Case 050Stock pitch and thesis defenceHard

Your stock pitch on a restaurant chain says margins rise from 12% to 17% as input costs fall 10%. The interviewer asks: what if costs don't fall? Show earnings per share under both cases and what the current price implies.

Apollo Global ManagementAnonymous interview candidate in · 2021Apollo Global ManagementRemote · 2021Apollo Global ManagementAnonymous interview candidate in · 2021

The situation

Rasoiwala Quick Service Restaurants runs a chain of north Indian fast food outlets with revenue of Rs 2,000 crore. Food and packaging inputs, mostly edible oil, wheat, dairy and paper, are 50% of revenue, and the operating margin is 12%. Interest is Rs 20 crore, tax 25%, and there are 50 crore shares. The stock trades at Rs 168; listed restaurant peers trade at about 40 times earnings.

Your pitch: commodity prices are easing, input costs will fall 10% over the next year, and the operating margin will rise from 12% to 17%. The interviewer asks what happens if costs do not fall.

Your task

Show earnings per share with and without the cost fall, work out what the current price already assumes, and say how you would defend or reshape the pitch.

Quick check

At 40 times earnings, what EPS does the Rs 168 price imply?

Worked solution

Try it on paper, then open one step at a time.

30-second answerThe answer to give first

If costs fall 10%, EPS is Rs 4.80; if they do not, it stays at Rs 3.30, and at 40 times the shares would be worth Rs 192 or Rs 132 against Rs 168 today. The price implies EPS of Rs 4.20, a cost fall of about 6%. So most of the thesis is priced in: about 14% upside if right against 21% downside if not. The pitch must say that, or find a second driver.

Step 1What are earnings with and without the cost fall?

Inputs are half of revenue, so a 10% fall in input costs is 5 points of margin: 12% becomes 17%. Operating profit rises from Rs 240 crore to Rs 340 crore, and after Rs 20 crore of interest and 25% tax, EPS rises from Rs 3.30 to Rs 4.80, up 45%. Then reduce it to one sensitivity you can say in an interview: each 1% move in input costs is half a point of margin, Rs 10 crore of operating profit, and about Rs 0.15 of EPS, or Rs 6 a share at 40 times.

The relationship
EPS(c)=(2,000×(0.12−0.5c)−20)(1−0.25)50EPS(0)=3.30EPS(−0.10)=4.80EPS(c) = \frac{\big(2{,}000 \times (0.12 - 0.5c) - 20\big)(1 - 0.25)}{50} \qquad EPS(0) = 3.30 \quad EPS(-0.10) = 4.80
cchange in input costs, minus 0.10 for a 10% fall
0.5inputs as a share of revenue
20interest, Rs crore
50shares, crore
What it says in wordsEPS moves in a straight line with input costs: Rs 3.30 if they are flat, Rs 4.80 if they fall 10%, about Rs 0.15 for every point.
Step 2What does the current price already assume?

Reverse the question. At the peers' 40 times, Rs 168 implies EPS of Rs 4.20, an operating margin of 15%, which needs input costs to fall about 6%. The market is not ignoring the commodity story; it has priced most of it. On today's earnings the stock is on 51 times, a premium that only makes sense if margins recover. Your edge is therefore not that costs will fall but that they will fall by more than 6% and stay down.

Every point of input cost is 15 paise of EPS; the price already assumes a 6% fall23456-15%-10%-5%0+5%+10%priced in: EPS 4.20 (Rs 168 at 40x)thesis: costs -10%, EPS 4.80costs do not fall: EPS 3.30-6%Change in input costs over the yearEPS, Rs
Rasoiwala's EPS rises about Rs 0.15 for every point input costs fall, from Rs 3.30 with flat costs to Rs 4.80 with a 10% fall, and the Rs 168 share price at 40 times already implies EPS of Rs 4.20, a fall of about 6%.
Step 3What if costs fall but competitors pass the saving on?

When an input gets cheaper for one restaurant chain it gets cheaper for all of them, and some will cut prices or run offers to win customers. If half the saving is passed to customers, the margin reaches only 14.5% and EPS Rs 4.05, below the Rs 4.20 the price already assumes, so even a correct commodity call can lose money. If input costs rise 5% instead, the margin falls to 9.5% and EPS to Rs 2.55. Laid out together, the outcomes are lopsided.

Upside if the thesis is right is smaller than the downside if it is nottoday Rs 168Costs fall 10%Rs 192 (+14%)Costs fall 10%, half passed onRs 162 (-4%)Costs flatRs 132 (-21%)Costs rise 5%Rs 102 (-39%)Value per share at 40 times that year's EPS
At 40 times earnings Rasoiwala is worth Rs 192 if input costs fall 10%, Rs 162 if half the saving is passed on, Rs 132 if costs are flat and Rs 102 if they rise 5%, against Rs 168 today, so only the full thesis offers upside.
Step 4How do you answer the interviewer?

Concede the point and then show you have already measured it. A thesis that rests on one variable the company does not control is fragile, and a strong answer says so before the interviewer does. Then do one of two things. Either narrow the claim: you are not forecasting commodities, you are pointing to evidence that the company keeps its savings, such as a history of holding menu prices when costs fell, a loyalty programme that reduces the need for discounts, or longer supply contracts that lock in cheaper inputs. Or find a second driver that does not depend on costs, such as new outlets reaching mature sales or a rising share of delivery orders. A pitch with two independent legs survives the question; a pitch with one does not.

Where candidates lose it

The usual loss is defending the commodity forecast harder: oil prices are already down, wheat is plentiful. The interviewer is not asking for a better forecast; they are asking whether you know what happens to the investment if you are wrong, and how much of your view the price already holds.

The second is assuming a cost saving stays with the company. In a competitive industry, cheaper inputs for everyone are often handed to customers, so the margin you pitched never appears.

What the interviewer asks next

  • What would you watch each quarter to tell whether the thesis is working?
  • How would you change the pitch if peers traded at 30 times instead of 40?
  • Could the company hedge its input costs, and would that make the stock more or less attractive?

Asked at Apollo Global Management, Investments, Anonymous interview candidate in, 2021 (Wall Street Oasis): Are you sure you thesis can be backed up? What if their costs don't fall?
Asked at Apollo Global Management, Investments, Remote, 2021 (Wall Street Oasis): Asked to prep a stock pitch. Are you sure your thesis can be backed up?
Asked at Apollo Global Management, Investments, Anonymous interview candidate in, 2021 (Wall Street Oasis): some grilling questions based on your pitch and your thesis

Company names and figures are illustrative.