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Consumption slowdown overplayed as an excuse for buying wrong stocks: Saurabh Mukherjea

ET Now|
Updated: May 16, 2019, 02.36 PM IST
Saurabh Mukherjea-1200


  • Don’t lose yourself in the noise and lose the signal.
  • We need another 25 bps rate cut.
  • Don't overplay consumption slowdown.
After a 10-year blast up of consumption and a 10-year fall in savings, it makes sense if for 2-4 years, the savings rate recovers back to where we were 9-10 years ago, which is around 25%, said Saurabh Mukherjea, Founder, Marcellus Investment Managers, in an interview with ETNOW.

Edited excerpts:

Are we reaching a level where one should be looking for bargains rather than focussing too much on the election permutation and combination?

I have always felt elections are relatively irrelevant to Indian equities at two levels. First, as I have said several times, I do not think any political party in our country really has the answers to the big policy questions, the big economic issues of our era; such questions as to how do we improve the health of this financial system, how do we create jobs, how do we create social security safety net etc. In the absence of politicians having answers to the questions which really matter, I am not so sure it makes a difference either way who comes to power on 23rd, 24th May. So that is a fundamental reason.

Secondly, the challenge with the Indian market as I have been saying for the last couple of years has been that it has been overvalued -- 26 times trailing earnings or 29 times trailing earnings. The market is still overvalued and until that overvaluation corrects, I am not so sure overall market level buying will make a great deal of sense even now, regardless of who wins on 23rd May.

These two points make the elections a non-event for investors. Where I am getting interest is say a situation like ITC. It is a classic coffee can company -- 10% revenue growth, 15% ROC. It meets those criteria comfortably over long periods of time. It is a monopoly for all intents and purposes in cigarettes; it has got a chairman and an MD who knows the company inside out but the stock has not done that much in three, four years. That is the kind of situation which always appeals to me, a high quality dominant franchise, but it does not seem to me that the market has really priced to a level where it becomes unattractive.

I am looking for bargains in companies where the franchise is superb but the market does not seem to appreciate it. I am not looking for bargains for the market as a whole in totality, which still looks too expensive to me.

You talk very positively about names like Asian Paints, Nestle. They are high quality franchises but it is interesting given the slowdown narrative that has been predominant over the last few weeks. When you are talking about long-term plays, would you still consider buying into some of these names at these levels?

If you are trying to make money in the Indian stock market what is really important is not to lose yourself in the noise and lose the signal. Nestle and Asian Paints have given the signal that they have given over the last 20 years, that in specific segments of the Indian economy, they have an absolutely dominant position. So Nestle’s case in baby milk powder from which comes the majority of their profits. They have almost 90% market share.

In Asian Paint’s case, for the last 50 years, this company has had more than 50% market share in paints. On metrics like working capital cycle, ability to generate cash, ability to translate profits into cash, ability to drive high ROCE over long periods of time, Asian Paints is unrivalled.

I suppose my team and I have developed such an appreciation for the strength of these franchises that we do not lose too much sleep over short-term developments. But if other investors out there can do the same, what you are able to buy is really world class franchises. World over, in the last 30-50 years, you will find very few companies which have performed like Asian Paints. It is up something like 1700 times since the IPO in 1983 and over the last 40 years, the underlying fundamentals have been quite unbelievable.

If you take a longer view, and I am not saying take a decade-long view, even if we take a five-year view, franchises like ITC, Nestle, Asian Paints make you lots of money. If on the other hand, you choose to lose yourself on what will happen on 23rd May well you might be able to entertain yourself on the results day but it is not a particularly lucrative way to invest in a country like ours, which is giving you these incredible franchises which make tons of money.

Everyone says the slowdown is very short term in nature, that the consumer slowdown and the auto slowdown will pickup. What will it take for the demand to come back and historically what are the factors which have contributed to a comeback?

Two things; one, the slowdown is very selective. Look at Titan’s results. There is nothing called a slowdown in Titan’s results, if you speak to manufacturers of high-end apparel, it is not apparent that there is a massive slowdown in luxury consumption. Yes, there is one in auto and there is one in consumer durables, but that is for understandable reasons. Those sectors were funded through NBFC credit and we all know what is happening in the NBFC sector.

The other thing which is worth doing is just zoom back up and look at what has happened in the last 10 years. Ten years ago, India’s household savings rate was around 25%. Over the 10 years, it has dropped to something like 17%. That is great news for consumption, but that is not very good news from a savings perspective!

Banks are struggling to get deposits and the problems the NBFC sector is facing is in attracting money. We do need resumption and a recovery in savings in our country to infuse low cost capital into the financial system, into the banking system and therefore, after a 10-year blast up of consumption and a 10-year fall in savings it does make sense for two, three, four years the savings rate does recover somewhere back to where we were nine, 10 years ago which is around 25%.

From both perspectives, it is worth not overplaying the consumption slowdown. It is not across the board and looking at the big picture over the last 10 years, where we have had a steady decline over a decade in the household savings rate, it is worthwhile pushing that savings rate up because it helps a large sector in our country; the financial services sector. I am not that fussy about this consumption slowdown. It has been overplayed by people who want to create an excuse for why they have bought the wrong sorts of companies.

Besides ITC, which you said is a perfect Coffee Can Investment portfolio stock idea, where else are you digging out the opportunities?

So, if we go back to the great Rob Kirby’s investment philosophy that he laid out in 1984, we should look for companies which over a decadal period, can give you steady performance year after year. The frontline Indian private sector banks, especially HDFC Bank and Kotak Bank (both are in our client’s portfolios). HDFC Bank and Kotak Bank fit that description very nicely. They have demonstrated over the last 10 years an ability to stay clear of these epic NPA disasters that seem to befall other banks -- both public and private.

Going into what looks to be a fairly significant financial crisis, they have been going with ample fire power -- both in terms of tier one and a strong CASA franchise.

Kotak Bank size is now over above 50% which is quite unbelievable in the Indian context. If you want to go beyond consumer and say you are losing sleep about the consumer slowdown, then look at the financial services sector where a combination of sclerotic PSU banks and troubled NBFCs sector is basically going to concentrate the entire lending activity into the hands of four perhaps five private sector banks. The top two are HDFC Bank and Kotak.

It is a very interesting situation in private sector banks. It is very rare to be able to sit in a market and see the entire concentration of economic activity in one sector getting focussed on three or four companies. We are seeing that in private sector banking in India today.

Does it make sense to buy a Bajaj Finance even though it is 6-8 times price to book?

I reckon NBFCs will emerge from this ongoing crisis. The NBFCs will stand tall and I would put a Bajaj Finance in that list. There are three specific things in works for this company which I think are quite rare anywhere in the world. First, you have not just the large corporate backing, but a cash generative cooperate group. There are others in India which have large corporate groups’ backing them, but very few of those corporate groups have an outstanding cash machine in the form of Bajaj Auto and the broader group.

The second is, Bajaj Finance has worked very hard to reduce the duration of its asset. Then the entire portfolio is not housing finance or real estate developer finance. The portfolio stand is made much lower by auto finance and consumer durable finance.

Thirdly, intriguingly, in 2017 and the early part of 2018, when every other borrower was reducing the tenure of their liability and looking for shorter and shorter dated money. Bajaj Finance from what I can see the annual report did not do that, they dragged up the tenure of their liability. So, if you have a longer-dated liability, shorter-dated assets, you are crunching the asset liability mismatch down. You got a big cash generating corporate group behind you and over and above that you have got a competent management. It is a good combination and as I said repeatedly, I have never lost that much sleep about short-term valuations for franchises of this quality. It is a part of several of our client’s portfolios.

But choose between an HDFC Bank or a Bajaj Finance. There are sometimes compulsions. You cannot buy both and if somebody has a compulsion for a three-year time frame, which one will make more money?

It is a very tough question I would rather not answer the question. My point is if you got two flares coming up which are going to make lots of money, why worry about choosing? I would have both in my portfolio.

You see growth impacting auto and auto ancillaries in particular, the shift to EVs and also the entire ride sharing phenomenon. What kind of impact do you see there?

I will caveat all of this by saying we are not experts in EV. We are not experts in this whole shift to electric. We read the same newspapers and articles on the internet that you guys do. But what it looks to us is that a combination of policy pressure, policy pressure from governments around the world and the fact that growing scale is making electric batteries and electrical vehicles cheaper. It does mean that our auto industry will also transition to a place probably 10 years hence. Perhaps 30% of cars on our roads will be EV.

So the old-fashioned ICE cars now going to die away very soon. But it does look that there is a transition underway. Obviously that begs the question as to which Indian auto EM will be able to deal with it. So the auto situation is quite interesting. I do not think the near-term cyclical downturn will last indefinitely. Sooner or later. we will come out of the near-term cyclical downturn.

But there is the longer-term question as well. How do the giant auto OEMs, which are ICE driven, companies like Maruti, M&M reposition themselves? These are well managed companies. They will find a way out of this cycle, out of the ICE and into the EV world. But I think free cash flow will get squeezed. As these companies take out more money to invest in the EV platforms first an R&D, then in manufacturing I think return on capital employed and free cash flow will come down which in turn has a bearing on what sort of long term valuations the auto OEMs can command. So I would be careful about jumping into buying autos saying that the sector is bottomed out. I think the scale of investment is necessary by the auto OEMs to transition to EV will be quite substantive. The impact to long-term valuations could therefore be quite meaningful.

Let’s touch upon money markets as well. We all know what the market wants. What are you anticipating or what are you pricing in?

I do not think the central bank has that much choice. Look at the scale of challenges facing us in the financial system and the RBI has to keep the system flushed with liquidity. It has done as good a job as it possibly could be expected to do in the last seven-eight months.

Second, I think we need another 25 bps rate cut. We are in a pretty tricky situation both in terms of bringing down the short term cost of money and in terms of system liquidity infusion. RBI should do as much as it can to take us through what will be a pretty tricky summer for the CP and the NCD market.

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