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Select smallcaps looking tasty in terms of quality and prices: Saurabh Mukherjea

"Pharma has now been the flavour of the season for a lot of people" says Mukherjea.

ET Now|
Jun 21, 2019, 02.42 PM IST
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"I reckon the lending activity in our country will end up getting concentrated in the hands of three-four private sector banks, and two-three capable NBFCs"
Saurabh Mukherjea, Dalal Street veteran and founder of Marcellus Investment Managers, says when India’s economic cycle is at the weakest point, it will be hard to defend the rupee at 70 level over the next 12 months. Well-run IT and pharma companies will be the biggest beneficiaries of that. Excerpts from an interview with ETNOW.

ET Now: Since you have a rather optimistic tone to this conversation, I assume either you have started shopping or your shopping list is ready. How are you using the current poor or bad headlines to your advantage in the market? I mean we both know good news and good prices do not come together. News is bad, but prices are good now. How are you taking advantage of that?

Saurabh Mukherjea: Our investment philosophy has been relatively unchanged for a long period. We continue to look for outstanding franchises which we think are available at reasonable prices. I reckon the lending activity in our country will end up getting concentrated in the hands of three-four private sector banks, and two-three capable NBFCs. We have invested in four of these lenders. So something like HDFC Bank. Bajaj Finance is also a stock we have bought quite aggressively for our clients over the past five-six months. We think it is a well-run NBFC with a further assurance of a large, cash generating corporate like Bajaj behind it.

Secondly, we expect a more fairly-valued currency to create a better environment for top quality IT and pharma firms to make money. Pharma has now been the flavour of the season for a lot of people. So we have taken advantage of that to buy two good pharma companies in one of our client’s portfolios. In IT services, we have made sure that we have got something like TCS in our bag, as we go into what I think will potentially be a year to one-and-a-half years of currency devaluation. So we try to keep our temperament on an even keel. We neither get overjoyed by election results, nor did we get too flustered by the events in the NBFC sector.

If you keep doing then and keep buying high quality names, what my 11 years in India have shown me, it can get relatively steady compounding returns through booms and busts. Ours is quite a unique market and it is a privilege, therefore, to be able to live and work in this market.

ET Now: Outside of financials, how are you strategically looking at some of the other pockets -- you have spoken a little bit about the auto space and there is still a question mark about the recovery there. Can, perhaps IT and pharma, be tactical bets against the slowdown that we are seeing as we talk?

Saurabh Mukherjea: On one hand, we do want to stay invested and have in our portfolio companies with good governance, high quality balance sheets, strong cash flows. On the other hand, we have to take the economic cycle into account. When the economic cycle is at the weakest point, the currency would give way comprehensively and, in our reckoning, it will be hard to defend the rupee at 70 to the dollar over the next 12 months. Hence, a 76-77 level becomes more likely. Well-run IT and pharma companies will be the biggest beneficiaries of that. Keeping in mind quality governance, quality accounting, high cash flow and strong balance sheets, we have chosen to go and buy pharma and IT companies in our client portfolios.

The other area I am getting very interested in is high quality smallcaps. They have received an absolute pounding over the past 18 months or so. I do not think this year has been any better for them than last year. There are some small companies which are looking decidedly tasty in terms of quality of their franchises and the prices at which they are available. Doing some more work on this should take us another couple of months to finalise the strategy. But the smallcap space is beginning to look interesting and one of the things I have always felt is when people get most disappointed and most despondent is when you should be most aggressive as an investor looking for high quality names.

When they are most exuberant, like there were on a day like May 23, you need to be little careful. In smallcaps, the situation is looking very interesting.

ET Now: I must flag that aspect of the market which you always focus on: individual stock picking. In this market when you are talking about serious price distortions, does it make sense really stick to a HDFC or a Bajaj Finance or for that matter some of these quality names which are great franchises but they may not give you the bang for the buck, because they are fully priced, that is where bulk of the concentration is, that is where large amount of institutional money has already moved in?

Saurabh Mukherjea: You need to look at the underlying compounders of a stock. Forget prices for a minute. Look at the underlying earnings compounding, and make a call at what rate do you believe this company’s earnings compounding can chug away at. If the earnings compounding of a stock is steep, say a Bajaj Finance or a Asian Paints or a HDFC Bank, if the underlying rate of compounding is steep, whether I buy it relatively rich or relatively cheap, the slope for my compounding is still pretty good. Now, the challenge in India is that these sorts of companies with steep compounding are at the most 30 in number. The vast majority of companies in the market have a much more shallower compounding slope; instead of 25%, they have say a 10%. When you have a shallow compounder, whose underlying engine itself is pretty weak, if you buy it expensive, you might not get any return over 10 years. That is a trap a lot of our largecap funds fall into, because they are running these enormous sums of money and end up buying a lot of the shallow compounders. With that kind of money, you cannot buy 20-30 stocks, you end up buying hundreds of them and you end up ramming your portfolio full of such shallow compounders. That is the challenge for large funds face in our country. For them, valuations are all important. Buying the market at these valuations clearly is a major challenge. But the irony for them is that at rich valuations when they get most of their fund flows, fund management becomes a challenge. You get most of the flows when you least need it, and when you can choose least number of companies with good valuations.

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