Markets

Bullish on 3 themes, financials off the table: Kenneth Andrade

Talking to ET Now, Kenneth Andrade , Founder &CIO, Old Bridge Capital , says utilities, consumers and agri are the three themes he continues to find attractive now.

Edited excerpts:

How are you viewing the markets at the current levels in the global market context and in the context of the recent PNB scam?
We just need to refocus back on the way the numbers are actually panning out. A lot of things are happening as far as the macros are concerned but if you look at the underlying micro environment and the quarterly numbers, there are not too many disappointments. Ans that is probably what we should be expecting, going into the next couple of quarters also.

The worst of the bad news is already there as far as the environment is concerned and we need to focus on the fact that the quarterly numbers are good and for the remainder part of the year, this should maintain itself. The balance sheets and even in the near term and the longer term, if I just switch the conversation back to balance sheets of corporate India, you are going to get one of the best balance sheets going into the next couple of years.

We do have issues as far as the financials are concerned and that is more specifically contained in one part of the environment which is the public sector companies. But we know the size of that or we could guesstimate the size of the non-performing assets that are there.

All we need to do is find a solution for that. This will eventually wind itself down, but apart from just that, part of the corporate sector I think rest of them are pretty much ongoing. As far as global macro environment is concerned, I think the volatility is here to stay this year. Quite clearly, the biggest dampener to equity investing today is valuations and valuations are stiff. Valuations will continue to hold on to these numbers only if earnings actually rebound and that takes us back to the focussed back to earnings and if earnings hold on to growth that they have displayed in this year, the environment should be quite good for equity investing into the next couple of years.

Let us talk about the opportunities that you foresee in this sort of market environment. Taking a leaf from what you just mentioned, actually the earnings picture in Q3 did not look that bad. There were more numbers in line. There were a few which were definitely outperforming but largely the sense that you got was things were on the mend. In that sort of backdrop, where do you see the opportunity from risk reward perspective emerging in the market? The only sectors that look more attractive on a relative basis are IT, pharma and infrastructure. Where do you go about finding value in this market and how do you propose to make investments?
We need to look at the breadth of the market. Like I said, the dampener for equity investing today remains valuations and valuations will continue to remain stiff. If the news on corporate earnings continue to come in, it will continue to hold on to those valuations. We have to go for companies that had capacity on the ground and are growing in line with demand which is equivalent to GDP growth or a little higher than that. Corporate India’s capacity utilisation is around 70% and every time you are stressed and every year, you add another 5% to GDP growth or 6% to GDP growth and that should increase capacity utilisation.

As long as there is no supply side coming in, that is what we see from corporate India. There are no new large-scale projects that are really there on the anvil. As long as supply is constrained and demand is continuous, that is going to add a significant amount of operating leverage on balance sheets. The key to all of this is big businesses that have incurred capital expenditure, businesses that are low on financial leverage and just run with them. They are not coming from one or two sectors. The breadth of the market is completely open out there.

The challenges in the market like this is how do you pick growth and if you are trying to pick growth, what valuations are you willing to pay for that? Those are two challenges that are there in the environment but there is enough of capacity on the ground. There is financial risk compared to what we saw about five years down. Investing today does not have any financial risk because no companies on the ground are really leveraged.

We just have to put together for most investors a portfolio of 20 to 25 companies and that is all you need to run with it. It is a fairly large spectrum of businesses that are doing well and we just need to find the couple of them that are growing faster. I cannot possibly think about one domestic industry. Exports do have their challenge when it comes to pharmaceuticals and some part of IT but the domestic businesses do not really have that kind of challenge in terms of growing profitability.

Where are you finding value right now?
If you are talking about utilities, that industry is relatively in distress. There are a couple of businesses out there that you find merit in. I have been speaking of media for some period of time right now but we are finding traction on a couple of companies already that are showing reasonable growth in both top line as well as profitability.

In some part of the agri value chain, valuations are already there. What is required is finding out where will the growth actually come from. The macros are conducive and we will need to see how it actually plays out over the next couple of quarters. This space is a little expensive compared to where it used to be about two years back. If you go into the automobile basket, commercial vehicles have not done anything for a long period of time and there are just a couple of companies out there that you could align with. This is another part of the business that we are looking at.

Even within the consumer space, you will find opportunities. These are places that are showing relevant growth in top line or in turnover. Bottom line will get magnified going into the next as capacities continue to get utilised but one space that we have navigated through or we have not participated in yet is financials. The asset side of the entire economy is doing relatively better than probably the companies that are actually funded. We clearly stay away from that part of the market for now.

Is that a strategy that you would continue to follow or are you tempted to jump into any of these financial names?
No, I think we are pretty comfortable in the spaces that we have.

Does it mean that it is really all bets off the table even for some of the large cap private banking names which have actually delivered good returns and consistent returns and are compounding stories? What about HDFC Bank or a Kotak Bank or an IndusInd Bank where the numbers have looked good and some of the housing finance companies where the rally has been strong?
Well, for the last year and a half, I do not see any reason why it cannot be in continuation but we have been holding on to the premise that we are looking at companies that offer reasonable amount of value and have enough capacity on the ground to actually leverage it into the economy. We find a lot of them in manufacturing and currently from the format that we work on in terms of advisory and portfolio management we do not necessarily need to be across all industries.

We as a manager can basically pick two or three spaces and dominate those particular industries. That is the format that we adapt and financials is where we do not fit into that entire market. Now we got to distinguish between good companies and good stocks. I am not saying that these are not good companies like you mentioned. There are a couple of names that have been compounding stories over long periods of time. I should have been in that going into 2017 and 2018. In my previous careers, I have participated in some of these names. But currently, where valuations stand and from your return expectations, a lot of it is already priced in.

I would not know how to make significant amount of money out of this basket because while a few companies will generate reasonable amount of upside, the format that we operate in, means, we can choose to stay out of these names and we are happy to do that. It worked for us in the last couple of months.

The way you approach your portfolio is that you like to pick up small, niche businesses not popular yet but very decent mid and small cap stocks. Do you think it will be difficult for the small and the mid-cap category now to remain an outperforming category? In 2016 and 2017, it was the game of tick tack toe, you bought any small and mid-cap stocks and they did better than large cap stocks. Do you think that wave is now behind us?
The divergence is already showing up and it has been showing up for the last year and a half. Any company, that has not been able to deliver the quantitative numbers will not be participating in the market. So, I do not think that trend will break. We are clearly not in a valuation driven market anymore, we are clearly in a very growth driven market. We necessarily have to find opportunities that will continue to expand themselves. So, going forward, I am not too worried about the space that we occupy which is small niches and companies that are mid-capish in nature. We will still find opportunities, we will still find industries at the bottom end of their entire industry cycle and timing these things are always fraught with uncertainty but any industry at the bottom end of its economic cycle gives you enough opportunity to pick companies within that entire space itself. That is where we are and we find reasonable amount of space to occupy out there.

Are Coromandel Fertilisers and Kaveri Seeds still your favourites or is that passé now?
I did mention that that entire IP value chain is not as cheap as it used to be about 18 months back and we just have to wait for growth to kick in in that space. The macros are good for these companies. We will have to see how they play into the environment and increase volumes out there. Challenges continue to remain, markets are fairly well priced.

You have bought liquor stocks in the past and now there is evidence of earnings recovery and demand stabilisation. Is it time to revisit some of these good old liquor names?
Well the worst in terms of news and bad news is behind them so yes, that means that they can go back to constant rating on growing the business and markets and less on how the environment actually works for them. It is all about growing the business from here. I think they have got the– they understand that and they are running with it.

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