Once it is established that the company is a true leader, it is extremely important that it keeps growing, says Charandeep Singh, MD, Girik Capital.
The optimists would insist that markets are forward looking and one should not look at the current year. Next year may not be a great year but if you have patience to look outside 18 or even 24 months, this is a great market! The challenge with that logic is that in the last four or five years, every time people have argued that tomorrow will be better than today, that logic has got defeated. Hopes of an earnings recovery have not been realised. What is the guarantee that this time there will be an earnings and demand recovery 18 and 24 months from now?
I will try to break up the answer. You are right, over the last five years Nifty has returned maybe 2.5-3% per annum. But let me wind the clock back a little. One of the most pessimistic times in Indian markets was the period from 2011 to 2014. A very similar kind of value was available in the markets back then.
I am talking about the top 50 companies in India which are a very select elite group of companies which also keep changing. If you built a portfolio at that time when the news was terrible, the headlines were terrible and there was much pessimism, you could see that pessimism turning into optimism and by 2017-18 you had virtually rule of optimists.
So markets are made to climb the wall of worry. Bull markets are built on pessimism and they culminate on optimism. I would encourage people to go out and build portfolios now and do not just look at the headline index because the headline index can be very misleading. It is presently loaded with probably 55% financials and consumer stocks which is a very natural phenomenon since these stocks have done so well over the last decade and they tend to get crowded in the index. In 2010, the index was crowded possibly with real estate and infrastructure names.
The index had to consolidate, build a base, throw out some of the losers, add some of the new names. An HDFC Bank and a Lever went from Rs 50,000 to 1,00,000 crore market cap — six times the size and obviously their weight increased. To put this into perspective, the combined weight of telecom and pharma sectors in the index will not be more than 10%. So it is all about perspective and navigating. It is not so straight forward as to say that the last five years have seen 3% per annum return. One has to take a little deeper than that in my opinion.
There are good companies which are outperforming. These could be a Bharti or am ICICI Lombard or HDFC Life or maybe Reliance or Britannia. Then there are stocks where the future looks dark and which are underperforming. These are the BHELs and BELs of the world. These are currently struggling but that is where the value is. How does one go about investing in this market? If you invest in the darlings of the market, isn’t the margin of safety missing?
I will answer the value question first. Value can be very deceiving. One must be a value investor. But I will give you an anecdotal example. In 2011, the last cycle which was severe and sharp, Hindustan Lever was probably trading at 35 times earnings. Bajaj Finance came out of a 15 year cycle trading at 2, 3, 4, 5 times book. It was expensive at even Rs 10,000-crore market cap.
Hindustan Lever was expensive at 35 times earnings eight years ago when it came out of this long period of consolidation and made a new 52-week high! So yes, I do take that point there are companies like Bhel which present enormous value and the equity holder will probably gain some of that value if the government privatises the company. We do not know but it is very easy sometimes to write off big winners after they have doubled or they have 50% and say bahut high PE hai, mat lena (Don’t buy it, the PE is too high!) . One has to really carefully evaluate the leadership and the growth. If there is really growth over there. that could be so humongous that people cannot forecast.
Secondly, are the leaders facing competition? Do they have pricing power? Are they gaining subscriber traction or customer traction? Are the volumes growing? One has to be extremely careful, rather than paint everything with the same brush just because something has made a high or bottom , it should not be ignored.
ICICI Lombard, Bharti, Reliance, D-Mart are part pf your declared portfolio. Don’t you think some of these companies are priced to perfection? When D-Mart went public, everyone said it is too expensive, that you will not have great returns if you buy a stock at PE multiples of 40-50 times. But all the naysayers have been proven wrong and D-Mart has gone from Rs 500 listing price to about Rs 2500. Abbot was at Rs 2,000 a couple of years ago and now it is at Rs 10,000. How do you defend these arguments?
I will answer this question as a portfolio manager should. We have 20 to 25 companies in our multicap portfolio. We tend to overweight and underweight certain stocks over time. We have had D-Mart since the IPO. Now obviously had we continued to hold our original position, it would have been very large. We have been taking profits along the way. We do go out and rerate and rebalance our exposures over time if they become too large or if we feel a lot is priced in. We have methods to do that. We are very systematic. So assuming something becomes too large, we think too much is priced in and we tend to reduce the size of that position and D-Mart in particular.
Your other point about being priced to perfection, I will come back to the point about leadership and growth. It is very important not to take one’s eye off the quality of the leadership and the signs of the growth opportunity that lies ahead of any company that one wants to own. Once it is established that the company is a true leader, it is extremely important that it keeps growing. So yes, I could be willing to pay a 50 PE for a company today but who is to say if the earnings will double in the next three years?
The idea and the art here really is to look forward and to be able to make a case that you truly own a leader and that is growing because markets tend to reward growth. Again, between 2010 and 2020, the consumer and financial bull market growth kept getting rewarded. Both consumer and financials kept looking expensive. But the growth kept coming in as well and the PEs kept expanding. But when the growth stops what happens is right in front of you — the correction in the financial space and even select consumer pockets which have become too expensive.
It is very important to be able to understand leadership and growth. Without that, this becomes an exercise in isolation.
Is there a conscious strategy to avoid companies which are heavily leveraged? I am keeping Bharti and Reliance aside. They have debt on their balance sheets but that is not a problem for them to serve. But in general, you have taken bets in almost zero debt companies.
Since we started Girik, we have learnt in a very hard way that great companies do not leverage themselves. There are very few like Reliance that can get away with it. Leverage kills. You have to have leverage of the right proportion, the right cost and the right structure. We find that Indian companies in general have not been successful employing more leverage than they should, Very few have. In general, I would say it is a virtually a strategy to avoid leveraged companies in India.
I found that the greatest companies of course other than the financials have not needed to leverage themselves to succeed. They have very high ROEs and very high return ratios, superb margins, great working capital cycles and the leverage requirement is absolutely minimised.
Do you think consumer staples the Britannia, HUL, Nestle will now struggle to give double digit returns on a CAGR basis for next five years?
It is a possibility. A lot depends on the earnings growth. Companies like Nestle, Lever, some of these very large entrenched franchises like Britannia have become so large and such amazing market leaders that for them to squeeze out double digit growth is not that hard. These guys are so well organised they sit right on top of the food chain so earnings for these guys could keep growing.
For the entire consumer pack, I do not know what happens. When the leaders in a particular sector do well, the entire sector does well, everybody raises capital and the party continues. It happened in the last decade but I think leaders will always differentiate themselves. I would be a fool to tell you that and bet against guys like Lever, Nestle, Britannia because these are truly amazing companies. Whom am I to say they would not deliver double digit returns? It is extremely possible that this may not happen over a three year period, but over a five to seven year period it may easily happen.
What would be the point somewhere in the next one or two years where you would be happy to take the chips off the table irrespective of what central bankers are doing?
I will be very honest with you. We at Girik, have over the last decade, paid very little attention to headlines on what central bankers are doing. We respect what these guys do but it is absolutely not within our skill base or our skill set to evaluate how much liquidity there is in the system, how much of it is going to come into Indian markets and how much is going to get allocated to high yield bonds. These are very difficult things to track. What we continue to do and we think we do a reasonable job of is to actually understand the businesses we are in, identify the leadership and get the growth right.
It is extremely important to give the Lever example. We may not want to own some of these large consumer franchises. I am just using this as an example because we do not think the growth is sufficient to justify the multiples. They are great leaders. They can be in a portfolio for 20 years and sure you may get to double digit return. We would not ideally make much more money than that. We are going to go out and keep looking for new winners. D-Mart was an example at an IPO. At that time it was 50 PE now. When you look back and look at the earnings expansion, it probably traded at 15 or 12 PE. So everybody got the earnings wrong because people did not spend time to understand the leadership of this business.
So the idea is we are not going to get everything right in the portfolio of 10 or 15 companies. If you are able to even get four or five of these right and the earnings growth is outsized, you will get rewarded like you did in the financials in the last decade, like you did in the Titans and the Whirlpool’s and the great consumer franchises of the last decade. The massive rerating continued because the earnings growth just surprised the entire sell side and it kept surprising most fund managers. That is where the chase begins so to speak. Ideally that is when you do get an exit.
So these are the things we think about every day. The idea is to keep identifying new winners, keep understanding where the leadership is and where the growth is and there are enough sectors out there today which are showing growth. There are several companies where earnings have exploded in the last two-three years. The stocks are up five or 10 times and the idea is to understand those and own those.
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