We do not think we are in such a bad place even if we are in the small and midcap space right now, Kenneth Andrade, Founder, Old Bridge Capital Management, tells ET Now. Andrade finds value in infrastructure, manufacturing and all companies with a rural footprint.
Edited excerpts:
When you started your fund, you communicated to investors that you would not buy financials, did not like NBFCs and that there was a bubble about to be pricked in some of the NBFCs. You got it right.
It is just the investment process that we go through. We always mention that we like to be early into a cycle, pick that cycle up and run through it. Two parts of the markets have been there for a period of time – the financials and the consumer businesses. We still do not have too much of exposure within our portfolio in these two spaces. I guess it is just following a methodology that we have been used to in our prior experiences and just running a format in what we do right now.
Would you like to revisit that pledge because financials have corrected?
We are not very opportunistic in terms of searching valuations. What we try to do is pick a business cycle and then ride it from the bottom end and hopefully somewhere in the middle to the top. Right now, we are just seeing a correction of the entire industry. As we move forward, any business that goes through this kind of correction in this case it is one particular industry that we are going to see you will have consolidation move, you will have a business that move sideways for a period of time and then you will have leadership being re-established, some of the smaller players actually finding the feet back again and then re-establishing themselves back in the entire system. So we will wait for all of that to happen. Like I said we are not very opportunistic in just trying to pick falling valuations that has not been our style for a long period of time.
How are you reading into the market construct right now? We should soon be breaching even that 10,000 mark. Is there no end to the pain because global markets have just about begun their fall?
There is very little you can do because at the end of the day we value our business for its ability, potential and the numbers that are delivered on the table. This is a nice time because in the next couple of weeks, you will be inundated with a lot more results. We try to take ourselves away from the market place and just involve ourselves into finding the numbers.
Over a period of time what makes a bottom in the cycle is that beyond a certain valuation, markets do not fall, beyond a certain valuations stocks do not fall. I am not too sure that we are there right now but we are very close. This is the first time in probably last two decades where you have seen a market correction of this size where corporate balance sheets are completely unleveraged. You have got growth happening on the ground but probably not growth in the consumer and the retail finance part of the entire market.
That seems to be one spot of trouble but we can go through this cycle time and again and for extended periods of time. But there is always an opportunity that will surface over the next couple of months and as long as you are in the part of the opportunity, the next couple of years should not be so much of a problem.
I understand there is concern about what is happening in the international market but sooner than later, that contagion would go past us. 2018 has been a soft spot for all of us but also remember that this is coming on the back of five very good years in equities.
You got to take this in the stride and have to believe that after a point in time markets do not fall and you will get valuations support somewhere down the line. You just have to choose the spaces that you want to be in and the next cycle will emerge in those spaces.
Despite the valuations support for a lot of quality financials which have fallen, you do not want to buy into that fall.
Just try to address that question on financials. Let me take you back to the last decade and the last cycle where everything was funded by the corporate banks and a lot of money went into infrastructure and the commodity business. At that time,all corporate banks traded between three times price to book to five times price to book. On the other extreme, there were the infrastructure businesses which were trading for anything between 20 times multiples to 60 times multiples. Retail consumers never existed in that decade.
You can flip over to this decade and see what is happening right now. It is something very similar. Everything that is going to do with retail finance is being led by the housing finance companies and the auto finance companies because those are two largest parts of the entire retail finance basket. They went to valuations which we have not seen before in financials. They also went to valuations we have never seen before in the other side of the market which is the consumer driven companies or the auto and FMCG stocks.
So we have very similar situations playing out. Just the part of the economy that played out in the last decade is very different from the part of the economy that is playing out in this decade. This transition will also go through. The deleveraging process that came up from the last decade is over. We just have to rehabilitate or restructure our financial, our liability side of the business which is effectively the banking business and all should be okay going into the next decade.
You have to expand your horizon. Just look at what is happening on the ground, choose to be in places you want to be and obviously eliminate places where there are question marks. If you do that, the portfolios will behave perfectly well.
Smallcap and the midcap spaces are where you normally hunt for ideas. How are you dealing with this kind of excruciating fall in small and midcap stocks?
These are all collateral damages. 40% of the market is actually imploding or there is trouble in about 40% in capitalisation of the business. All that will lead to collateral damages with everything that is there on ground. You can look at it from a risk point of view or as an opportunity.
In my last experience, we actually came through. Everything came back to CAGR of 15% return on portfolios in about three years. So 2008 happened, 2009 was the recovery period and that was only the recovery period. We came back flat or even negative in 2009 and then 2011 and 2012 you did not even notice that 2008 and 2009 actually ever happened to you.
That is the way you have to condition yourself to move the entire situation forward. Stocks are down, businesses are down. You have got an opportunity to move your portfolio around to look at the best part of the entire market where you want to be in and where your conviction is highest and the ride the next cycle.
Markets do not give you these chances too often. The all-time highs and all-time lows are opportunities where you should churn a significant part of your portfolio into doing something and that is what the environment is telling you to do. So, we are taking this in our stride, at least a lot of our portfolios and lot of our stocks have started behaving very differently from where the market is currently. We do not think we are in such a bad place even if we are in the small and midcap space right now.
Where is that opportunity right now? You said buy this fear but what do you buy?
We have got a very simple construct. Almost 35-40% of our entire portfolio has got to do with manufacturing, infrastructure and utilities. We have not seen valuations like this since 2011-12. Absolute debt on some of these businesses are the lowest that they have ever been and their execution is at an all time high. We have got almost 30% of our portfolio and this is a carry forward from what we have been doing for an extremely long period of time in 2016 and 2017 in everything that has got a rural franchise or a rural footprint.
These are the two sweet spots that we are in, neither of these two sectors have been through any kind of overvaluation. Both these industries are going through massive consolidation phases on the ground because it is extremely difficult to do business in an environment which has actually got no capital coming in. Also, there is no incremental amount of comparative pressure on the ground. So that dominates our portfolio right now.
Of course, we have a little bit in healthcare, media businesses and a couple of alcohol stocks. But that is a very tiny part of the portfolio. We are still beginning to understand that space and naturally build a portfolio around those environments but these are the two dominant parts of our entire portfolio; infrastructure, manufacturing and all companies with a rural footprint.
What are your new themes?
We have been in manufacturing and infrastructure — two dominant part of our portfolio right now and utilities of course.
NBFCs were shouldering a lot of credit growth in the system while banks were not lending. What kind of impact do you think NBFC crash have on sectors which are dependent on credit growth?
There are only three large borrowers — the consumers, the corporates and the Government of India. Right now, there is a freeze on lending through the NBFCs which is essentially a part of what is going into consumer credit. If lending has to go, it has to go either to the government or to the corporates.
Corporates are looking at balance sheets. The government remains the only borrower for the time being. But going into the next year, they have to rationalise and they have to get out and lend to some part of the economy and that is when they would go and look for basically solvent balance sheets.
I am not too sure and it is probably too early to take that call that the next six months retail lending will re-emerge, it probably would not re-emerge for some period of time that means banks will have incrementally look at additional money going somewhere. It is the same with the equity investors or the banking system. They have all new money coming into the cycle, it has to find its way into some part of the economy and that is when the credit growth to these industries will actually start.
We have to give it six months to see how the macros shape up or how this industry cycle shapes up. Money always follows solvent assets. There is a reasonable amount of volatility around lending through the NBFCs. They are not going to get money in a hurry. Retail credit will pause for a brief period of time. The only beneficiary of all of that holding still is corporate India.
Corporate India has the appetite. We have seen a reasonable amount of expansion or capex coming in on the ground. The only question that most of the corporates have is where is the access to the finance. We believe all of this will ease out probably in the next two to four quarters.
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