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Auto, auto ancillaries would be my favourite play on economic recovery: Saurabh Mukherjea

Two-wheelers likely to recover quicker than cars and trucks as their ticket sizes are smaller.

ET Now|
Nov 20, 2019, 11.41 AM IST
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ETMarkets.com
Saurabh Mukherjea-1200
We are buying one of the two-wheeler companies in some of our client’s portfolios says Saurabh Mukherjea, Founder & Chief Investment Officer, Marcellus Investment. Mukherjea also says getting high teens to low 20s returns consistently by buying great compounders is very doable in India. Excerpts from an interview with ETNOW.

There is every reason why one should not buy telecom stocks. In the next 10 minutes, we can find 15 reasons why one should not buy telecom stocks yet Bharti is at a 52-week high. What is going on?
I guess there are probably enough people out there who are hoping that that the industry consolidates around two players and Bharti benefits from that from being one of those two players. I do not see any other logical way to understand this other than the fact that a number of investors out there are making a punt that they are in a two-player industry. Bharti will get its fair share of spoils. I cannot give you anything more substantive than that, I am afraid.

Can we imagine our life without power? The answer to that is no. But have shareholders of power companies made money? The answer is “no,” at least in India. Do you think telecom is like power? You need telecom but for minority shareholders, telecom companies will struggle now?
Most regulated industries in India are similar -- whether you look at airlines, telecoms, power, infrastructure or real estate. Wherever the regulatory construct is such that the regulator or the government calls the shorts in terms of who gets in, who stays out and what are the rules of the game, it is very difficult for minority shareholders to make any money. That is the rule of thumb I followed in my 11 years in India -- stay away from sectors where the government or the regulator determines the rules of engagement. In such a sector, it is very difficult for minority shareholders to make money be that telecom, power, real estate or airlines.

ETNOW sources seem to be indicating that today the cabinet is going to decide on disinvestment in BPCL, Concor and SCI. Earlier also, the finance minister had indicated that disinvestment process is going to come to a close and she hopes to close in on that by the financial year end. Would you say though that the best is already in the price somewhat?
I am not so sure how easy it will be to make money from high quality privatisation plays such as BPCL and Concor. Both are actually very good quality assets but I am not so sure how easy it will be for minority shareholders to make a punt on them and make money. What is more encouraging, what is more upbeat for the generally is that the government is clearly saying that in the next 6-8 months, we will move towards privatisation or large stake sales. That is probably the most bullish step forward towards privatisation we have seen in 14-15 years. The last major privatisation was made by NDA-1, a good 20 years ago. Beyond the stock specifics, this momentum in selling class assets is very encouraging for the market as a whole.

Given the degree of underlying uncertainty in the economy, we are looking for companies where we know with a very high degree of certainty that the books are clean and the numbers are real.

-Saurabh Mukherjea



What is the overarching theme that you are going with in the current environment? Is it domestic focussed names, is it valuation?
Given the degree of underlying uncertainty in the economy, we are looking for companies where we know with a very high degree of certainty that the books are clean and the numbers are real.

Secondly, we look for companies where the products are as close as is possible to be essential for day-to-day life in India. We are trying to avoid companies where the product or the purchase is discretionary in nature.

Third thing is barriers to entry. Clean accounts, essential products are very good to have but you need to have barriers to entry to make sure competition does not come and take your profits away. And when we find such companies we go and buy as proactively as we can without losing sleep on what was the PE multiple yesterday morning, what it will be tomorrow morning. We found in India around 20 such stocks; half are already in our portfolio and hopefully in the next year or so, we might find a couple of more stocks like this.

As and when the economic environment becomes less hostile, we might become a little bit more adventurous in our stock picking. Over the last couple of years, it has been very tightly defined mantra, clean accounts, essential products, very high barriers to entry.

Sunil Singhania said buying a good business and buying a good stock are two different things. D-Mart is a great company, Indigo is a great company, a classic compounder which you own. Something like Aventis is a great company but if you are buying them at PE multiples of 50, 60, 70, the chances of making double digit returns for next three years are very rare. Do you think those classic compounders which you like and which are based on previous history, return ratios, ROE and ROC, they are outpriced right now?
Sunil Singhania is a long-standing a guru, a friend, I have learnt from him in the years to come and we hope to learn a lot from him in the years to come. I learnt from him two years ago as to how to think about setting up an independent asset management business. Sunil is saying if you try to do what we are doing in India and try to do this in America, you will get slaughtered.

In most efficient markets like the UK, USA, Germany and Japan, it is very difficult to maintain return on capital at 40% or even 30% over an extended period of time. Most glamorous well known American or Japanese firms will have return on capital of barely 15%. If they get to 15%, they will be celebrated on TV channels in America, on the covers of magazines and so on.

Our country is unique amongst the world’s 10 largest economies in that we are the only large economy which has around 20-25 companies whose ROC is a million miles above their cost to capital for decades on end. When we say million miles, I am saying 40% ROC for a very extended period of time. If you can keep return on capital so far above the cost to capital for an extended period of time, it gives you a mountain of free cash flow and if you keep reinvesting that money in the business (as we have seen in India over the last five, 10, 20 years and even last year), you get a very high chance of keeping earnings growth around 20%-25% mark.

If we take one example of the several in our portfolio, this is exactly what Asian Paints has done for the last 30 years. Asian Paints 20 years ago was trading at exactly the same PE multiple. Asian Paints over the last 20 years has given close to 100 times returns. Nestle 20 years ago was trading at pretty close to the same multiple. Nestle over the last 20 years has given close to 80-90 times your money back. I do not know about the next three weeks or next three months, but I am pretty confident that if we carry on focussing on this type of company with very high barriers to entry, with return on capital being well above the cost to capital, we chug back plenty of free cash flow into the business. Whether you are Asian Paints, Pidilite or Dr Lal Path Labs, you reinvest the free cash flow back into the business.

In a poor country like ours, the growth potential is immense. Even in a downturn, you are seeing these companies -- Asian Paints, Dr Lal Path Labs and even Page Industries -- which is a big part of our portfolio, give you volume growth between 9% and 19%. That gives you a sense of how far we have to go in terms of development to our country.

PE-based investing has a big place in everybody’s portfolio. In the west, PE-based investing, value investing as it is better known as, is the definitive way to manage money by and large. It works in India as well. There is a small set of companies in our country which are able to keep return on capital very high and thus earnings growth is very high and if there you invest even at 100 times PE shown over the last three years and in my books I have shown over the last 20 years you still make very healthy returns, high teens, low 20s returns.

If I make high teens, low 20s returns for our clients consistently, that is a pretty decent outcome for them. We are not claiming we can do 30-40% return by timing the market or by getting the PE multiples right, but high teens to low 20s consistently by buying great compounders is very doable in India.

You are completely staying away from power, metals, real estate pockets. If we do see an overall pullback which we have already started to see when it comes to the market regardless of the fundamentals or growth indicators, do you see more participation across the board?
The most interesting one will be auto and as we all know October has been a pretty decent month for the auto sector where everybody is trying to figure out whether October is the beginning of the auto revival or whether it is a flash in the pan. What we have started to do in some of our client’s portfolio is, selectively buy one of the two-wheeler companies. I am not at liberty to disclose the name but we are buying one of the two-wheeler companies in some of our client’s portfolios not because we expect the two-wheeler revival to have begun a month ago and from now on it will grow, but given the quality of the franchise, the high ROCs, high cash generation the sheer quality of the corporate governance, we felt that the two-wheeler company was just too deliciously cheap to be ignored.

We will see if the two-wheeler company carries on showing us that even with low volume growth they can hold up their business, you might buy some more. I am not so sure cars and trucks are going to recover quite as quickly as two-wheelers. I think two-wheelers are likely to recover quicker than cars and trucks because their ticket sizes or purchase are smaller. But this is probably the biggest sector if one wanted to play a potential economic recovery. More than cement, steel or real estate, two-wheelers and the auto would be the industry to look at. There are several good auto ancillaries which are absolutely smashed in terms of valuation. Again, these are cash generative companies with strong balance sheets. So, auto, auto ancillaries would be my favourite play on economic recovery as and when we get visibility on that.

Also Read

In every sector, 1-2 giants emerging at the cost of the rest: Saurabh Mukherjea

India needs an index with a blend of m-cap and macros: Saurabh Mukherjea

BPCL, Concor sale to bring $15-20 bn to fisc: Saurabh Mukherjea

Economic reform is not a panacea for all companies: Saurabh Mukherjea

Go bargain-hunting as markets near bottom: Saurabh Mukherjea

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