phenomenal EBITDA margins for Divis of 41% compared to pharma sector margins which range between 20-30%
- Even during the supply chain disruption in H1FY22, the company’s margins have remained healthy indicating a wider moat
- Also, it has led to decreased dependence on raw materials for companies from countries such as China.
- However, this is a strategy that a lot of other competitors like Aarti Drugs are now starting to implement to reduce import dependence.s
2) Efficient Scale:
- In terms of efficient scale Moat, due to any particular competitive advantages, a company tends to grow at a much faster rate. Here, Bajaj Finance is the best example.
- Bajaj Finance’s loan book has compounded at an astounding CAGR of 38% in the last 10 years This humongous growth has been achieved because the company is offering finance on various products, especially consumer finance segment
- Another positive factor for the company has been its Asset Liability Management. This is because Bajaj Finance lends money for the short term(1-3 years) & borrows money for the long term(more than 3 years) which creates a regular inflow of money for the company
- They have expanded their networks with Brands/Manufacturers. Increasing Cross Selling, as well as processing fees revenue, have led to the phenomenal growth of Bajaj Finance over the years.
- A brief overview of the increased product catalog:
- Bajaj Finance has a strong moat in the consumer lending business where it is growing at a rapid pace. The AUM growth, revenue growth, and profit growth of the company each year are a testament to the cross-selling and scaling magnitude of the company. However, lending is a crowded space where there is going to be competition from banks and NBFCs. Banks like IDFC First are already getting aggressive in this space.
- The increasing product portfolio brings a lot of cross-selling opportunities. This is something Bajaj Finance has been banking on. They are now using technology and data to help themselves have better opportunities to sell their products which will help them widen and deepen their moat
3) High Switching Cost:
- Switching Cost is yet another big Moat which some company enjoys where a customer has a higher cost involved in case of switching the service of a particular company.
- For the case of high switching cost Moat, CDSL is one of the companies which enjoys this Moat.
- CDSL is a depository, A central body where all the records of investors and their securities are maintained. The customers of a depository are a broker. There are only 2 key depositories in India – CDSL and NSDL. CDSL has a market share of 61%. For depository participants to change the depository could be a herculean task considering the procedural compliances and lack of options in the sector. The early mover advantage here was huge.
- The moat rating of CDSL is high mainly because this business is a duopoly. With the idea of investing in shares and mutual funds getting more and more prominence, the number of investors will see an increase. CDSL currently has around 600 depository participants as their customers each of which will bring an income to CDSL as more and more investors open their accounts and transact more in the equity markets. However, the regulatory risk remains for SEBI allowing other players to venture into this business. The charges are also SEBI controlled in this business.
- The company has been doing certain digital initiatives and systemenhancements and has gained a good share from NSDL in the last 3 years.
4) Intangible Assets:
- This kind of Moat is enjoyed by those companies which own/possess intangible assets like patents, copyrights, etc. which provides companies exclusivity.
- For the case of Intangible Assets Moat, an example of Saregama India is the best case.
- Saregama is the oldest music label company in India.
- The subscription-based revenue model in the music industry led by digital access and streaming has revived this sector massively after years of being marred with issues of piracy. Record labels are now able to monetize now from various sources – Music streaming, short-form video, Youtube, etc.
- When a company acquires music rights of any content, it has the sole distribution rights to various mediums.
- Top 6 Music Labels companies – T-Series, Saregama, Tips, Sony Music, Zee Music, and Yash Raj Films control 80% of this industry. Hence, any revenue from the streaming of any music across platforms will eventually flow to the owner of the copyright in the industry.
5) Network Effect:
- It refers to those Moat, where the customer needs to take services of particular company’s good/services
- For Network Effect, IEX is one of the best examples to understand this Moat.
- Indian Energy Exchange (IEX) is an energy exchange platform that facilitates buying and selling of electricity through an efficient price discovery mechanism. It has a market share of over 95% in the space. Over 6700 participants are registered on the exchange. There are only two major energy exchange platforms in India and it can be said that IEX enjoys the monopoly status in this sector.
- The network effect can be seen to be fully played in the case of IEX. If all participants know that all other participants are using a particular exchange, more and more participants will use that same exchange for liquidity and better price discovery. This is the network effect. It is difficult to disrupt this in a company that enjoys such a high market share.
- The one major risk that the business has is the regulatory risk. IEX is governed by Central Electricity Regulatory Commission – This could be a serious hindrance to the growth of the company if there are any regulatory changes proposed by the Commission.
- In the last 3 years, the company’s investment into IGX proved to be a gamechanger for IEX and has paid rich returns.
6) High Brand Value:
- Such as Moat where the company has higher brand value.
- Chandru Kalro is the MD of TTK Prestige – A company mainly into pressure cookers having the highest market share in India in the segment.
- In the excerpt of an earnings call, he talks about how low entry barriers do not mean the moat of the company is at risk. This is because Prestige as a pressure cooker brand has a long standing in the market and even after being in the business for a long time, the brand still commands the highest market share.
- TTK Prestige is a dominant brand in the pressure cooker segment. However, this segment does not have a deep moat. The total addressable market is not huge and the effect of this can be seen in the growth in revenues of the company which seems to be plateauing in the last few years.
- In the 2000s the company transformed itself into a total kitchen solution provider by venturing into appliances like stoves, mixer grinders, etc. However, this space is very competitive. The bulk of the company’s revenues still are from pressure cookers today and building a moat in another kitchen appliance might be difficult for the company.
What Should Investors Do?
Moat refers to the competitive advantage belonging to a particular company that protects its profit margins from competitors in the market and other external threats. There are several types of Moat that companies enjoy in various sectors. Moat is considered to be an important factor that also provides a good earnings visibility for the company and hence an investor should carefully watch the moats of the company that they are interested in. Do follow due diligence before making an investment decision.
Disclaimer: The information here is provided for reference purposes only and should not be misconstrued as investment advice. Under no circumstances does this information represent are commendation to buy or sell stocks or MF.