Brand as a Competitive Advantage online version · April, 6, 2018 Brand as a (Durable?) Competitive...

April, 6, 2018

Brand as a (Durable?) Competitive Advantage

RajScuttlebutt Investorwww.scuttlebuttinvestor.com

http://www.scuttlebuttinvestor.com

My General Philosophy on Investing❖ Long only and long term

❖ Becoming a part owner in a business

❖ Just because it’s liquid and easy to sell doesn’t mean you should

❖ Look for a sustainable or durable competitive advantage (moat)

❖ Valuation is art and science

❖ Operating leverage is like magic

❖ Pricing power is wonderful and must be used responsibly

❖ A great horse is nothing without a great jockey (i.e. management is really important)

www.scuttlebuttinvestor.com

My Process - Art and Science❖ Read, read, read - public filings, company presentations, competitors,

industry books, trade sources

❖ Scuttlebutt - eat the dog food, talk to consumers/users/customers (those that pay for the product or service)

❖ Dissect the business model - understand company does, how it makes money and the levers of growth

❖ Logically and creatively think through the core economics of the business

❖ Understand the moat and don’t talk yourself into it


Sources of Competitive Advantage (Moat)❖ Switching Costs– financial costs or resource intensive – enterprise software

❖ Barriers to Entry– capital intensive, regulatory - railroads

❖ Network Effects– value is derived from more users – social networks

❖ Technological Superiority – high degree of expertise required - aerospace

❖ Economies of scale– large volume provides cost advantage – large manufacturing

❖ Strong Brand– well known brand signals quality or consistency – packaged goods

Not enough to benefit from a moat, you have to monetize the moat


Castle Protection of Google• Widening the moat around search ads: Google has built businesses around the core to protect the goose that lays golden eggs• Chrome Browser, Android, Maps, etc. are all ways to ensure that Google’s direct access to consumer’s search isn’t abstracted • Google Home came about likely because Amazon Echo is an existential threat in a potential future where consumers search for

everything through voice commands


Kingdom Building of P&G• Proctor & Gamble is a portfolio of consumer brands that could easily live independently of each other.• The key source of competitive advantage for each individual business (e.g. Tide, Pampers) is brand• Being part of the master company is advantageous in terms of scale, salesforce, capital and logistics.


What is a brand?❖ “Distribution of outcomes you can expect from

a person or a company” (Brent Beshore)

❖ Brand isn’t about having the highest quality; it’s about keeping the distribution of outcomes narrow so consumers know what to expect

❖ Functional and emotional attributes of a product or a service that drive willingness to pay over a similar unbranded product (Me)

❖ A brand doesn’t really have a reason to exist if you can’t use it to drive willingness to pay

Brand


Types of Brands❖ Lower search costs (Tide, Kleenex, Kirkland Signature)

❖ Confer Badge value (Ferrari, Tiffany, Apple, Lululemon)

❖ They also lower search costs but have the added benefit that consumers want to show them off

❖ Tend to be more premium/luxury but not always (e.g. Nike)


The death of brands has been greatly exaggerated

❖ Private label brands (Trader Joes, Target, Kirkland) have improved in quality and consistency

❖ New economy brands (Dollar Shave, Casper, Airbnb, Warby Parker) have invested to build new brands and sometimes have a value bent

❖ Barriers to entry for new brands have come down: the internet, social media and online marketing have lowered the cost of communicating to the end consumer and distributing product to the consumer

❖ Legacy brands (Gillette, Sealy, Hilton) have mostly rested on their laurels and legacy distribution models

❖ There’s nothing fundamentally different about these new economy brands versus legacy brands - they are younger/hipper but they still drive consumer willingness to pay through consistency of product communicated through brand

What’s Changed? What hasn’t changed?


For example: BrandlessNew economy company Brandless wants to be the “unbrand” but it walks, talks and smells like a brand with a trademarked name and investment in marketing (Google search ads) even though they’ve removed the supposed “Brand tax”


Do brands provide a competitive advantage?❖ Undoubtedly, YES.

❖ Brands generally drive a price premium and willingness to pay because consumers are willing to pay for consistency, trust and piece of mind

❖ And consumers are also willing to pay even more for badge value


Is the competitive advantage that brands confer durable?❖ Less so than it once was

❖ Brand generally provides a temporary competitive advantage - not as durable as maybe some other competitive advantages like network effects

❖ Brands confer a lead or head start that protects above average pricing/returns for a period of time but competitors can catch up

❖ Companies have to continue to invest in Reasons to Believe in the brand - product benefits, emotional benefits - because competitors will catch up if given enough time

❖ On the surface, badge value brands are likely to be more durable than search cost brands because changes in distribution models and the cost to communicate to consumers doesn’t meaningfully change consumer desire to “show off” these brands,

❖ …but badge value brands can still be vulnerable to brand dilution


Case Study: National Beverage Corp. (FIZZ)❖ Rev growth for latest period: 19%

❖ Operating Margins: 21% in LTM period from ~11% in 2013

❖ ROIC: 81%

❖ EPS Growth (5yr CAGR): 19%

❖ Conservatively financed; No debt

❖ Share growth over last 5yrs: 0.6%

❖ Owner operator run with high inside ownership by CEO at ~74%

❖ Incorporated in 1985; trading since 1991

Net net: Really strong financial performance by any measurewww.scuttlebuttinvestor.com

Case Study: National Beverage Company (FIZZ)❖ Operate in two segments

❖ Power+ Brands - active/health conscious - LaCroix, Shasta Sparkling Water, RipIt Energy Drinks, Mr. Pure juice

❖ Carbonated Soft Drinks- Shasta Cola, Faygo

❖ La Croix is the story and thesis with volume growth of 43% in latest period

❖ La Croix has “cool” factor and has become increasingly popular among younger consumers as a healthier alternative to soda as per capital consumption of soda continues to decline (especially in the US)

❖ FIZZ doesn’t break out gross margins for La Croix but pretty sure they are stellar: carbonated water + a few drops of essence (packaging likely costs more)

❖ Distribution has expanded considerably over last few years and now carried at nearly all major retailers in the US

❖ No traditional marketing

❖ Sparkling water category growing at double digits: +16% in 2016


High returns attract new competition

by Coca-Cola by Pepsi by Nestlewww.scuttlebuttinvestor.com

Is the La Croix Brand Sustainable?

❖ La Croix occupies a certain positive emotional place in the minds of younger millennial consumers that drink it (has some badge value)

❖ Packaging and brand name is differentiated

❖ It feels like an authentic brand

❖ Secular tailwinds for sparkling water category could sustain brand even as competition enters

❖ I’ve seen what brand managers create when they get in a room and engage in consensus decision making (e.g. Bubly - trying too hard?)

❖ Sparkling water is nearly indistinguishable to consumers in blind taste tests - it’s all about the brand

❖ The La Croix product itself is not very differentiated - especially with new competition in the sparkling water category

❖ Coca-Cola, Pepsi and Nestle have massive marketing, promotional/trade budgets

Bull Case Bear Case


La Croix falls in the “too hard pile” for me❖ While the pure financials are very strong and enticing,

it’s tough to tell if the La Croix brand can sustain an increasingly very competitive marketplace

❖ Key questions:

❖ How important is brand in the category of sparkling water?

❖ Does the brand still retain “cool factor” if everyone is drinking it (brand dilution)?

❖ What is FIZZ doing to stay ahead or keep its head start? New products/innovation? Can it really do anything?


Some Takeaways❖ Competitive advantages are wonderful and provide a thesis for investment

❖ Brands narrow the distribution of outcomes so consumers know what to expect and consumers will often pay a premium for this

❖ Brands confer a competitive advantage but that advantage can often be temporary

❖ Especially nowadays for search costs brands where the barriers to entry (marketing, distribution) have come down for new entrants

❖ Badge Value brands are likely to be more durable (but not invulnerable) over time


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