Alpha Moguls: Prateek Agrawal On Why Consumption And Financials Are Growth Engines
Consumption and financials are the two sectors in which Prateek Agrawal expects continued growth.
The business head and chief investment officer of the portfolio management service provider ASK Investment Managers Pvt. Ltd., in fact, perceives the sectors as “compounding machines for long-term wealth”.
Agrawal’s assertion is backed with strong reason. Nearly 70-80 percent of ASK’s investments are in these sectors, he said in the latest episode of BloombergQuint’s special series Alpha Moguls.
Fast-moving consumer goods companies, Agrawal said, will continue to generate strong growth for a long period of time. “If an expensive name (company) grows at above average rates, then the growth will take care of the steep valuations.”
He also gave the thumbs-up to consumer durables companies and firms that employ contract manufacturing for these products. “There’s a favourable runway for the growth of companies that can churn out a whole lot of products—including washing machines and cooling solutions—much faster.” He listed the availability of power, need for comfort and improving brand and distribution as tailwinds.
Even the volatility due to the upcoming elections doesn’t deter Agrawal. “Investors need to remember that elections are an important economic activity,” he said. “As an election period ends, the consumption space sees a spurt in demand, and consequently the country sees a better GDP print.”
A drop in the cost-to-income ratios, technology and the benefit of reforms are the reasons Agrawal is bullish on the financial sector. “Discipline towards lending will be key to companies doing well in this space,” he said. “We like managements which don’t look to maintain or enhance margins when their profitability allows them to bring margins down by passing on benefits to the lender, as it augurs well for the company over the long-term.”
Regarding asset management companies, organic growth and new flows would help these businesses grow at 15-20 percent, said Agrawal, and operating leverage could help generate even higher profits. “The companies don’t require cash, disbursement of profits is high and the terminal growth rate for the AMC industry is over single digits.” Agrawal said the impact on valuations can be high “as soon as you plonk a 10 percent terminal growth rate”.
Here are the factors, according to Agrawal, that will augur well for investing in AMCs:
- Extreme under-penetration of equity funds.
- Disintermediation, which will result in debt mutual funds competing fiercely with banks to lend to corporates.
- Fewer regulatory hurdles in the near-term.
Agrawal said he believes in staying invested with the larger firms as they’ll benefit from brand equity and distribution strength.
Watch the interview here
Below is the edited transcript of the interview
The first six-seven months of this current calendar have been different for portfolio managers, mutual funds and individual investors. It is diametrically opposite of what we saw in 2017--return of volatility, midcaps underperforming large caps, flow has not been as robust. Is it possible to predict that the next 18 months will see leniency as far as market treatment towards investment portfolios is concerned?
We do believe that the next 12 odd months will be more volatile than what we have seen over the last year to one-and-a-half year period. That’ll be mostly because, state after state and all meaningful states will go into elections. Two, we are seeing a lot of outflows from emerging market funds. China-U.S. are having their issues, Russia-U.S. are having their issues, Brazil has its own set of issues. So, the major EMs are not looking too great and that itself brings in some degree of volatility in the marketplace.
Other than that, on the earnings front, this year should continue to be pretty good. This quarter has come out okay. Next quarter will be post-GST quarter. Last year, it had the benefit of inventory buildup. To that extent, year-on-year growth will be a bit lower than where it is. But we do see a positive economic scenario. In my interaction with companies, people were very happy and said nice things about GST. Corporate earnings give us hope of growth over the next three-four quarters. Given that buoyancy, we believe market will track earnings and overall should deliver decent returns.
Would you, as a manager, look to place yourself in specific buckets in a disproportionately larger manner to take advantage of themes that you believe will outperform, or would you be spread across the market because by and large the markets might move?
We are not too focused on the index. We are trying to provide preservation of capital and growth of capital for our clients and our clients are the people who have made money already. So, it is not a retail-retail clientele we have. We seek to do it by investing into high quality businesses which can grow very well over long periods of time and not one year. If you find them at reasonable valuations, then you buy and hold them--the compounding of businesses make you money.
It's easier said than done because it’s a combination of high quality and high growth is extremely rare. High quality is the ability of the business to generate more free cash flow. Only if you are pricing your products higher than where they should be, or you are paying your distribution channel lesser than what others do, in either of these two cases, why should your consumer buy you or why should the distributor sell you?
So, having a combination of quality and growth is rare and one has to start from it. That’s our biggest differential. People start from valuations, go into growth and then see qualities. We start from quality, see a combination of quality and growth and then check whether the valuations make sense or not. That is what we do. Today, when we see the market place, the two spaces where we are seeing prospects of continued growth is consumption and financials. Of the money that we manage, 70-80 percent is being positioned in these two spaces. The index is 35 percent financial while we are not index focused. Consumption includes not only FMCG, durables but also automobiles, etc.
For staples, we have seen a very impressive number in the quarter gone by, they have surprised a lot of people on the upside. Valuations are very steep right now. Do you believe that this is quality at any price which is the factor right now in staples because of the consistency that they show, or do you believe that the kind of premium that market is paying for staple companies is justified?
If you look at our portfolio, we have staples but not too many of them. Dabur is valued nicely. HUL seems to be expensive, that is something which we don’t have. I believe that this is the space which will continue to generate strong growth for a long period of time going forward. The expensiveness, if you are talking in terms of price to earning ratios, has to be seen in the context of the term of your investment horizon. If something which is fairly valued is growing at 15 percent and then there is a staple which is expensive at 20 percent and it is growing at 25 percent, then if your term of holding is three-four years, where will you make more money?
In one place, at 110-125 percent compounding, you deduct 25 percent expensiveness and you are still doubling your money for four years. In the other place it is fairly valued, and you just get the compounding, so 70-80 percent. It is basically what happens. What we tend to do is to put in the stock price and see what kind of growth the business has to do over the next 10-15 years and see whether the business is able to do that or not. We have missed the levers, for example. It looked expensive to us, but it has performed. It is a liquid stock, so it is well followed institutionally. So, the price is correct, and the error has been on our side, that's the market feedback that we are getting. We missed it because the premium story which is played out in levers is extremely difficult to predict and sustainability is also difficult to fathom.
If you look at it category by category, staples is one place in FMCG where you have seen GST resulting in lower taxation and hence lower prices at the consumer end. What we have clearly seen is consumers up trading--they are not sticking to the same product--they are sticking to the same price which means that the company will be able to have higher margins. That is also working in the favor of consumers.
Typically, India is a cost-conscious country and we are seeing different trends. People are happy with the particular cost and are happy to buy more expensive and premium products.
It is very easy to say in an auto company. Your lowest end car is no longer your best-seller model. It is with some more features, slightly higher end car which sells better. We are seeing it and we will see more of it. The biggest failure in the automobiles segment is the Nano. So, if cheapness was what would sell, then it would have sold well. It is just that people aspire for something better.
What will work in autos in the next 18 months and more importantly why?
We are happy to look at premium products across categories where the business is already built and has survived. As India gets richer, we should expect to see these categories grow faster. In two wheelers, we have looked at Eicher Motors Ltd. It manufactures an old bike and is not the most technologically savvy bike. But people like it. Wherever in the country you see pockets of wealth emerging, you see Eicher selling more. I do expect India to get richer and hence this bike is likely to do better. Earlier I used to associate it more with the Punjab-kind of situation like big guys over big bikes, but it sells very well in Kerala. If Uttar Pradesh is doing better, then that is a huge signal of growth. That is something which we are clearly seeing.
In autos, we like cars. We were at 50,000 cars in mid-90s. From there, we are now at 3.5 million. China is 8-10 times larger with a similar population. We should get there in the next 10-15 years. They started along with us. So, 10-15 years’ timeline for our kind of country is long and it gives you a very strong CAGR.
Put on top of it premiumisation. The lowest cost model doesn’t sell much but it is the next one. Then on top of it, put in another trend which is that cities are no longer the growth engines. It is the tier 2 cities. For tier 2 cities, the MNCs don’t have service stations. So, which company will gain market share? It may be an Indian company or a Hyundai. So Maruti, Hyundai, Tata, Mahindra should be expected to do very well. In tier 2 towns, there are no service centers. Even in metropolitans, if you have a premium foreign car and if it gets bad, then service centers take months to give it back to you. We believe that Indians have lot going for them. There is great chance that they gain market share as we go forward.
What about cooling solutions or durables? Do you have a view on contract manufacturing space as it seems to have picked up?
We are positive on both. The contract manufacturers, contracts for practically everybody in this space is also diversified. We believe that except for seasonal changes which may make one category sell a bit more than the other, there is lot going for it. There are technology changes in the space. For example, in television, viewing experiences have changed dramatically over the last 4-5 years--from small screen television, we now have larger screen televisions. Prices have dropped massively. It has made that segment do very well.
You have cell phones which do not last over two years and people want to show new ones. Even if they don’t use it they still want newer one. It is crazy but that is how is it. These are still-penetrated categories. Then there are categories like refrigerators which are less penetrated, washing machines too and as soon as you come into cooling solutions ie: air conditioners--they are not penetrated at all. Air conditioners have started to come up in offices. I find Delhi and Bombay offices putting them on most of the time but in Bangalore and Chennai, they put off ACs. As you look at homes around, even for the affluent class, do they get kitchens air conditioned? That is one place where even they can fit an air conditioner in. The most luxurious apartments in for instance the Lower Parel area, have ACs in the whole house, barring the kitchen and that’s the room which is most heated.
If you look at the penetrations of air conditioners in a home, they say it is 4 percent penetrated, but room-wise, it is not even one percent penetrated. So, it is a long way to go. On top of it infrastructure is getting better...it requires a particular quality of power. It can’t run on batteries. As things improve, this is something which can do very well. So, in Uttar Pradesh, in towns this year, there has been no power cut which is a huge change. We used to be so skeptical about Uttar Pradesh, but this year there has not been any power cut. If two more years go like this then people would be more confident of buying an air conditioner. So, how many non-AC cars get sold? Practically, everything sold has an air conditioner installed, so people know that it adds to comfort. It is just that the cost of power and quality of power...as soon as people are assured of it, we think that this is the space which can do well.