Hey there everyone - have another question here when it comes to analyzing businesses where the "unit economics" are not so easily ascertained because of the diversity of the business or lack of transparency (or it is just a poor return on time to make so many assumptions).
Couple random examples - businesses like GEHC or DHR, or maybe HON and ROK. I am generalizing here, but these businesses can have large installed bases, huge diversity in the products that are being sold, a large range of prices, can be large pieces of hardware to smaller consumables, sometimes there is an attach rate here sometimes there isn't, etc.
If a PM were to ask you - what are the unit economics here? What would you say? Is it is a simple as just pointing to historic financial records and highlighting what the typical margins for the different segments are, ROIC, ROIIC, and highlighting some of the products they sell.
Furthermore, how granular do you attempt to get when modeling out these types of businesses? I guess the best course for most of these businesses is try and capture how much growth has historically come from volume and price - sometimes you are already making a ton of inaccurate assumptions in this simple stage already. Try and tie that in to margins in some shape or form? Then when meeting with management and industry insiders, or whatever industry data you are also leveraging, you look for signs you can point to and highlight how it may tie in to volume and price components going forward?
In my current job, I am primarily looking for an attractive risk reward through a LT lens, so I can highlight margins in a number of future scenarios, growth in a number of scenarios, and viola I can end up with an attractive risk/reward on the outcomes (then add in a framework of the business/industry improving/deteriorating at the moment, and you are most of the way there). But if I were in a MMHF or even other L/S funds, I feel like I would have to build greater conviction on the timing of these volume/price/margin changes, and translating that into next quarter's/year's earnings. So doing that when you are working with businesses that have such a diversity of products and services (who also tend to give very broad guidance) feels a bit difficult. Maybe it is as simple as finding the biggest COGS or other expense, figuring out that trajectory, and keeping a tab on general volume and price trends for the industry...
Its just that that feels very different than in the case of a SaaS business where I can point to users/seats and pricing a bit more easily, CaC, NRR, RPO, take rates, etc. OR if I am dealing with some consumer business and pointing to sales/sq ft., etc. And I am not sure I would be able to answer the question of "what are the unit economics" - like the incremental margin of any number of new machine sales for GEHC is so vast idk.
It's a great question. And not one I can answer because I struggle with the same thing. Welcome to Industrials!
I tend to start with where these companies are in their life cycles. They're generally large, mature companies seeking steady and consistent organic growth - inflation+/GDP type growth. Due to the markets they operate in higher growth in essence implies market share gains etc.
Ideally, both revenues and EBIT by segment/division are provided which allows you to look at incremental margins. This is the best approximation for operating leverage I find. The problem, like you said, is that it's a struggle to understand if margin gains are coming from price or quantity.
For me, it's just about reading transcripts/earnings call for any additional detail you can get.
I don't know if my answer even explains anything but that's just my approach to diversified industrials.
Fellow industrials analyst! No it is definitely helpful I really appreciate it. From my current seat sometimes it is hard to tell what’s going on “behind the curtain” at the top hedge funds, and what processes and analyses I need to start incorporating to become a better investor (honestly most of this is tied to wondering how much more granular the models are vs. what I do now, which is usually leveraging the typical transparency you get from the filings and maybe a handful of other assumptions).
I’ve had a thesis on a name and am getting ready to present it for an upcoming interview, and it’s along the lines of these kind of businesses, so naturally I was thinking of the classic push back questions that a PM would ask. Just trying to close the gap between my current seat and a HF seat.
I'm actually a generalist but industrials is a large part of my coverage.
While I like to be as granular as possible, that is constrained by disclosures of the company. We're all working with the same information in public equities.
I look at granularity with respect to conviction. I.e. does getting more granular improve my conviction on my thesis. When you're working with limited information would you rather base your forecasts on one variable you have reasonable confidence in or in multiple variables you have to make larger assumptions about?
It can be hard to pick up new coverage and have strong confidence in the company from the get go. But after following the company/sector for a long time you start to understand it better purely as a function of time.
I agree with this. Unless you are doing some type of deal, in which case you’d eventually be given a lot more detailed information, segment level is a perfectly reasonable level of detail
Great advice thank you everyone- more or less was my general thoughts but good to confirm.
DHR has been a nightmare for me to model recently haha (they love re segmenting). I’ve mentioned this in the past but would love to see any HF model on any somewhat diversified/industrials company (honestly any name) - just been super curious about the KPI drivers beyond segment level growth rates at +/- 1-2%
If you have an old model you are willing share please send a DM!
With multi-industrials it’s more about monitoring end-market exposures, growth of those end markets, segment level margins and book-to-bill, readthroughs in the supply chain and customers. Price vs volumes vs mix. Incremental/decremental margins. In some like aerospace or autos you can tie to content-per-unit for suppliers or to government data. Visit factories to understand utilization and input costs etc. try to estimate basically 1 level below what is disclosed in filings at least
interesting thread
Wanted to expand on this thread if there's any new thoughts. I understand the pricing component which wouldn't directly impact cogs/opex, but how would you go about modeling the impact on the pnl from volume increases, specifically on (variable) opex?
Is there a sellside model that utilizes unit economics that anyone knows of?
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