The COVID-19 pandemic continues to evolve. As I write this, COVID-19 cases have exceeded 14 million worldwide and more than a million in India. There are nearly 220+ vaccine candidates in development and nearly 17 in human clinical trials. Few drugs have been effective in reducing the mortality rate and improve recovery time. The vaccine should be available by the end of 2021, if not earlier than that.
The crash in March very few people foresaw coming, and then the surge in April-June, almost no one saw coming. There can be a very wide range of outcomes. There are more unknown unknowns than known knowns and known unknowns. We are into a terrifying tailspin.
New business models are emerging and will continue to turn up. Few old business models will perish. We will see the ’91 movement in a few sectors. The consequences of this pandemic – both positive and negative, will unfold over the next 1-2 years.
I wrote back in April regarding the relative strength of businesses to survive this crisis.
Across the companies with a market cap of more than 1000 crores, the average drawdown was 37% between 1st February and 25th March. Smaller the market cap, larger the drawdown with companies with a market cap between 1000-5000 crores falling nearly 42% on an average basis.
Only 13% of the companies fell less than 20% between 1st February and 25th March.
The majority of the companies belonged to Pharmaceutical, Chemical, IT, and Consumer non-durables. These are the businesses that are either exported oriented or cater to essential needs.
Retail investors pile into stocks
While the markets were crashing in mid-March, Nithin Kamath, the founder, and CEO of Zerodha posted on 17th March, “Seeing this happen for the first time in my 15 years of broking. Account openings going through the roof after a crash in the markets, new customers being smart, not panicking, and telling that it is a good time to start buying for the long term. It is unreal!”
Surprisingly, the trend was playing across the globe. In the U.S., Robinhood, Charles Schwab, E-Trade., and TD Ameritrade, each saw record sign-ups in the March quarter, driven by retail investors. In the emerging markets, local investors were jumping in to ride what they hope will be a strong rebound, even as foreign funds flee.
Robinhood had 3 million new account openings in Q1 CY20. This is nearly double the 1.58 million new account openings in Q1 CY20 for Charles Schwab, TD Ameritrade, and ETrade combined.
*Recently, Schwab bought TD Ameritrade, and E-Trade was sold to Morgan Stanley.
In India, the monthly NSE cash turnover recorded a high of 13,50,681 crores in the month of June. Just to give you context on how high it is, the average monthly turnover in the 5 years is less than 5,50,000 crores.
The average daily turnover (ADTO) in June touched 61,000 crores. On the other hand, the net inflows into equity-related Mutual fund schemes crashed 96% from 5,666 crores in May to 240 crores in June, the lowest since March 2016. The figure is 97% below last June’s 7,741 crores inflows.
Source: NSE Website
Retail participation has never been such high in the stock markets. And because of work-from-home, people are looking for an alternate source of income.
And the rapid price fall gives the perception that things are available for cheap. Baiju Bhatt, the co-founder of Robinhood was asked about his reaction to increased volume on the service. He answered, ‘Surprised’ is not the word I would use. For more than a year prior to the current crisis, the company was focusing on people who had registered for the service, but hadn’t used it to buy any stock, essentially asking: What’s preventing you from getting in the market? “One of the most common answers we got is that people thought it wasn’t a good time to buy. They thought the market was too expensive,” Bhatt says.
NSE active clients data
*NSE active clients – defined as those clients who have made at least one trade in the last 12 months on NSE.*
In the last 15 months, the new active clients have increased by nearly 3.4 million and in the 4 months, we have added nearly 2.1 million accounts.
The interesting fact is that out of the total of 3.4 million accounts being added in the last 15 months, nearly 2.5 million accounts are being added by four brokers namely Zerodha, Upstox, Angel, and 5paisa.
Traditional Brokers Vs Full-discount brokers in India
Let us look at the long term growth in the active client accounts in the last 5-7 years. I will classify the brokerage houses in two buckets: A & B.
B includes the top four full-discount brokers namely Zerodha, Upstox, Angel, and 5paisa. A includes all brokers excluding the above mentioned four brokers.
Growth rate for Bucket A
Even if exclude the full-discount brokers, the growth rate for traditional brokers in the last 5-6 year has been very healthy near 12-13%.
And for the top-16 traditional brokers in bucket A, the growth rate has been near 14-15% with the market leader like ICICI Securities, Kotak Securities, Motilal Oswal and many others growing at 20-25%.
Growth rate for Bucket B
The growth rate for the full-discount brokers has been phenomenal. In the last 15 months, Upstox’s active clients have grown 7x, active clients have grown 4x for 5paisa, and have nearly doubled for Zerodha and Angel. The lower growth rate for Zerodha and Angel is because of the higher base relatively.
While the demonetization has got its backlash, it has created a shift towards capital markets given the fact that full-discount brokers started their remarkable journey of growth since FY18. And COVID-19 added the fuel to their growth engine.
I borrow the words of Nithin Kamath, “Demonetization got people using AADHAR, which meant finally customers could on-board online. Work from home enabled a lot of people who otherwise didn’t have time, to think of investing. Right place, right time – the most underrated aspect of building a business.”
Market Share and Consolidation of Industry
The four brokers namely Zerodha, Upstox, Angel, and 5paisa now form nearly 1/3rd of the total active clients up from 3.8% in Mar-14. On the other hand, the marginal brokers (below Top-20) have lost the market share significantly and share has come down from 41% to 23.5%. The top-10 market share has increased from 50% to 64% in the past 7 years and the trend should escalate.
But the most critical thing to consider is that the market leaders of Bucket A have hardly lost market share rather the companies like Kotak Securities, Motilal Oswal, Axis Securities, SBICAP have gained the market share.
Incremental Market Share
The four full-discount brokers have captured nearly 74% of the incremental market share in the last 15 months. Even after such a brutal market share gains by full-discount brokers, the market leaders of Bucket A has done an incredible job of maintaining market share as their active clients grew by 30-50% in the last 15 months.
Creating a pie Vs Capturing a pie:
When a new product is launched or a new business model is introduced in an Industry, it has two resultant effects: 1) It captures the market share from the traditional business model and disrupts them 2) It expands the total addressable market size and hence expands the profit pool.
For example, prior to Honda launched Activa (Moped bike) in India, women in India hardly used to drive two-wheelers. If we see the current scenario, the majority of urban women and teenagers in India use moped bikes. And gradually, even a reasonable number of Indian men also use the moped bikes.
As a result, the introduction of moped bikes exploded the total addressable market size of the two-wheelers in India in the initial one and a half-decade of the 21st century.
Similarly, incumbent brokerage houses have the majority of customers with the age of more than 40 and it implies that hardly millennials used to trade and invest in equity markets before the arrival of full discount brokerage.
To support this hypothesis with a fact, I would again borrow words from Nitin Kamath, “Our clientele has become very different. About 55-60% of our clients are first to broking and over 70% of them are under 35 years of age. And I’d say traditional brokers have the exact opposite demographic — people who want help, advise on the phone, who value the dealer relationship.”
What traditional broking firms have not done well is to introduce markets to the masses and full-discount brokers are the ones adding new people to the ecosystem.
As many as 70-80% of the customers of 5paisa and Upstox are from Tier 2-3 cities and an equal proportion of the company’s customers are millennials.
On the other hand, the company like ICICI securities has nearly 35-40% of their active clients for more than 15 years. In fact, they generate 65-70% of their revenues from customers who have been with ICICI securities for more than 5 years. (Source HDFC Securities)
Let us look at the profitability of broking and commission division of the few traditional brokers:
Source: Annual Reports, Website and Investor presentation of respective companies
Profits are growing or stable. This proves the hypothesis that full-discount brokers are expanding the TAM and the profit pool rather than capturing the share from incumbents. Stagnant growth in the last 1-2 years is a result of the cyclical nature of the broking business given the fact that the equity market has not performed well in the last 2-3 years.
Market share captured by full-discount brokers is noticeable in their financials:
Source: Probe42, Annual Reports, The Ken, HDFC Securities, Own-estimates
*Zerodha PAT and Revenues includes proprietory trading*
That does not mean that they have not disrupted traditional brokerage houses. But the intensity of disruption is quite low and has been offset by the general growth in the industry.
What holds for the future and my educated guess:
In the US, the largest discount brokers in Schwab, Fidelity, TD Ameritrade, and Pershing already control ~62% of the broking market. In the last 15 months, Indian full-discount brokers have captured 74% incremental market share.
In the next 5 years, Zerodha, Upstox, Angel, and 5paisa may grow at a 2x rate relative to the traditional top-16 brokers. Implying 16% growth in active clients for Bucket B given the very high base, 8% growth in the clients for bucket A (top-16) and 0% growth in brokers below TOP-20, we may see the market where the bucket B will have 44-45% market share and the brokers below TOP-20 will lose out market share from 23.5% to 15%. This implies overall growth of 9.4% and we may add new 7 million accounts over the next 5 years. Hence, the top 10 players will have an 80-85% market share.
Implied Market Share:
Implied Incremental market share:
Shrinking pie of growing market:
As the industry consolidates, let’s imagine a situation where discount brokers corner market share as huge as 80% and rest 20% stays with incumbents. In such a scenario, market leaders like ICICI Securities, HDFC Securities, Kotak Securities, Motilal Oswal, etc might see even sharper growth as the less efficient full-service brokers might need to shut their shops and this phenomenon can be best called as ‘Survival of Fittest’ and in a way will be like a shrinking pie of the growing industry.
Traditional Brokerage is More than Active clients and Market share
There are multiple other factors apart from growth in the active clients and market share that leads to better revenue and profitability profile. To be honest, this is a very broad topic and deserves an article for itself but I will try to put my thoughts briefly.
DP Holding size:
The average DP holding size for a traditional broker might range between 5-5.5 lacs and on the other hand for discount brokers, the average DP holding size range between 1-1.5 lacs. (Source: HDFC Securities)
The obvious reason is that the older generation has more average assets as compared to younger ones given the fact that the older generation has a better income profile and hence the better investible surplus as compared to younger ones.
The higher average DP Holding means a higher average revenue per customer. Hence, even though the discount brokers gain market share in terms of active clients, the majority of revenue and profit pool will lie with incumbents.
The following is the average asset per client for ICICI Securities classified based on the age groups:
Source: ICICI Securities presentation
Wealth management and distribution business:
Traditional brokers earn a good chunk of their revenue from Financial Products Distribution (FPD) and Wealth Management. Hence, the traditional brokers are looking at generating better ARPU rather than looking for earning higher broking yields.
In fact, they have accepted the fact that rise of discount brokers will impact the yields but then the quality of customer will improve which will help in increasing the ARPU as such customers will also start using the platform for buying financial products (Distribution segment) and hence lifetime value of a customer is higher and act as a trade-off of lower broking yields.
To compete against discount brokers incumbents like ICICI Securities are launching new brokerage plans – ‘Prime brokerage ‘and ‘Option – 20’ to compete against the discount brokers.
Prime brokerage plans are prepaid plans and the subscription charges are in the range of 900-9500 and the brokerage rates are between 0.15%-0.25% depending on the plans chosen vs 0.55% on cash delivery which they used to charge before. Along with lower brokerage rates, another added benefit is of quick liquidity (within 30 minutes of trade) which these plans offer, the limit ranges between Rs.10 Lakhs – Rs.1 Crs depending on the plan chosen by the customer.
As a consequence, the brokerage yield for ICICI Securities has fallen from 4.5 bps in FY14 to approximately 0.5 bps in FY20. Similarly, for Motilal Oswal brokerage yield has fallen from 4.0 bps in FY14 to approximately 1.5 bps. While discount brokerage like 5paisa has 0.2 bps as their brokerage yield. (Source: HDFC Securities)
There is a question regarding whether the brokerage yield can go to zero in India like the US. This is very unlikely to happen. The reason US brokerage firms can withstand this 0-commission onslaught is that they have many more ways of earning compared to their Indian counterparts.
Customer is more important than broking yield
Vijay Chandok, MD and CEO of ICICI Securities said in a con-call, “We do not look at it from a product segment point, we look at it from a customer viewpoint. If there are redemptions in MF, the redemptions are not disappearing away. It is staying within the network in some other form, either it gets into equities or it gets into fixed income or into some other investment category. In every space for us, the customer is more important than the product.”
Incumbents aim to bring in customers on their platform through brokerage but then attract the customers towards their distribution business and hence better to look at what revenues they can generate from a client.
The following is the FPD AUM of IIFL Securities:
Source: IIFL Securities presentation
The AUM is growing at 20% YoY on an average even though the active clients are growing at a single digit. Basically, they are able to monetize their current clientele.
Total operational accounts Vs Active accounts:
Along with NSE Active market share data, another important metric to keep in check is active clients on NSE as % of Total Clients. For traditional brokers, this metric on average has been in the range of 24-32%. For ICICI Securities, it was 23% in FY20. However, this number for Zerodha is ~70% and the best in industry. (Source: HDFC Securities)
Though the traditional brokers do not earn fees and commissions on inactive accounts, they earn Annual maintenance charges on such accounts. Also, they can monetize their inactive clientele for the FPD segment.
I think these sectors do have the potential for above-average returns in the medium term though not every company will be equally benefited. The success or failure of each company will be the result of the unique business model and competitive advantages built by the management and their execution going forward. As a result, a single company bet can lead to losses even if the rest of the sector does well.
One thing I have learned and applied in my short investment journey is that when you are confident about a sector but not sure about the companies, it is appropriate to use a basket approach.
The sole purpose of writing this blog is to have a better thought process and the skillset to build the thesis around the hypothesis and the data.
I have been following the monthly active clients’ data since Sept’19 when IIFL Securities got demerged. I have selected four companies based on the upside and have been building positions in them from the month of April. Out of the four, in the two companies, I have twice the allocation relative to the other two. As John Huber says, select the stocks based on upside and allocate based on the downside. Of these companies, some are long term plays whereas others are more tactical in nature.
The joy is in getting thesis right. Return is a by-product.
Hopefully, we could write more such blogs in the upcoming weeks. Happy Investing.