While the margin of safety is low in equities right now, cashflows for companies are expected to become more stable in the next couple of years, says Kenneth Andrade, Founder & CIO of Old Bridge Capital Management.
Cashflows will improve on back of policy changes and not monsoon. Spread of credit is also expected to improve as more money will be in hands of people, he says.
Banks, which have recognized stressed assets, have value, but pricing them is difficult. Not many structural changes are happening and thus banks cannot be priced high.
The consumption story is looking strong with wage hikes across segments. Near-term valuations in consumer durables are rich, he says.
Prashant: What are you doing, just tell a little bit about what you are doing right now. You are setting up a fund raising money and going out on your own?
A: I stepped out of the industry about a year back and currently just putting together a small team. We will get back to active money management, the course of the next couple of weeks, I hopefully raise a little bit of money.
Prashant: Raise money.
A: It is never a good time to raise money when markets are on the upswing, but I guess it always an opportunity in equities and as long as you in a pre-defined space and willing to stomach the volatility, in the longer term including the near term thing should be quite okay.
Prashant: Actually, paradoxically good time to raise money because people are willing to handover cheques right, but for you to actually put that money to work gets that much more difficult.
A: Yes, the margin of safety in equities in quite low right now. We have upfronted a lot of returns and we expect the execution has to kick in and earnings have to come back again. It is a pretty long cycle. The near term visibility is low and you got a lot of arguments around how liquidity is going to change the underlying characteristics of the price earnings multiple of the markets. So that’s not a very good argument to hold if you are a value investor.
Prashant: You said margin of safety generally in this market is low. What do you like right now?
A: We continue to build a very large picture of the Indian environment. All investors usually build a large environment in the Indian industry and break it down into verticals. So the opportunity as we seen it is the large demographic pattern that exist out here and the conversations currently are all around monsoon and good agriculture.
It pertinent because that 60 percent of your population or virtually 60 percent of your population, but if you just eliminate the monsoon spread and look at structural changes that are happened. First in the urban economy and now going back to the rural economy, I think cash flows will be lot more stable going into the next couple of years. That’s because of a policy change and it got little to do with the monsoon.
We should see start of the credit availability in the system expand quite rapidly and if that happens, you are transferring capital and money in the hands of the base of the Indian population, so that’s when I guess the demographic dividend will actually play out, but it is a very long cycle. You made a start this year, how it plays out like I said it is a lot of execution out there.
Ekta: We have seen the whole asset quality review (AQR) finished by banks last quarter, two quarters of it is completed. Do you think that this quarter might be better in terms of banks earnings or when do you think the cleanup will actually start showing, we in fact had the SBI management say that maybe, we have bottomed out in terms of non-performing asset (NPA), the NPA cycle right now would you concur?
A: Well, you haven’t had a bad assets that has come into play, that’s gotten funded after 2012, so what the banks are actually grappling with is something that is prior to year 2012 and you bought it forward to 2016.
So, you have been able to define the deterioration in your balance sheets, all management I guess have been able to identify the deterioration on their balance sheets and the good part of this entire system is, till last year they were refusing to acknowledge it.
The sooner you acknowledge the problem, you can actually see visibility that it will bottom out someday. Now whether it this quarter or next quarter, I think 2017 is the year that it will definitely bottom out.
Prashant: So any opportunities there? Sanjay Bhattacharya once told me that Kenneth is a true value investor, lot of claim the title, but you are one. Is there any value there?
A: There is lot of value in these businesses, but how do you price them in a cycle like this I am not too sure. I won’t pay top bucks for companies like this, because if you look at a 10 year return on equity (ROEs) in the banking business, very rarely have you come across a bank who has been 15 percent ROE plus right through the cycle.
So you average it out across some of the corporate lenders that exists, it is a pretty weak business. So you might be able to play a valuation bounce, but this is something structural happening in these companies, I don’t really think so, so it is a trade.
Prashant: I think Coromandel International is something that is top of your mind at this point. Just talk about that business.
A: As I look at it everything that’s got to do with monsoons and consumers is being a good run for all these companies. It is more to do with the segment that he operates or the sector that he operates in rather than the company itself and that essentially what is changing long term.
So, I am saying that if you are fortunate to have a good monsoon, but once you take cyclicality out of the system and that is coming from the way the crop insurance is actually priced on the ground, so that one large change availability of crop insurance and there is a pricing formula to it and what the farmers with the crop actually fail, the financial system now will have recourse to the general insurance companies and not really to marginal farmers, so you credit availability to the system now expands to AAA companies which take on the risk of a bad crop cycle which will happen.
To enable to price the product well and the government price the product obviously it has been subsidised to the hand of the end user, I think takes away the cyclicality of the cash flows from the system.
Ekta: Seventh CPC which is eventually suppose to flow down to state government employees, PSU employees. How much of a game changer do you think it is in the consumption story and if you had to play it, would it be via say the NBFC space, would it be via your consumer staples durables.
A: The entire space is extremely well priced. A lot of the businesses or lot of the returns have been upfronted already. We need to see how execution takes place, but when you talked about wage increases it is not just happening with the government employees. It is a stated objective of the government to double farm income by 2022 also.
So you seeing this time your GDP growth could be led by higher per capita income, now it can’t be as linear as that because you need a lot of asset creation at the side itself, but the asset utilisation of lot of corporate also necessarily needs to get used. So first you create the demand and one of the ways to create the demand is actually stimulate the consumption, per capita income and then bring industrial productivity into play before you grow into the next cycle of capacity creation and you get falls through.
I think yes you will get spikes in the consumer space which you already seen happening and you will have to look at that in that part of the market actually get fragmented itself, so you are asking me near term valuations are very rich and very priced in, so the argument is all about how much liquidity is going to chase that basket and that’s not an answer I have readily available
. Prashant: So you raise Rs 500 crore or more, what do you do at this point and what do you with that?
A: Let put it this way a lot of the markets already pricing in that consumption will happen and that is a small space before per capita income goes up there and companies that lead to the higher per capita income creation.
Prashant: Give me an example just to name them.
A: So step back into what’s really building per capita income on the grounds and farm don’t double because the government say they are going to double, you have got to work through the cycle and you got to bring your cost down and you got to take your incomes up, so lot of this is going to materialise on the ground and once that happens you create an entire ecosystem around it, so you get services that come in, you get large financial business that’s get created which is relatively small, so I am not talking about the banking system here.I am just talking about maybe the insurance companies that are there and that you create the entire logistics chain around the entire business out there.
So I think there a lot of multiple opportunities out there. It is not your consumer consumption led businesses you will have a lot of commodity businesses that will suddenly look like they are consumer companies over a period of time.
I think that’s the space you need to get into, so what happening with fertiliser at this point in time, I am little averse to stepping down into smaller companies in a market environment like this, but that a fairly large business and it remained within the government purview of how to price it on the ground for the last 20-25 years, that maybe changing, like I said it maybe changing.
So if the macros are supportive of some of these companies business models, I think dramatically you will see a lot more traction happening in the space.