Has anything changed in your approach to your portfolio post the Budget?
Not really. I thought it was a no-nonsense Budget. The economy continues to open up; for the first time in two years, my kids are going to school every week and that is a positive for children across the country and the entire ecosystem of vendors which survives by catering to our schools.
So the economy is improving, the fiscal position is better than I thought it would be. Honestly, I think that the Budget painted a far better fiscal position than I thought it would be. The short term issues around oil prices and bond yields are there, but we never really lose too much sleep about that as our focus has been to invest in strong, well run companies and benefit from the underlying compounding in great franchises in this massive economy.
I fully endorse the idea you do not look at macros when you invest and look at individual companies. But macros matter. If the cost of capital goes to 7-7.5%, it will impact demand, valuations and flows. At what point would you start paying attention to macros?
There are two ways to understand macro. The way we understand macro is the structural story. For example, India’s 10-year government bond yield in 2004-2005 was 17%, today it is 6.7% and we are fretting that it might go to 7%. So, that for me is macro, the fact that we have a structural downtrend over 10-15 years. A 10% points drop in your cost of capital is what transforms countries. If I look at that structural type of macro, I do not see what I should exactly lose sleep about.
The financialisation of our country continues as the cost of capital structurally continues to go down. Three-four Fed hikes are not going to be a structural story. Those are cyclical waves and our job is not to second guess and nobody should be trying to second guess cyclical waves and make money from that because that is absolute. Focus on the structural story. Macro matters but structural stories matter. The cyclical story is the noise. What is the price of oil today? What will it be next week or next month? That does not matter so much. It does not matter for two reasons: a) It is a mean reverting story, a cyclical story. There is always plenty of noise on oil price; and b) structurally the oil price is not going to stay high nor is it going to stay low. Oil prices structurally tend to hover around $50 to $80. So focus on macro stories which are structural rather than cyclical macro stories.
I am going to get stock specific. The last time we interacted with you, you spoke about picking out stocks that have strong volume growth and are growing very strongly in free cash flow. So, investing heavily in midcaps like Astral Poly, Dr Lal, Relaxo, Page Industries etc, could you walk us through some of those names and tell us what the performance has been like and if there is anything else within the midcap universe that you think fits this bill?
We have discussed building materials several times. So let me focus on three other aspects of the midcap universe where we are investing fairly enthusiastically in our rising giant’s product.
There are two disclaimers; one every stock I mention is a part of Marcellus’s portfolio and two my family’s money is invested via Marcellus’s products in the stocks.
So the part of midcap where we are getting even more excited than we were three months ago is midcap lenders. With asset quality troubles for lenders largely behind them, we are seeing midcap lenders post not just loan book growth but profitability growth which is north of 25%. So we are building larger positions in Cholamandalam and Aavas Financiers and we hitherto had done. Also, we like ICICI Lombard. It is not a lender but a general insurer, ICICI Lombard is a stock where we are continuing to build a larger position in our flagship product which is a consistent compound.
Moving on to second area specialty chemicals which has been a big favourite of us over the last couple of years ,for obvious reasons as input cost pressures have built up, there has been margin pressure in specialty chemicals. As I just said five minutes back, I reckon input cost pressures are transient. The volume growth and the market share gains that we are seeing Indian specialty chemicals deliver are more structural. So, our position buildup in midcap companies like Alkyl Amines and GMM Pfaudler continues.
The third area is the IT services space. TCS is a long standing favourite, but in midcap IT, L&T Technology Services continues to be a company where we are building a larger position. Like in financials, in midcap IT, specialist providers who can deliver 30-40% fee cash flow growth, 20%-30% PAT growth are not that common. Larger IT services companies find it hard to deliver 20-30% PAT growth consistently. We think L&T Technology Services has a product suite around engineering R&D which will give it a solid five-six year growth runway and hence that is part of our midcap build up.
I know you have flagged off midcap IT but what about new-age tech companies? What is the outlook on and where do you stand on Zomato, Paytm, Nykaa, PNB Fintech?
We have been looking at last year’s IPOs quite carefully. Honestly, in the tech names, we have not yet been able to convince ourselves that there are sustainable comparative advantages there. We are very conventional, old fashioned investors. Forget free cash flows, forget profitability, if we do not even see operating profit, operating margins, then it is very difficult to convince ourselves on the franchise there. Sure they raised a lot of money and have built on GMVE or whatever metric, but if they are not able to deliver operating profitability, then it is difficult for us to convince ourselves why many of these companies are not able to deliver operating profits. Our reckoning is many of these franchises are flattering to deceive.
Ironically, out of the IPOs last year, the one that we have built a substantial position in is Tarsons. It is a provider of lab equipment and equipment to the diagnostic labs. Dr Lal PathLabs for example used to be a Tarsons customer. Tarsons has built a business with 50% EBITDA margins, 30% PAT margins in an industry which is around Rs 1,200 crore but as the specialty chemicals industry and the pharma industry grow, we reckon the lab equipment space will grow similarly because they will supply to the speciality chemicals companies who in turn will supply to the pharma companies.
Tarsons is the dominant player in this lab market. It is a small company today with Rs 300 crore top line but 30% PAT margins and our discussions with dealers and distributors of Tarsons suggest that this is a well run, moated company with very few competitors in the Indian market.
