It is turning out to be quite a stellar market after the Monday slide. How are you reading into the situation given the new Covid strain in the UK and lots of clampdowns coming in globally. It seems Indian markets are not taking too much notice?
We have to realise that the vaccinations across the world will take a long time. I have been speaking to my friends and relatives in the UK but it is going very slowly and it does not look like anytime in the next 12 months we will be done with this whole drive to vaccinate the world. It will probably take the best part of two years and we are going to be prepared for the two-steps forward one-step back dynamic. This time it is in the UK, perhaps next time we would not be so lucky!
In that context of two-steps forward and one-step back, it makes sense to invest in companies that benefit from this in the early stages of this economic recovery. They have been very emphatic since March that we are in the beginning of an economic recovery, Indian economic recoveries are driven by cheap money and cheap oil we have got both of those. We are in the early stages of recovery but because of these two-steps forward one-step back dynamic, people should be careful about investing in quality and by all means play the high quality financials, play good auto companies to benefit from the recovery but do not get suckered into low quality smallcaps, broken balance sheet financials or broken balance sheet companies in power, infrastructure and real estate sectors.
What is the pecking order when it comes to the IT basket and your stance on its future?
Over the last 20 years, the leading Indian IT companies especially TCS and Infosys and to a slightly lesser extent HCL Tech and Wipro — the top four Indian IT companies — have shown themselves to be very capable and very adept at changing their businesses according to the changing needs of the western clients. When infrastructure management was doing well, HCL Tech made a lot of money from it. Now that we have moved into a world of remote working and cloud, it is relatively clear that the Indian companies have adapted very well to post Covid and the world of cloud computing.
The top four companies have shown themselves to be very adaptable. Clearly western technology trends change and that is why one should be wary of going down the market cap spectrum. Historically, we were longstanding investors in TCS across several of our portfolios and our faith in TCS stays. Like everybody else, we are excited by Accenture’s bumper number recently. It is quite remarkable how strong the Accenture numbers are and we are hoping that TCS too gets some of that business.
One should not get carried away and go down the market cap spectrum and start investing in monoline IT services firms. Stay with the giants, stay with TCS. Over the last 20-30 years, the company has shown itself to be the scale gorilla in Indian IT. It is nearly as large as the number two and three companies in India put together. At 30% ROC, almost the entire pack has been paid out as a dividend. What is there to complain about getting scale, getting profits, getting dividends and growth.
Is it the right time to relook at some of those consumption plays?
Let us divide the consumption plays into staples — classical FMCG stocks such as Nestle which is a longstanding Marcellus’s favourite. Depending on your taste, you would classify an Asian Paints and a Pidilite in that same basket of classical compounding companies whose products are part of day-to-day life in our country and our view for a long time has been very simple. These are dominant franchises, they really have very little practical competition at the day-to-day level at the market place and as a result they have very high return on capital which gives them heavy free cash flow which they reinvest and compound at a steady 20% over long periods of time.
The more exciting piece around consumption where pulse starts racing is when the economic cycle picks up is auto. My view is that auto does very well in the first three, four, five years of an economic recovery. We are at that phase and therefore it makes sense if frontline auto stocks like Maruti Suzuki and Eicher Motors form a part of our portfolios.
The next part of consumption is of discretionary consumption and the ecosystem built around it. So tiles and sanitary ware and laminates and so on. We have tried to do a lot of work and find good companies in this space. So far Astral Poly is the only one where we have been able to build confidence. This company can give us multi-year compounding as we go into a three-four year economic recovery. So, Astral Poly is our main play. I see Asian Paints and Pidilite as FMCG — very reliable, very stead compounders.
So, if you divide consumption at that steady staples and more exciting plays in consumption the auto piece we have loaded up quite nicely from March, April, June onwards and we stay committed to auto for I think at least the next two, three, four years. The building material space doing more works so far Astral Poly has been our main investment there.
Would you expand your basket when it comes to pharma and healthcare names?
Our country does have several good pharma companies and I have been a big admirer of Cipla for a long time. I have never bought the stock but one cannot but admire what Yusuf Hamied and his family have done for Indian pharma. It is a remarkable company. But a challenge with classical Indian pharma stocks like Cipla, Lupin and even a Sun Pharma is, there are just so many moving parts to it that it is difficult for people like us on the outside to understand where exactly the competitive advantage lies.
In that context, a couple of years ago, we realised that there are two other pharma companies where it is much easier for us to understand the demand dynamics. One is Divi’s Lab. I have discussed it extensively on your channel over the last couple of years. Divi’s is the world’s largest manufacturer and we have done a lot of work on who exactly Divi’s clientele are. Our reckoning is the world’s six largest pharma companies are driving 80%, perhaps even 90% of Divi’s profit.
So you can see the monopoly and the base. You can understand the business and go forward and commit to a long-term investment as you have done in Divi’s. The other pharma company where we have understood the business quite clearly and been able to commit significant parts to our portfolio is Abbott Labs. It is similar to Nestle in some regard. They are selling essential products like Vertin, Thyronorm and Cremaffin to the Indian public.
If you look at those categories, if you speak to general GPs in Mumbai, Delhi, Bangalore they will tell you that it is very difficult to consider for a GP why they should recommend a competitor to Thyronorm or Vertin. These are high quality drugs which generate heavy free cash flow for Abbott. We cannot really see much competition and therefore we went in and bought Abbott.
Beyond those two, we find most of the other pharma names to be quite speculative in nature with too many moving parts and very heavy regulatory uncertainty. I would love to say we would build a larger pharma portfolio beyond these two but we have struggled to build conviction beyond these two. We have also got in our small and midcap portfolios names like Alkyl Amines and GMM Pfaudler which feed into the ecosystem and feed into the supply ecosystem which leads to Abbott and Divi’s manufacturing their drugs. But in the front line pharma names, it will be Divi’s and Abbott Labs sitting in our portfolio.
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