Transcript Introduction to Industry and Company Analysis (Ch. 9)

CHAPTER 9
INTRODUCTION TO INDUSTRY AND
COMPANY ANALYSIS
Presenter
Venue
Date
USES OF INDUSTRY ANALYSIS
Understanding a
company’s business and
business environment
Identifying active equity
investment opportunities
Portfolio performance
attribution
APPROACHES TO IDENTIFYING SIMILAR
COMPANIES
BusinessCycle
Sensitivities
Products
and/or
Services
Supplied
Statistical
Similarities
Industry
Classification
CYCLICAL AND NONCYCLICAL
COMPANIES
Cyclical
Company
Profits
strongly
correlated
with
economic
activity
Expensive,
nonessential
products
High
operating
leverage
LIMITATIONS OF INDUSTRY AND COMPANY
DESCRIPTORS
Defensive
Industries
Cyclical
Industries
Growth
Industries
Growth
Companies
COMMERCIAL INDUSTRY
CLASSIFICATION SYSTEMS
Global Industry
Classification Standard
(GICS)
Russell Global Sectors
(RGS)
Industry Classification
Benchmark (ICB)
REPRESENTATIVE INDUSTRY SECTORS
Basic Materials and Processing
Consumer Discretionary
Energy
Financial Services
Industrial/Producer Durables
Technology
Telecommunications
Utilities
GOVERNMENTAL INDUSTRY
CLASSIFICATION SYSTEMS
International Standard Industrial Classification
of All Economic Activities (ISIC)
Statistical Classification of Economic Activities
in the European Community (NACE)
Australian and New Zealand Standard
Industrial Classification (ANZSIC)
North American Industry Classification System
(NAICS)
CONSTRUCTING A PEER GROUP
Examine commercial classification
systems
Review company’s annual report
Review competitors’ annual reports
Review industry trade publications
Compare business activities
EXHIBIT 9-2 FRAMEWORK FOR INDUSTRY
ANALYSIS
A Framework for Industry Analysis
Demographic Influences
Macroeconomic Influences
(stage of business cycle, longer term growth, and structural economic trends)
Governmental Influences
(regulatory, political, legal)
New Entrant Threats
Economic
Sector
Group of Complementary
Industries
Industry
Supplier Bargaining Forces
(affected by number of industries
buying suppliers’ products, of
supply substitutes, switching
costs of suppliers’ customers,
industry, and customers’ ability
to enter industry.)
Internal Competitive Forces
(affected by economies of scale, cost advantages, other
brand loyalty, customers’ switching costs, product
government regulation, industry’s competitive structure,
corporate rivalries, cost conditions, entry and exit barriers)
Life Cycle Analysis
(embryonic, growth, shake-out, mature, declining)
Business Cycle Sensitivity
(cyclical: leading, lagging, coincident; defensive, growth)
Analysis by Position on the Experience Curve
Customer Bargaining Forces
(affected by number of suppliers,
number of purchasers, their
size/power, switching costs to
other suppliers, number of
contracted suppliers, customers’
ability to produce the product
themselves)
Product / Service Substitution Threats
Technological Influences
Social Influences
STRATEGIC ANALYSIS: PORTER’S “FIVE
FORCES” FRAMEWORK
Threat of New Entrants
Bargaining
Power of
Suppliers
Intensity
of Rivalry
Threat of Substitute
Products
First focus
for analysis
Bargaining
Power of
Customers
EVALUATING THE THREAT OF NEW ENTRANTS
AND THE LEVEL OF COMPETITION
What are the barriers to entry?
How concentrated is the industry?
What are capacity levels?
How stable are market shares?
Where is the industry in its life cycle?
How important is price to the customer’s purchase
decision?
BARRIERS TO ENTRY
High Barriers
to Entry
Potential for
Greater
Pricing Power
Sustainable
Economic
Profits
INDUSTRY CONCENTRATION
MNO
Company
ABC
Company
XYZ
Company
What percentage of
the market does
each of the largest
players have?
INDUSTRY CAPACITY
Tight or
Limited
Capacity
Greater
Pricing
Power
Demand
Exceeds
Supply
MARKET SHARE STABILITY
Unstable
Market
Share
Limited
Pricing
Power
Source: Based on Figure 2.4 in Hill and
INDUSTRY LIFE CYCLE
Source: Based on Figure 2.4 in Hill and Jones (2008).
Source: Based on Figure 2.4 in Hill and Jones (2008).
LIMITATIONS OF INDUSTRY LIFE-CYCLE
ANALYSIS
Technological
Changes
Regulatory
Changes
Demographic
Changes
Social
Changes
PRICE COMPETITION
Price strongly
affects
customer
purchase
decisions
Competition
within the
industry
MACROECONOMIC INFLUENCES ON INDUSTRY
GROWTH, PROFITABILITY, AND RISK
Interest Rates
Economic
Growth
Availability of
Credit
Inflation
Industry
Growth,
Profitability,
and Risk
OTHER INFLUENCES ON INDUSTRY GROWTH,
PROFITABILITY, AND RISK
Examples of
Technological
Influences
• Invention of the microchip
• Digital imaging
Examples of
Demographic
Influences
• Baby Boomer generation
• Aging populations
Examples of
Governmental
Influences
• Tax policies and government spending
• Regulation
Examples of Social • Changes in tobacco consumption
Influences
• Women in the workforce
INDUSTRY ANALYSIS FOR BRANDED
PHARMACEUTICALS
Major Companies
Barriers to
Entry/Success
Level of
Concentration
Impact of Industry
Capacity
Industry Stability
Life Cycle
Price Competition
Demographic
Influences
Government &
Regulatory
Influences
Social Influences
Technological
Influences
Growth vs.
Defensive vs.
Cyclical
Pfizer, Novartis, Merck, GlaxoSmithKline
Very High: Substantial financial and intellectual capital required to compete
effectively. A potential new entrant would need to create a sizable R&D
operation, a global distribution network, and large-scale manufacturing capacity.
Concentrated: A small number of companies control the bulk of the global
market for branded drugs. Recent mergers have increased the level of
concentration.
Not applicable: Pharmaceutical pricing is primarily determined by patent
protection and regulatory issues, including government approval of drugs and
manufacturing facilities. Manufacturing capacity is of little importance.
Stable: The branded pharmaceutical market is dominated by major companies
and consolidation via mega-mergers. Market shares shift quickly, however, as
new drugs are approved and gain acceptance or lose patent protection.
Mature: Overall demand does not change greatly from year to year.
Low/Medium: In the United States, price is a minimal factor because of the
consumer- and provider-driven, deregulated health care system. Price is a larger
part of the decision process in single-payer systems, where efficacy hurdles are
higher.
Positive: Populations of developed markets are aging, which slightly increases
demand.
Very High: All drugs must be approved for sale by national safety regulators.
Patent regimes may differ among countries. Also, health care is heavily
regulated in most countries.
Not applicable.
Medium/High: Biologic (large-molecule) drugs are pushing new therapeutic
boundaries, and many large pharmaceutical companies have a relatively small
presence in biotech.
Defensive: Demand for most health care services does not fluctuate with the
economic cycle, but demand is not strong enough to be considered “growth.”
INDUSTRY ANALYSIS FOR OIL SERVICES
Major Companies
Barriers to
Entry/Success
Level of
Concentration
Impact of Industry
Capacity
Industry Stability
Life Cycle
Price Competition
Demographic
Influences
Government &
Regulatory
Influences
Social Influences
Technological
Influences
Growth vs.
Defensive vs.
Cyclical
Schlumberger, Baker Hughes, Halliburton
Medium: Technological expertise is required, but a high level of innovation
allows niche companies to enter the industry and compete in specific areas.
Fragmented: Although only a small number of companies provide a full range of
services, many smaller players compete effectively in specific areas. Service arms
of national oil companies may control significant market share in their own
countries, and some product lines are concentrated in the mature U.S. market.
Medium/High: Demand can fluctuate quickly depending on commodity prices,
and industry players often find themselves with too few (or too many) employees
on the payroll.
Unstable: Market shares may shift frequently depending on technology offerings
and demand levels.
Mature: Demand does fluctuate with energy prices, but normalized revenue
growth is only mid-single digits.
High: Price is a major factor in purchasers’ decisions. Some companies have
modest pricing power because of a wide range of services or best-in-class
technology, but primary customers (major oil companies) can usually substitute
with in-house services if prices are too high. Also, innovation tends to diffuse
quickly throughout the industry.
Not applicable.
Medium: Regulatory frameworks can affect energy demand at the margin. Also,
governments play an important role in allocating exploration opportunities to E&P
companies, which can indirectly affect the amount of work flowing down to
service companies.
Not applicable.
Medium/High: Industry is reasonably innovative, and players must re-invest in
R&D to remain competitive. Temporary competitive advantages are possible via
commercialization of new processes or exploitation of accumulated expertise.
Cyclical: Demand is highly variable and depends on oil prices, exploration
budgets, and the economic cycle.
INDUSTRY ANALYSIS FOR
CONFECTIONS/CANDY
Major Companies
Barriers to
Entry/Success
Level of
Concentration
Impact of Industry
Capacity
Industry Stability
Life Cycle
Price Competition
Demographic
Influences
Government &
Regulatory
Influences
Social Influences
Technological
Influences
Growth vs.
Defensive vs.
Cyclical
Cadbury, Hershey, Mars/Wrigley, Nestle
Very High: Low financial or technological hurdles, but new players would lack
the established brands that drive consumer purchase decisions.
Very Concentrated: Top four companies have a large proportion of global
market share. Recent mergers have increased the level of concentration.
Not applicable: Pricing is driven primarily by brand strength. Manufacturing
capacity has little effect.
Very Stable: Market shares change glacially.
Very Mature: Growth is driven by population trends and pricing.
Low: A lack of private-label competition keeps pricing stable among
established players, and brand/familiarity plays a much larger role in consumer
purchase decisions than price.
Not applicable.
Low: Industry is not regulated, but childhood obesity concerns in developed
markets are a low-level potential threat. Also, high-growth emerging markets
may block entry of established players into their markets, possibly limiting
growth.
Not applicable.
Very Low: Innovation does not play a major role in the industry.
Defensive: Demand for candy and gum is extremely stable.
PORTER: COMPETITIVE STRATEGY
Scope
Broad
Narrow
Source of Competitive Advantage
Cost
Differentiation
Cost
Leadership
Differentiation
Cost Focus
Differentiation
Focus
COMPANY ANALYSIS
Provide a company profile
Explain relevant industry characteristics
Analyze demand
Analyze supply and input costs
Explain the pricing environment
Present and interpret relevant financial ratios
DECOMPOSITION OF ROE
Net
Profit
Margin
Asset
Turnover
Financial
Leverage
ROE
SPREADSHEET MODELING
Optimistic
Expected
Pessimistic
SUMMARY
• Uses of industry analysis
• Industry classification systems
• Establishing a peer group
• Strategic analysis: Porter’s five forces
• Industry and product life cycles
• Demographic, governmental, social, and technological
influences
• Company analysis
• Cost and differentiation strategies
• Spreadsheet modeling