Market Polarisation Will Continue To Be India’s Theme For The Decade, Says Marcellus’ Saurabh Mukherjea
Waiting for small caps to pick up pace? Don’t hold your breath, says Saurabh Mukherjea.
India’s weak economy and impending economic reforms have cemented “polarisation” as the theme for Indian markets in the decade ahead.
That’s according to Saurabh Mukherjea, founder of Marcellus Investment Managers—the second-best portfolio manager in 2019 with a 28.3 percent return.
Historically, all major reforms in India have taken place within the first two years of general elections, Mukherjea told BloombergQuint in an interview, adding that we are in that time in our political cycle when a weak economy should lead to positive reforms from the government. The disruption from these reforms will force the economy into the hands of 50-60 companies, he pointed out.
“In every sector you end up with one or two dominant leaders who scoop up the lion’s share of spoils in the sector,” he said. “A polarisation in the economy that forces the economy into one or two sector champions while thousands of smaller companies fall by the wayside.”
Residual fire from the past economic reforms and the expectation of more is the only thing that will keep India’s market buoyant, he said.
That comes when India’s economic fundamentals are weak with employment rate and labour participation rate dropping to all-time lows in November 2019. Tax collection by the government also fell significantly short of the target due to a consumption and investment slump. India’s GDP growth plunged to 4.5 percent in the quarter ended September—falling from its stature as the fastest-growing major economy just a few years ago. Another pain point is India’s financial system—described as “in the intensive care unit” by Mukherjea—which is still grappling with bad loans.
Also Read: SBI Seeks To Resolve Rs 1 Lakh Crore In Stressed Cases By March
India’s benchmark Nifty Index, however, hit multiple all-time highs during the same time, led by gains in a handful of companies, such as Reliance Industries Ltd. and Bajaj Finance Ltd. And Marcellus Investment Managers is looking for those market leaders in every sector, Mukherjea said. “The rest of them barely get by and they are the guys in the doghouse now,” he said.
Whether it is the GST, tax cut reform or the impending land reforms, all these policies are very conducive for the top two players, less conducive for the rest of the sector.Saurabh Mukherjea, Founder, Marcellus Investment Managers
Mukherjea’s analysis of the future comes as a stark contrast to several other investment managers. Care Portfolio Managers Pvt.’s Amit Doshi, in an earlier interview to BloombergQuint, said that with a huge valuation gap between large and small caps, there is a realisation to move towards stock-specific investments in small caps where significant price erosion has taken place despite strong financials.
Max Life’s Mihir Vora expects small- and mid-cap stocks to bounce back in two years. Aditya Birla AMC’s Mahesh Patil also sees small- and mid-cap funds faring better in the near future.
Also Read: Top Mid-Cap Stock Picks Of Analysts For 2020
Mukherjea, however, said paying a premium for growth and quality will still work beyond 2020. “The underlying economic constructs seem to be very positive for leaders and very difficult for laggards,” he said.
There are exceptions to the rule though. In sectors such as specialty chemicals and pipes, market leaders such as Pidilite Industries Ltd. and Astral Poly Technik Ltd. are midcaps that are expected to perform well, he said, adding that it is best to stay away even from the market leaders in large-cap stocks in sectors with a dominant role of the government, such as aviation, oil and telecom.
WATCH | Marcellus’ Saurabh Mukherjea on which stocks to pick, which to avoid
Read the full transcript of the interview here:
I want to come to you on smaller spaces. We are talking about FMCG, we are talking about pipes. If you talk about exhibitors such as INOX, PVR. These are a few themes that have worked well. Speciality chemicals for that matter, even the shrimp-based companies suddenly look extremely attractive and there is that B-line of investors looking to invest in them and that’s where the stocks have had three months of rally of about 100 percent. Do you think that this is just temporary? And like you said, everything is going to go back to those 10-15 stocks because these companies are also not doing bad in terms of delivering numbers.
So, I think the answer is a partial yes in that. You can build strong, sustainable franchises in several of those smaller sectors which you just mentioned. An example of a small franchise from 20 years ago which is now a big company is Pidilite. Pidilite today is the best $10 billion in market cap. 20 years ago it was pretty much a mono-line company largely making adhesives. Now, it’s a dominant parent construction company for construction chemicals, sealants and potentially is into a more dominant market leadership mode in production chemicals. So, similarly in pipes, a decade ago very few people heard of Astral Poly. Now, it’s a prominent company and Astral Poly has shown you can grow moats in the pipe sector. On the other hand, I can’t see the moats in multiplexers, and nor can I see the free cash flows of the two exhibitors you mentioned. So, if you take the basic definition that people like us, we need to look for companies where term capital is well above the cost to capital, thus generating free cash flow. On that basic smell test, pipes pass. At least the top two or three pipes player pass. For example, Pidilite and Asian Paints pass but the exhibitors don’t. The airline companies don’t, the telecom companies don’t and there in are the answers to where will a minority shareholder make money, where will they not make money. Share prices per se doesn’t mean much. I completely agree with you. Whether PVR’s share price has gone up or down in the last 12 months is neither here nor there. But PVR’s cash flows do tell a story and similarly some like Astral Poly’s cash flows tell a different story of a moated company with a very strong free cash flow generation. But neither PVR nor Astral Poly are in our portfolios. I was just using them to illustrate the point about one type of franchises, there is pipes; weather its moats and exhibitors, where I can’t see the moats.
I want to understand the city gas distribution view from you for some of these companies. We’ve got some government support in or is it just an analogy factor where in these stocks come into favour and suddenly they are at the back of mind, not the top of mind?
I think it’s a very interesting sector. Because at a level, you can see the urbanisation dynamics playing out for these firms and, as you said, the fundamentals look very promising and there are genuine, free cash flows there. The worrying aspect which has kept us weary is governmental interference. Indians at the long end have an undistinguished track record of interfering wherever it sees companies making lots of money. That has kept us weary of getting into city gas distribution companies. On the face of it, the underlying dynamics is very positive. You can see the growth runway, you can see the free cash flows, incremental capex etc. that the city gas distribution companies should be that much. The fly in the ointment is potential adverse governmental interference.
You’ve been helping us identify these few gems for quite some time now. Anything that you have identified as something that could be one of the larger value creators that we haven’t really discussed for 2020?
I think we discussed Divi’s Lab for some of our clients’ portfolios. The more we have looked into it, the more convinced we’ve been that Divi’s Lab potentially is a massive cash engine which can last for a long time. The growth runway is big, the cash generation has punched in, the ROCs are at 7-38 percent. I will suggest for a very punchy, free cash flow generation. Alongside that, they have had a double-digit growth for the best part of 20 years. So, it’s a dominant franchise in painkillers, four APIs which are essential for consumers around the world and not just in India. It is a dominant franchise, not just in India but on a global basis. They have very smartly stayed out of the formulation market; they have very smartly stayed out of confronting the big pharmas in the West. So, pharma generally is a beaten down sector. I’m not sure how many Indian pharma companies have it in them to stay just for a sustainable recovery. But Divi’s Lab looks to us to be a potentially, what we call a consistent compounder.