Intrinsic Compounding

Intrinsic Compounding

26-07-2022

14:25

What is the Topline of a company or What are different ways of looking at the sales/Topline of a company? This is a detailed thread on a common yet often misunderstood topic. Retweet to educate maximum investors and those who are running businesses 🧡🧡🧡🧡🧡

What is the topline of a company? In simple words Topline is nothing but sales/revenue of a company that is generated by selling products or services. Why is it called topline? As this is the first line item that is reported in an income statement of a business. Check πŸ‘‡πŸ‘‡

What are sales and how are they calculated? Let's take an example. Imagine that you are the owner of Pepsi ;) and you sell 10 packets of Lay's chips for Rs 10. In this case, Sales=Volumes*Realisations/Value/Price Memorise the above and write it down somewhere

Your total sales will be= 10 Packet of Lays=Volumes Rs.10= Value/Realisation/Price per packet Total Sales= 10*10= Rs.100 of total sales

So far so simple? Let's take it up a notch with real life case studies and how investors get trapped+How Businessmen should be careful before adding new products or segments.

Example 1 from Public Markets:- Volumes of a company grows and Realisations remain stable or increase. This is an epic outcome, possibly only happens when trends are structural or continue. Look at the total Volumes of Varun Beverages between 2017-2022 πŸ‘‡πŸ‘‡

P.S Remember:- That highest quality of sales growth is often led by volumes growth or product mix drastically shifting to higher value added (Realisation or tough to produce products)

What this means simply:- More Number of Lay's being sold πŸ”Ό Pricing is the same or increases slightly 🟰 Sales growth led by VolumesπŸš€

Example 2:- This is the deadly one. When Sales growth is driven just by temporary pricing growth in a business. This is when if Multiples are elevated and Pricing is temporary. Things becoming extremely dangerous in the short term.

Example:- Astec Lifesciences Q4FY22 Just read the concall snippet carefully

In some of the molecules which Astec Life Manufactures the Pricing increased Drastically due to supply shortages in the market. Such things are never structural and margins peak out with unsustainable pricing. Just check prices of their Key Product πŸ‘‡

What this means is simple:- Volumes are more or less Flat for Lay's🟰 Prices have πŸ”ΌπŸ”Ό due to Demand>Supply. These trends are never structural. Thus, sales growth led by temporary pricing growth. Which becomes risky when it reverses🚨🚨

Example 3:- Volume growth but Realisation de-growth. This is a deadly combo and can hurt the most if Volume growth doesn't compensate the Price growth.

Eg:- Majority of Kaveri Seeds business comes from cotton seeds and the Government in 2015 capped the Prices of the Cotton seeds. Business has grown its volumes, but Pricing has taken a hit. Thus, sales still haven't reached back to the 2015 level.

Check this:- This data Blew my mind when I mapped it with the Stock Chart and Sales chart of Kaveri Seeds. Realisations in Cotton Seeds per packet has fallen post price capping from Rs.800-Rs.900 to Rs.639. Volumes grew from 5.6M packets to 7.23M packets (exc 22).

Sales of cotton seeds in FY16 were=422 Crores, Price Per Packet=Rs.753 Volumes=5.6Million Sales of cotton seeds in FY21=Rs 440 Crores Price Per Packet=Rs628 Volumes=7.09Million Packets

Basically, You sold more Lays, but prices of Lays declined from Rs 10 to Rs 9. And growth in volumes wasn't able to compensate for de-growth in Prices/Value/Realisation per product. Thus, tough times for you to grow sales unless you introduce new products.

Example 4:- Volume growth is low but you introduce new products which are much higher in Value. You intentionally de-grow old flavours of Lay's which are low margin for you and add new spicy flavours which have epic Margins+Tough to manufacture.

Thus, Volumes de-grow in old business and Volumes grow in new business. Realisation per product improves. This is what we investors or business people should call= Improving quality of sales or Climbing the value chain of the industry.

Classic example is that of Garware Techincal Fibres In 2014, nearly 65% of Product mix was commoditised for Garware and only 35% was hard to manufacture products with less competition. Just see how it has shifted drastically over the years

A curious example:- Increasing Traded goods as a % of Sales. To show higher sales growth. Essentially I can trade as much as I want and just shift Chips of other companies and show higher sales. This is one of the Accounting Shenanigan 101 for inflating revenue

or in some cases can even point to poor quality of business. Trading business is a low margin, but high asset turns business. Usually, at the lower end of the value chain.

Classic example is that of Kwality Ltd:- Just check Traded goods as a % of total sales. Co grew Traded goods aggressively between 2012-2016. Fraud was eventually out in 2018 and stock is at Rs.2 today vs Rs 160 at the height of the last bull marketπŸ‘‡πŸ‘‡πŸ‘‡

Thus, in conclusion we can say:- 1⃣. Always ask Why before proceeding with anything in investing. Asking questions on even simple looking concepts like sales growth can give you uncommon insights. 2⃣. Sales=Volume*Prices/Value/Realisations

3⃣. Pricing/Value Growth if temporary, usually tapers off in the short term. 4⃣. Volume growth without realizations declining off is epic. 5⃣. Volume growth with Value declining, means business has to work twice as hard to grow sales/topline.

6⃣. Volume's remaining flat but underlying mix changes as Price per product increases due to newer products being introduced. 7⃣. Volume's growing but underlying mix also changes as Price per product increases due to price hikes being taken by the company.

Epic Example is:- Balkrishna Industries Just check Net Sales per KG of Tyre sold between 2011-2020

+On the coming Sunday, I will be doing a webinar on one of the most misunderstood yet crucial topics in investing. -Cash Flow Statement Demystified+What is Free cash Flow Compounding? Link to registerπŸ”—:

Thank you so much for reading!!



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