Alpha Moguls | Ravi Dharamshi On How To Bet On Zomato To Nykaa
The winners of tomorrow’s stock markets will likely emerge from India’s newly listed internet businesses, according to Ravi Dharamshi. But he advises to not ignore the risks and be selective.
“I strongly believe a lot of value migration is happening to new-age companies. You have to give it to these entrepreneurs to have created a strong-enough moat to either be a category leader or one of the last survivors in the category,” the founder of the portfolio management company ValueQuest said. “There’s a lot of value that they carry.”
However, such companies, he said, face risks like cash burn and survival concerns. “It’s not easy to say if a company will exist 5-10 years down the line,” Dharamshi told BloombergQuint’s Niraj Shah in a conversation on Alpha Moguls. “We don’t know what (would) happen tomorrow; if Amazon enters the beauty and personal care space or food delivery.”
“There are risks involved definitely, but you can adjust your risk by not betting on every company there is,” he said.
The right way to manage risk is by placing the right bet, he said. “You can’t ignore the sector, but neither can you bet your house on it. One must have presence in this and see along the way who’s going to be around and is ready to ride the next wave.”
The Nykaa Example
Dharamshi cited the example of Nykaa, listed as FSN E-Commerce Ventures Ltd., to illustrate what new-age companies can do well. “Nykaa has actually done very well in the beauty and personal care segment, with 8% market share. With that share, they’re feeding the fashion segment,” he said. “They built that with a minimum cash burn of $300 million. The IPO was one of the last cash influxes they needed, organically. Now, if they can expand to other adjacencies without burning too much cash, then it would be very credible.”
He said if investors can find such a story, where a company needn’t burn a lot of cash, that’s a big plus.
“They might not be making much profit right now, but their value isn’t zero,” he said. “There’s likelihood that these are companies that one should be betting on, from a 5-10 year perspective.”
He also expects new-age firms to make up a significant chunk of the market value of exchanges in the next 5-7 years. “We’re at $3.5 trillion m-cap today. This could go up to $6-7 trillion over the next 5-7 years and I’m very sure about $1- $1.5 trillion of it would come from new-age firms.”
He cited the precedent of U.S. tech companies. “They weren’t the top firms in 2010. So, we have seen such a story pan out elsewhere in the world.”
Watch the full interview here:
Read the edited transcript of the interaction
On the back of the last 24 months your clients would be a happy lot because you generated a significant alpha, over a well performing market…
RAVI DHARAMSHI: Yes, it’s been an unbelievable 20 months of market rally and I don’t think that the most optimistic minds would have foreseen as to what lay in store for us. In March 2020, we could not have visualised what is going to happen. We were all been very fortunate, off course, a thought goes for those people who had to go for hardships during this crisis time, even so, it was a health crisis and probably a financial crisis for some lower strata economic people, so we cannot ignore that humanitarian aspect of it but from markets point of view it has been a blessing in disguise, and we have spoken about it, last year, at length.
Yes, we have, now the question is how one sees the next 12 to 24-odd months from the portfolio creation perspective. Now, in the first fortnight of November 2021, we have had five or six large global broking houses strategists come out and downgrade Indian markets, on the way. That means number of optimistic Indian money managers who had said that over the next 12 months may be, the index will be a flat line, So, with the benchmark with the NIFTY generating Alpha would be that much easier, but that notwithstanding, what is your view of it?
RAVI DHARAMSHI: You know, giving a bullish view at this point, does sound a little stupid, especially, when we are sitting on such great returns but to sound intelligent, one has to be little skeptical, a little circumspect, but honestly, with every passing day, as the market doesn’t correct, probability of a correction increases, but everybody is playing a different game, you have to understand that, the brokers have their clients whose portfolios they have to churn and we are not here to churn our portfolio but we are here to create wealth, buying right and sitting tight, is essentially what we aspire to do so. Usually, I get this question from my clients that, is this the right time to invest in the market? I usually flip it to them the question and ask them, is it absolutely the wrong time not to invest and the answer I get is a resounding NO. It’s not an absolutely wrong time to be investing you have to expand your horizons and you have to temper your expectations of your return because we are sitting on a rally. So, the journey of the 100 rupees that you invest this point of time might not look like 100 rupees going to 200 in a straight line over the next three years, but it can be 100 rupees going to be 70 and then going to be 200, over the next three or four years.
So, that is how I explain it to my clients to temper their expectations and expand their horizons but stay bullish. And reason resoundingly and in an emphatic manner, stay bullish, the opportunities starting and expanding in India. And there is a likelihood that this economic cycle can last longer and expand even more, over the next few years. So don’t be panicky and don’t try to be acute in trying to time the correction. We could have, you know, had the same discussion six to eight months back and we could have reached the same conclusion, I mean, obviously eight months have gone by, and the returns have been fantastic. So, I believe at some point of time, the naysayers will come. They will be right and there will be a correction and a drawdown. One can’t avoid that. That is a feature of the market. That’s not a bug, but you have to keep your eyes on the price, that is the larger picture at the Indian economic cycle is just about reviving. And whatever boom has been happening till now is not a debt fueled boom. So, we are not sitting on an imminent crash. You will get your chances, but you can possibly get a better entry point. I don’t deny that, but from a three-year to five-year outlook point of view, I think we must be bullish.
Ok, let’s try and figure out how would you believe you would want to generate that alpha? By the answer that you are giving me, I am presuming that you might be fully invested with hardly any cash levels. And what do you do when you are hit constantly by these classic markers of euphoria, right there is heightened retail participation. There is a lot of primary issuances. We are seeing what is arguably, a big bugbear for India, usually, fundamentally, if you will, which is crude oil prices starting to inch up and the fact that we have been sitting on a stimulus for a long time, from the central banks at some point of time at least, in even India, that may start to get weaned away. So, what do you tell yourself when you come across these classic markers?
RAVI DHARAMSHI: Right so, no doubt about it. All these classic markers are pointing to the fact that may be from a one-year perspective, your risk-reward is not very favourable. And there is some readjustment at some point of time. And we don’t know how the market will respond. We might think that it might react to stimulus being weaned away, but till now market has not shown any signs of taper or tantrum. In fact, there is a taper but there is no tantrum, that is happening. So yes, at some point something will trigger a correction in the market. You cannot wait at this point of time. What I am focused on or what drives me and keeps me bullish is that I draw a lot of comparison with the 2003-2008 economic cycle, and I see that this particular cycle will be more elongated and can have a much more lasting effect. See what happens is that lingering effect of the confluence of all the steps taken, which basically converted the vicious cycle that we were in, into a virtuous cycle is going to last a long period of time. The conditions today are far better than what they were in 2003 also, and I will explain to you 2003 preceded, there was barring a dot-com bubble, the rest of the markets, in that cycle also did not do very well leading up to 2001 September 11. When that happened, there was the bottom at which everybody gave up hopes and the equities. But it was followed up by more than 200 bps interest rate cut in monetary policy response, the fiscal response at that point of time, whatever was there today, its more than that as a percentage of the market cap also as a percentage of GDP also.
So, a far larger stimulus has been given, demand conditions globally are far better than they were at that point of time. The demand drive revival locally has also happened far quicker, also because this particular recession was not some crisis that led to some recession. It was a manmade recession; people were just asked to stop coming to work. And now slowly they are opening now, we have the tools to fight the pandemic. So, with the tools having been there, the economic impact will only reduce, rather the economic impact of the pandemic will only be lesser and lesser. So, the opening itself is a big stimulus, to the economy. And add to that stimulus is being weaned away far slowly than anyone would have imagined. So, yes, there are these temporary reasons or in between markers, as you say, which is going to lead to some sort of a correction.
But what we people will realise over a period of time is that these things have led to a permanent or rather a structural shift in the cycle. We have become virtuous from being vicious, to give you an example. So, you know, a startup economy was nonexistent for all we know may be even a decade earlier. So, we put in place regulatory policies that help startups put in place tax benefits, we put in place digital stack, which is a public utility. We got everything on board with Jan Dhan, Aadhar mobile connectivity and then what has happened in the last two years is $25 to 30 billion of money coming in these startups. And this is only second to U.S., in the world. So that kind of money coming, it is the confluence of all steps taken over in the last five to seven years. So, what happens is we underestimate the impact of all these small steps taken over the period of time or in fact it might actually be counterproductive, in the short term, like demonetisation and GST. There were lots of issues with that and we have forgotten that these are all great reforms in the long term. And we can argue in isolation about a particular step being good or bad, but in confluence, all these things are adding to a rise, to a boom, in the startup economy. So many factors, and this is trickling off and you can see our job market is getting very tight and even wage hikes are two to three times a year in most of the IT companies and that is now trickle down into real estate. Most of the IT work force is a migrant work force and they are the biggest reasons for the real estate demand, in at least the top seven eight cities. So that is the trickle-down effect that we are already witnessing. Just an example how it has become a virtuous cycle.
A lot of people will come up and argue that the demonetization was not necessarily individually that great, but I think the point is valid for certain aspects. Conference of all these works very well. So, if it takes you back to 2000 to 2008, that was a cycle when most ships sailed and some sailed much further and much faster than the others as soon as would happen in any cycle, off course, but the old economy unless I am very wrong had a big bang. Move in that we started to see the first signs of the market starting to like some of the capex old economy team says, what is your sense of this cycle whether it is happening in here years, five years or10 years is separate issue. But do you think we could have a repeat of sorts out there, why and why not?
RAVI DHARAMSHI: No two cycles are the same. Absolutely, we are very bullish that the economic revival is on the cusp and the capex cycle will also pick up but the nature and colour of this cycle, will be dramatically different from the previous one.
One, because there is this mega trend that is playing out, where most of the capital expenditure is getting converted into operational expenditure. The new business that are coming up, they replace your capex and opex. Essentially, when earlier, I used to have so many subscriptions as it’s a subscription-based economy, that has come up by one-time expenditure has been cut down into smaller expenditure over a long period of time for life. So, the lifetime value of the customer increases but for me in the short term, the expenditure that I have to incur, has gone down, so that is the case with IP spend and that is the case with some of the other spends also, most of them at this juncture is happening in these kinds of business models. Having said that we are bullish on equipment manufacturing also, but the previous boom was driven by power, real estate scene and telecom. These four sectors are not likely to come back to the same level that they had happened in the previous, may be real estate does, may be steel does, to some extent, but telecom and power are unlikely to witness the kind of excessive spend that we saw in 2003 to 2008 cycle.
So, the nature of this cycle is going to be different, but there is no doubt at all that capital expansion cycle is just about beginning, you had six quarters of good profit growth for most companies, and everybody is looking to expand the capacity utilization is on the rise. And the demand order books of most of the companies is good three years out. So good order books, good order inflows, enquiries level rising, demand for talent is going up. All these are signs of demand coming back. And the natural progression of that is that as consumption keeps picking up, it will eventually lead to capex cycle. So, consumption has come back, probably got a little bunched up and a little advanced in the terms of the cycle. And that’s why the capex cycle spillover is also likely to get advanced, a little bit.
Okay, I will come to real estate in a moment, but since you have brought up this capex cycle, manufacturing etc. because there are uncertainties in the near term and we don’t know how much, how long can this supply chain issues last because company after company this time around said we just don’t want to talk about quarters three , quarter four right now, because we don’t know how to change from an Astral to do an Asian Paints to everybody is facing or grappling with these issues and now it is hitting the larger companies, as well, not just an organized space. Is it difficult to build a hypothesis, because of these challenges or are you taking a leap of faith?
RAVI DHARAMSHI: No, I think one can take the leap of faith in terms of the stronger balance sheet, will survive. These issues are more operational challenges, may be a little bit of P/L challenges. And that can lead to a little bit of quarter volatility, in terms of reporting earnings, but there is no doubt that these issues will sort themselves out in fact, already we are witnessing some amount of easing of, whether it is in the container freight rates or whether it is in the material commodities in China, the prices are beginning to come down. So that tells you that the tightness in the system, will get relaxed. It might happen at different points of time for different commodities but it’s not a structural issue and its more of a cyclical issue or hence, one can look through these issues, from a quarterly point of view, provided your bet is placed on companies which are leaders or challenges in the space, or the balance sheet is strong enough and their supply chain is strong enough to withstand it. Which means that when standards, the challenges that were faced and when the second phase happened of covid greater of what we are witnessing today, at that point of time there was a real challenge, but we sailed through that a lot of companies sailed through that in a strong manner. So, I would say, little bit of leap of faith is good, if your outlook is more than a year.
How are going about choosing within manufacturing? So, for example, I know of your earlier events wherein you, for example, bet not on the number one real estate proxy, a pipe company, but the number two or number three whichever size it was, you probably bet, may be on some real estate companies, as well. What is your thought around real estate and ancillaries? What is the best way you will play?
RAVI DHARAMSHI: So, we are betting across the value chain earlier. Yes, we did, bet only on building material companies. So, earlier on hypothesis was that the segment that is likely to pick up first, most likely affordable housing. And so what happened was that the least affected area, but the segment that has picked up the fastest is at the premium end of the economy, with so much of money floating in and for example, all these mid-level and high level executives are that are getting their ESOPS in cash or there is so much private equity money flowing into companies that has lead to a lot of release of capital for these entrepreneurs and they are the ones who are leading the charge in the terms of buying real estate. So, the premium end of the economy, premium end of the real estate is what has surprised us, positively. So, we are not only betting on building materials, but we are also betting on housing finance, as well as we are betting on developers. So, we were a little skeptical about betting on developers earlier.
Clearly because this sector had its challenges earlier, but now we feel that it has gone through a catharsis and there is a new dawn that has happened in this sector and supply shock is clearly there. I mean city like Mumbai had more than 1,000-1,200 developers. This number is now reduced to 400. And for all practical purposes, the listed space is down to 10 players or if you were to expand, may be to 15 players, there are quasi real estate players, so when majority of the real estate development is going to happen by these large players, then for sure, I think the pool is getting larger and getting shared, by fewer players, is going to see a disproportionate increase in profits for these companies. So, that’s how we are playing, we believe, very strongly that real estate cycle revival has started. We would bet on building materials, bet on developers, as well, as we will bet on housing finances.
What, within the newly formed themes is exciting you more, from a portfolio perspective and you want to, may be allocate, like a significant part of your portfolio. So, this is this whole EV juggernaut, that seems to have caught the fancy, power is riding along with, the ethanol players, come into that as well, but it will not be EV, but its clean energy and therefore that is coming in, we have had two behemoths, in India also, talk about green hydrogen. What is happening there, becomes difficult to try and separate the wheat from the chaff, how are you doing now?
RAVI DHARAMSHI: So, absolutely, you are on the dot. it’s a challenge, we grapple with, on a daily basis. There is no doubt about it, that there is a lot of disruption happening. There are a lot of cross currents in various sectors. If I were to take an example of auto, at one point there is a disruption coming. There are new challenges coming in the two-wheeler, OEM space versus the incumbents who are actually quite strong in their own right. So, I don’t have an answer at this point of time, as to who is likely to emerge a winner. But if the valuations are factoring in zero terminal value for the listed OEMs and I think it’s a fairly, risk reward, is in your favour, because they are also aware that opportunity lies elsewhere. And see, this disruption is more about, the mode of transportation, remains the same, right? You will still be riding two wheels, whatever the machinery or equipment that has changed. So, it is not such a big disruption that this industry will not exist or not. There are no network effects to it, as well. There is an opening available, for new challenges and they might come in and take away some amount of market share. But the incumbents who have the strength, in terms of the distribution, and they also have invested in the new areas. So, if you want, what you can do is treat the old business as a cash cow and use that cash, to invest in businesses that are disrupting.
Sorry, I have a follow up here, because may be, none of the newer businesses have positioned themselves as well as Elon Musk did when he came to Tesla. But I mean you and I think, even my grandma and your servant have got that WhatsApp about how Tesla’s market cap or value is this versus the other ten and the others are also having some presence out there, but somehow in the eyes of the beholder, the value that Tesla brings, that’s why its valued so much, right. So, my question is that so one, the others are doing their bit, you reckon this the new-age companies, which are completely focused, may be, they are nimbler, will walk away with the spoils, in terms of the value, in the eyes of the investor?
RAVI DHARAMSHI: Right. So, see where for the concern for the investors are arising is from the terminal value for the incumbents, who going to remain or more so, if today, the valuations are such that the implied terminal value is zero or negative. It leaves the betters in your favour. Now, coming to who can emerge the winner. See, the mindset is important. The new players are coming in with cheques written by private key players, who are asking them to go and grab the market share. They are not going to focus on profitability. So, if the incumbents can change their mindset that do not focus on today’s profitability, but focus on getting bigger share of the market, that will be ten years down the line. And then you can think about making profits. And there might be some amount of transition period involved for them, but they will eventually get away right. So, that is I think the clear point that needs to get across.
It’s very difficult for an incumbent to let go of profits. And they really have a good market share. So, to challenge themselves, and give away, some amount of their profits to seek their future growth drivers, is the mindset challenge that you have to first conquer in your mind, and then it is the new age incumbents, who actually are not, as you rightly pointed out, are not nimble enough. And they are really playing with private equity money. So, for them, it’s not really so much at stake personally, even if they lose out. I am sure there is some strategic value which others might get out of them. So, yeah, it’s a challenge that incumbents are facing, and they will have to, but they do have a good chance, I would say, I would not write them off. I think they have a decent enough chance to compete in this market.
Okay, this whole ethanol wave re-energy etc., any thoughts here?
RAVI DHARAMSHI: Energy transition is one mega theme that is playing out world over. And this theme is going to get stronger and stronger. So, no doubt today you might feel that crude is going to be $100 because there is no new capacity getting added or the supply is getting constrained by the OPEC and oil cartel of the world. But there is a real question mark on the terminal value of these businesses. Could be 30 years, 40 years, 50 years down the line. That, we actually completely move away from fossil fuel, so whether to price that today or whether there is a tactical play in buying these energy companies.
Because of the temporary shortage created in our transition period, that’s a separate matter, but mega theme remains and we will there are very few direct players available to play this energy transition thing. But we can see that investors are betting on the future and there will be new winners that will come out this. In India’s case we are going to go through, phase by phase, we will probably move first to E-20 then we will move to E85, then we will move to diesel coming in, then may be hybrid coming in, then the full electrification, so it might not happen everything at one go. But eventually transition away from fossil fuel is certain, what route we take, is not certain and which players might benefit out of this transition depends on the steps that government takes. At this point of time, it looks very clear that ethanol is their first thrust area, eventually that ethanol can move to, may be other compressed biogas and eventually to hydrogen, as well. So, the entire eco system will develop over a period of time, and there are very few players available on this theme.
Lastly, what about the whole portfolio construct aspect? Has it undergone a change simply because of the nature of how the markets are, wherein, some themes get rewarded disproportionately, I am sure it happens in every cycle, but this time around, a lot of people are talking about how it was really different? So, I am trying to understand whether the position sizing whether the allocation, whether the exit decisions, all of that has changed for you, in the last 24 months, compared to what it had always been?
RAVI DHARAMSHI: I take your point with two examples that I would like to give and more how we are doing this. So, first is specialty chemicals is one area where we are very bullish on, for the last six seven years. That is one area where, we are reducing, now the longer-term drivers of this trend are still very much intact. Whether it is China plus one or whether India, promoting chemical production through the PLIs. All those things are still in place, but seven years back, this sector was available at 20,000 crore, entire sector of specialty chemical of 25 companies was available at 20,000 crore market cap. This entire sector has gone up to five and a half lakh crores, entire sector twenty-two times bagger. Of course, there have been addition there have been ten twelve new IPOs in this space. And all these things have been added. But we are now, in my opinion, if I was to take a quadrant of inflated profits and inflated multiple, I think specialty chemicals flashes red, where the profits are inflated. They have been going on for five, seven years. And now markets are giving it a multiple which is also inflated. So, I would rather focus on areas, where it is very difficult to find today deflated profits and deflated multiples. That is not this market. But there are still pockets where the profits are deflated and in multiples are looking inflated more optimally, rather than actually So, those are the areas where I would focus on, so we are moving away from areas where high profits are getting high profit multiple areas where profits are on the lower side, though multiples may look a little higher. So, that is one change we are making in the portfolio.
Second, is, yes, it is a very controversial thing again to say that these new-age companies, one should not be betting on these companies are nowhere especially when they last listed $10 billion, $12 billion, $15 billion kind of market cap. But I strongly believe that the value migration is happening towards these companies. There are definitely risks involved. I think the winners of tomorrow are going to emerge from this area. So, you can adjust your risk by not getting on every company in the space. You have to first understand companies that are going to be around five years, ten years down the line. Its very difficult call to take again. It is not very easy to say if this company will what happens tomorrow. If Amazon enters the BPC space, what happens tomorrow if Amazon enters the food delivery space. Those are clearly the risks involved. But you have to give it to these entrepreneurs that they have created, a strong enough at this point of time to be either a category leader or are one of the last survivors’ categories and there is a lot of value to what they have now, if they can expand to other agencies, without burning too much cash and I think that will be very credible. That’s exactly what one of the players is trying to do.
So, I will name them but again, I just went to give a disclaimer that is only for illustrative purposes and not a recommendation. So, has actually done very well in the BPC segment, they have kind of gathered 8% kind of market share and that market share will grow and now with that cash flow, they are seeding the fashion segment, as well. There are already strong incumbents over there from a newer business as well like Myntra/s of the world. But what Nykaa has achieved in BPC segment is with the minimum cash burn, they have burnt less than $300 million. And in my opinion, this IPO was one of the last they might be needed. They might be needing unless off course there is an inorganic admission at some point of time, but organically, I don’t think there is any more cash needed for them, to burn, to get market share. So, if you can find a story like that, I think that is a big plus, that this company is going to not burn cash over a period of time. Yes, they are not, at this point of time making the kind of profits, but it’s not that the value of this company is zero, right? It might be overvalued, but not a bubble.
A 30% correction or 40% correction or even a 50% correction and there is likelihood that this is a company that one should be betting on, from a five ten-year point of view. See, today we are at three and a half trillion-dollar market cap industry and if Indian market cap dollar goes to $6-7 billion market cap over the next 5 to 7 years period. I am very sure trillion and trillion and a half is going to come from these new age businesses. You can take a look at the top companies of the world look like in 2010 and what they are today. Apple, Microsoft and FAANG stocks so to say they were not the companies in 2010. And once we have seen this kind of a story pan out in the world and now elsewhere in the world. And we have the conditions similar to them in terms of, you know, the boost to the startup economy then for sure the winners are going to emerge from this space.
However, the probability is stacked against you in terms of picking a winner. Probability is stacked against you that this particular company will be there 5 years, 10 years down the line. So, you have to understand that and risk management for that has to come from how you size your position, you cannot be betting your house on it. So, as you rightly pointed out, you can’t ignore this space as well as you cannot bet your house on it. But you have to have some presence and see along the way if you develop a conviction that this player is going to be around and is now ready to ride the next wave. I hope I answered your question.