GST Will Improve Profitability Of Commodity Companies, Says Kenneth Andrade

The underlying logic of farm loan waivers, according to Kenneth Andrade.

Kenneth Andrade, founder and chief investment officer at Old Bridge Capital (Source: BloombergQuint)
Kenneth Andrade, founder and chief investment officer at Old Bridge Capital (Source: BloombergQuint)

The steady rise in Indian equities has a lot to do with the lack of alternate investment opportunities, Kenneth Andrade, founder and chief investment officer at Old Bridge Capital said on BloombergQuint’s weekly series, Thank God It’s Friday.

He expects any slowdown, as a result of the Goods and Services Tax rollout, to last a month or two, at worst. The organised sector will reap significant benefits from the new indirect tax regime and may see “profitability surpassing historical trends”.

Here are edited excerpts from the conversation.

The last time we spoke the demonetisation wave had just hit us and led to selloff in the markets and here we are today, market continue to make new highs. This time around, earnings hit owing to GST is widely anticipated. Do you think market will overlook these negative cues and just move on?

Markets have been overlooking negatives for some time now. Basically, if we take the last five years of earnings, growth has been extremely tempered. But valuation multiples have expanded. To an extent, all bad news is getting digested and markets are finding ways to go higher. Of course, a lot of this has to do with the way alternative investment opportunities are decreasing and liquidity coming into equities. So, that’s the argument. A flood of liquidity, and domestic markets are attracting a significant portion of that, and we have price earnings multiples where they are. Demonetisation hasn’t impacted growth. You might struggle for a month or two this time with GST and then it will be back to normal. But it’s very difficult. We have seen in the last 5-6 months, that predictability is extremely low. I anticipate a slowdown for a month or two but we never know how that works.

GST As Earnings Trigger

Are there any pockets where we can see any positive surprises in terms of earnings given GST?

One of the things that has been talked about is the transfer of market share from the informal, unorganised business to the organized business. You see a disproportionate amount of that coming through in commodity businesses where you have a lot of MSMEs or small scale businesses, as they struggle to deal with compliance. So, a lot of these companies may not grow capacities to address the market in the near term and that’s the opportunity left for the organised business.

This is one segment of the market where you will see high growth in volumes relative to industry. You will also see profitability surpassing historical trends.

Media: Long-Term Spends Must Improve

We understand that you are interested in some of the media stocks included Jagran Prakashan, DB Corp and TV today. What is it that appeals to you in some of these counters?

Media, as a segment, has been impacted in the near term. In the last few quarters, it has been impacted by one reasonable investments of one part of the bouquet. Second, you have got events that have, in the near term, actually collapsed the size of the industry. They are struggling with growth but have been able to maintain existing numbers. So, that’s what we are paying for, maintaining existing numbers. The challenge with that part of the world is that expectations are high, but the delivery, due to macro factors, is not in line with even our expectations. In the long term, media spends have to improve. If you are in an expanding economy, the product has to get to the end consumer. And a lot of this companies act as bridges between the end consumer and manufacturer.

Farm Loan Waivers: The Other Side

A portion of your thematic portfolio comprises of agri-related stocks. You must have been very happy when the farm loan waivers were announced.

It’s a moral hazard. But we look at it through a small mathematical equation. Farm loan waivers announced till date stand at about Rs 95,000 crore. This is in five states. Next round would be in another 13 states, which is in the process. I am not saying they will happen. That number could be close to Rs 1.3 lakh crore. So, you are looking at the prospect of Rs 2.2 lakh crore to Rs 2.3 lakh crore of farm loan waivers over probably the next three years. This numbers effectively strengthen the balance sheet of the person who receives these numbers. If you strengthen the balance sheet of the person who gets the liability written off, if his balance sheet improves, you can create an income. That’s our underlying logic to farm loan waivers. How it gets implemented or does it get implemented are still question marks.

From our perspective Rs 2.2 lakh crore, if that’s the number, is close to 15 percent of farm GDP. Farm GDP is about Rs 15 lakh crore. It’s like stimulating that economy by almost 15 percent. And that’s what’s reasonably attractive. The quantum of capital which could be available in the next 2-3 years into the next two cycles is significantly large and we are interested in that.

Positive On Agrochemical Companies

Our conversations with analysts indicate that the impact of demonetisation hasn’t been absorbed as far as the rural economy is concerned. Also, the agri input companies are heavily dependent on monsoons. Aren’t these two big risk factors?

It’s been cyclical. It’s never been secular. What we like about companies in this business is that they are consolidated. So if you look for number 1,2,3, they will exist. Number 4,5, 6 are very distant. So, if capital or the cash flow in that cycle expands itself and this is led by government initiative, the net beneficiaries are companies which cater to that market. It sounds simplistic. It may not be that simplistic. But if these companies exist on the ground, this capital is put to right use in terms of productivity, the companies that are residual in the market actually absorb a significant amount of money. Now, whether demonetisation has played out or not played out, I think we will come to know after next 6-18 months of execution of the cycle.

NBFCs: The Risks Involved

Should we assume that you are also equally interested in NBFC names, microfinance names, and housing finance companies?

There I can’t grapple with credit costs and valuations. So, I don’t mind the businesses if the credit costs are low, then I am willing to pay a certain amount of value for these guys. But when you have high valuation and there is a question mark around credit costs, we can’t comprehend that kind of risk. So we side step that. You play the liability side and we play the asset side.

We prefer companies that cater to the liquidity in the system, rather than companies that provide the liquidity in the system.

Sugar Stocks: The Bright Side

Your interest in sugar stocks have to do with prices or do fundamentals have a role here?

If we are at the top of the cycle, as far as that commodity is concerned, I am there with no financial risk on the balance sheet. When I say no financial risk, all these companies are debt free. Even if sugar prices go flat and sugar as a commodity doesn’t make money, there allied business streams that these companies have, they will still be cash flow positive. So even with earnings which are scraping the bottom of the barrel historically, they are okay. So, I’m playing cash flow, sovereign balance sheets at a reasonable value. What is missing in entire equation is growth. But I find it very difficult to predict growth in a lot of businesses.

Small IT Firms: Room To Manoeuvre?

Are you of the opinion that relatively small IT companies do not have the flexibility where it comes to changing demand environment and the kind of changes we are seeing from clients and what they want from the industry?

So, small companies have flexibility because they have a small base and are adaptive to change in environment. Large companies take time to turn the tide. But if smaller opportunities get large, then larger companies actually benefit a lot from that. You have to mix and balance the two statements to see whether a large company is good because of the cash flow it is generating and in the verticals that are doing well or look at the smaller companies on a smaller base and how rapidly they are growing and can they scale it to a reasonably-sized opportunity for themselves.