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Some thoughts on Kewal Kiran

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Document written for my students at MDI

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Some thoughts on Kewal Kiran

  1. 1. AKillerPuzzle Some Thoughts on KKCL Sanjay Bakshi 8 October, 2013 1
  2. 2. AKillerPuzzle What's A Guy Like Me Doing In A Place Like This? Experienced value investors like to stay away from the business of fads and fashion because fads come and go and fashion changes are largely unpredictable and what's hot today may go quite cold tomorrow without notice, and so its very difficult to value stocks of companies in such businesses. Warren Buffett has written: "Severe change and exceptional returns usually don't mix. Most investors, of course, behave as if just the opposite were true. That is, they usually confer the highest price-earnings ratios on exotic-sounding businesses that hold out the promise of feverish change. That prospect lets investors fantasize about future profitability rather than face today's business realities. For such investor-dreamers, any blind date is preferable to one with the girl next door, no matter how desirable she may be."1 And Charlie Munger has said: "We make bricks in Texas which use the same process as in Mesopotamia."2 Kewal Kiran Clothing Limited (KKCL) is in the fashion (mostly denim jeans) business, so, why am I talking positively about it? The answer, largely lies in one of the company's own posters. Indeed, in the global apparel business, the one business with the slowest rate of change in fashion trends is the denim jeans industry. And that changes everything about the attractiveness of this business. 2
  3. 3. AKillerPuzzle How Did Denim Jeans Conquer the World? Look around most of the world and you'll find it hard to spot a garment as widely embraced, loved, and worn by men as well as women, as denim jeans. The sheer extent of the global reach of denim jeans is staggering. Authors Daniel Miller and Sophie Woodward write:3 "Except in Rural China and South Asia, majority of the people in the majority of the countries of the world are wearing blue jeans on any given day." In their subsequent work, the same authors write:4 "In order to gain some sense of the scale and scope of denim, we started to estimate the proportion of jeans that people were wearing in whichever country we visited, standing on a street corner and taking notes on the first hundred people to walk by. We found that in most countries outside of South Asia and China, perhaps half the population was wearing denim on any given day. Commercial research suggested that the global average is for people to wear jeans 3.5 days a week (Global Lifestyle Monitor 2008), with the highest frequency being in Germany, where jeans are worn 5.2 days of the week (and ownership is on average 8.6 pairs per person)." How did denim jeans become a global phenomenon? What's so special about them? Why do people love wearing them? There are, I believe, several clues which can help answer these questions. I classified them into three categories: (1) the physical characteristics of denim; (2) the economic rationale behind denim jeans; and (3) the psychology of denim jeans. 3
  4. 4. AKillerPuzzle The Physical Characteristics of Denim There is something about denim which makes denim jeans owners prefer them over trousers. Unlike other fabrics, denim has an ability to soften with use and become personalized to the shape of the wearer. Paul Trynka, the author of Denim: From Cowboys to Catwalks: A History of the World's Most Legendary Fabric tells this story.5 "Levi's, as the patented trousers became known, were made in two fabrics, cotton duck (similar to canvas) and denim. They found really early on that it was the denim version that would sell. Denim was more comfortable, softening with age, and its indigo dye gave it a unique character. Indigo doesn't penetrate the cotton yarn like other dyes but sits on the outside of each thread. These molecules chip off over time, causing the fabric to fade and wear in a unique way. Why did it sell? Because the denim changed as it aged and the way it wore reflected people's lives." And Daniel Miller and Sophie Woodward write:6 "Jeans last longer than trousers perhaps twice as long. Jeans are said to improve in appearance over time; both fading and even tearing might enhance their appearance. By contrast, all other trousers look best when brand new, and if faded or torn should be given away to the poor." 4
  5. 5. AKillerPuzzle The Economic Rationale Behind Denim Jeans The growth of the global denim jeans industry has given it huge economies of scale— so huge that it has, among other reasons, increasingly driven jeans tailors out of business. Commenting on the strucure of India's denim jeans industry, Daniel Miller and Sophie Woodward write:7 "Today, jeans are probably the single cheapest option in trousers. Unbranded jeans in the market can be found for 200 or 300 rupees. This is the reason why jeans sold as cut material that still has to be stitched have largely disappeared, since a tailor would likely charge around 170 rupees just for the stitching…" "Arvind's ventures such as Ruf N Tuf, a pack of jeans material for local stitching worked well for a time… until all such stitching became uneconomic compared to cheap unbranded jeans." Needless to say, Arvind Mill's adventures with Ruf N Tuf ended poorly.8 People want to buy and wear jeans for a variety of reasons and one of them is their low cost. Scale economics enjoyed by the denim jeans industry combined with wage inflation for tailors resulted in tailored jeans becoming uncompetitive over time. And scale economics of the efficient branded jeans players like KKCL combined with rising disposable incomes and aspirations are making consumers shift from unbranded jeans to branded ones. This is a long-term trend unlikely to reverse anytime soon. ******** Did the arrival of foreign players hurt KKCL? Paradoxically, no, as the numbers from the company tell and which I discussed in my earlier document. ( The company explains this in its FY13 annual report: "The entry and expansion of global brands provide the consumer with a wide choice, thus increasing competition. But these brands also condition the consumer with newer and higher price points that fashion can command for a high-quality product. What is perceived as a potential threat also provides an opportunity for the Company with its well established brands to deliver world class products to its consumers with a compelling proposition." (Emphasis mine) Over time, as many commentors on my earlier blog post and my students at MDI have pointed out, KKCL has successfully moved up the value chain by getting its customers to pay higher average prices over time, for the garments they buy from the company. 5
  6. 6. AKillerPuzzle Here are the figures for average price realization over the years. FY14 (1st Quarter): Rs 875 FY13: Rs 805 FY12: Rs 742 FY11: Rs 685 FY10: Rs 639 FY09: Rs 608 FY08: Rs 564 FY07: Rs 547 With those prices, KKCL was able to deliver average EBITDA margins of more than 25%. See table below (reproduced from my earlier document): Now, let's look at VF Corp's joint venture (JV) in India. VF, which owns Lee and Wrangler brands had a JV with Arvind. In Nov 2011, Arvind announced an end to that JV. The announcment9 revealed some interesting information. The business, in which Arvind had a 40% stake was sold to VF at an enterprise value of Rs 297 cr which translated into 2 times revenue and 17 times EBITDA. Working from these figures, we can find out just how big and profitable VF's Lee and Wrangler brands were in India around 2011. Revenues: Rs 149 cr. EBITDA: Rs 18 cr. EBITDA Margin: 12%. So, here we have proof. Lee and Wrangler (those iconic brands from USA) were not even half as profitable as KKCL. By the way, KKCL is not the only company to beat the likes of Lee and Wrangler. There are others in other countries. Take the example of Mc Jeans (download some data on the company from This company claims to control 38% of the Thai branded jeans market, with Levi's at 31%, Lee at 10% and Wrangler at 10%. I think it would be useful for investors to study the example of Mc Jeans which is highly profitable, just like KKCL is, and has the dominant share in its addresable branded jeans market, just want KKCL is aiming for. That is, here is a live example of a company which has beaten the US brands in its home market without sacrificing profitability. And a past example of a local company taking market 6
  7. 7. AKillerPuzzle share from established global giants is that of Pepe Jeans— the hugely successful British brand which, by the way, was started by three brothers from Indian origin. (See http:// Can KKCL's four brother promoters do it too? I don't know, but these KKCL posters may tell you something about their intentions. :-) ******** 7
  8. 8. AKillerPuzzle In my earlier document, I also compared KKCL with its local Indian peer: Spykar. I reproduce the same extract here. While I highlighted "high gearing levels, working capital intensive nature of the operation, long working capital cycle and increasing competion in branded apparel segment," I did not deliberately highlight the very imortant lower part of the extract containing the only reliable profitability data about the privately held Skypar I could find. I wanted to see if anyone will notice and compare Spykar with KKCL. No one did! Anyway, as the figures show Skypar had PAT margin of 3.6% in FY09 and 8.4% in FY08, KKCL delivered PAT margins of 9.8% and 13.3% respectively in those years. So anyway you look at it, KKCL has come out as a winner. It has taken market share from unbranded jeans players and it has delivered higher margins than its competitors in the branded space. This company surely knows a thing or two about how to compete without sacrificing profitability. So far. Anyway, I digress. Let me now write my thoughts on the psychological attraction towards denim jeans. 8
  9. 9. AKillerPuzzle The Psychology of Denim Jeans There are multiple psychological forces which make people want to own and wear denim jeans. The durability and the comfort of denim make denim jeans deeply personal and intimate. As Daniel Miller and Sophie Woodward write:10 "John talks about how he loved jeans and how after wearing them for a while they become more personal: “I felt they were mine."" But there are deeper reasons why people love denim jeans. Two of the most important psychological reasons are Robert Cialdini's models of liking and social proof (our tendency to mimic others, especially those we like and admire for one reason or another). 9
  10. 10. AKillerPuzzle When "ordinary" people see their idols wear jeans, they want to wear them too because it makes them feel good about themselves. The fascinating thing about those idols wearings jeans, however, is not that they do it as brand ambassadors (which of course many do). Rather, the fascinating thing here is that they do it partly to "become ordinary." As denim jeans are available at a very wide price ranges (unbranded ones go for Rs 300 and luxury brand ones sell for $600 and above), the poor "feel" affluent and the rich "feel" grounded to their feet while not making them "feel" poor. This "Democratization Effect of Denim" is pro-social (which I like) and an important factor contributing to the popularity of denim jeans. As Daniel Miller and Sophie Woodward write:11 "There is both an increased democratization of denim, where even those on the lowest incomes can afford a pair of jeans yet, at the same time, this wide price spectrum means that denim simultaneously retains a considerable capacity to mark social and class differentiation." 10
  11. 11. AKillerPuzzle "Jeans are already emerging as something that can be understood as quite impersonal and generic, a garment that allows a person to escape notice or blend in." "[For the rich] blue denim jeans represent a struggle to become ordinary." Additionally, denim jeans enable people who wear them to enjoy the feeling of their becoming "world citizens." Daniel Miller and Sophie Woodward write:12 "People not only regard jeans as having a greater capacity than other garments to become intimate and personal as they soften and mold to a particular body but also see wearing this global garment as the best means to present themselves as citizens of the world. Living with an increasing consciousness of the sheer scale of an often alienating world, people want to lay claim to being part of that world, but fear that in doing so they will lose their sense of individuality and specificity. So to have one garment that is simultaneously extremely personal and extremely ubiquitous can be important in its own right. Merely wearing jeans can be a way of resolving this contradiction, of becoming more personal and more global at the same time." So much has been the global domination of denim jeans that for billions of people it has become a sort of a "default choice." In other words, when you don't know what to wear, you simply wear jeans! This simple, automatic, habit-forming, System 1 choice should make the branded denim jeans industry very interesting for long-term investors. Daniel Miller and Sophie Woodward write:13 "At one level, jeans may be merely a pair of trousers, but they exhibit three characteristics: jeans are amongst the most global clothing in the world, they express their capacity to become the most intimate clothing in the world, and they have become the default mode for people uncertain as to which clothes to wear." (Emphasis mine) "Many people talk about having worn jeans most at the point in their life when they didn't care about clothing. When they were too busy with other concerns to think about what to wear, jeans were perfect to just “get on with things.”" And KKCL knows this as is evident from this poster from the company. 11
  12. 12. AKillerPuzzle On KKCL's Scalability The average German, as I mentioned earlier, owns 8.6 pairs of jeans while most Indians don't even own one. Think about this for a moment. India has a population of more than 1.2 billion people which is also one of the world's yongest, having a median age of just 26.5 years14. Jeans are worn mostly by youngsters. And most Indians don't even own a single pair of jeans! In contrast, people in the United States (which has population of about a fourth of India's population) spent $14 billion a year to buy denim jeans.15 So what do we have here in KKCL? We have the most profitable listed apparel company in India, and very likely the most profitable branded denim jeans company in India (as measured by margins, return on capital, and share of industry profit) operating in one of the least penerated and one of the most populous regions in the world having a dream demographic profile desired by sellers of denim jeans. When it comes to long-term growth prospects for KKCL, what more can you ask for? Given all this, a notion that the very long term growth prospects for established and profitable branded denim jeans companies in India are good, would be right, no? Now, add to this the fact that the asset light business model of KKCL which translates into its superior cash generating ability, together with its past track record of profitable growth virtually ensures that the company will be able to finance its future growth without resorting to issuance of any new equity or significant amount of debt. These will be important factors to think about when we come to the questions about the valuation of KKCL. Disclosure: I own shares in KKCL and am very likely biased in favor of this company. Ends 1 Warren Buffett’s Letter to Berkshire Hathaway’s shareholders for FY 1987. 2 Charlie Munger speaking about the nil rate of obsolescence in the brick manufacturing process at Acme (a large brick manufacturer acquired byBerkshire) at Wesco Financial’s AGM in 2008. 3 4 5 6 7 8 9 VF Stake Sale Announcement 12
  13. 13. AKillerPuzzle 10 11 12 13 14 15 13