Capex, Credit Growth, Consumption Are Themes That Will Do Well, Says Devang Mehta

Mehta: I think clearly what we feel is that in the last six months there has been these types of corrections, maybe starting September, October, November, December, January and now February. There have been these corrections to the tune of 3–4% where midcaps and small caps would have corrected a bit more the indices as well as the individual businesses. But what we have seen is that these falls have been bought into and that's the strength.

I think it's a confluence of factors where there are people coming in with a lot of great liquidity, the domestic investors are still wanting to pump money into the equity markets. This asset class is now clearly distinguished as an asset class where even people are talking about the money not going into FDs and coming into sort of stocks and mutual funds and stuff . So that's an important part of liquidity from Indian markets, from Indian domestic investors is huge.

Domestic macros have been sort of very good, micros have been good. If you look at the interim budget or the vote on account that also talks about a bit of growth 11–12% growth over a base of (Rs) 10 lakh crore for infrastructure spend, low borrowing. I think this all has sort of spurred the market in a different tangent and earnings season which just came to an end also actually didn't disappoint it. So I think there are a lot of green shoots there as well.

So I probably feel that no, we are in sort of good hands. Whether you beat the 2023 return that's going to be a bit tough because in '23, people were starting to talk about x returns. How many x you will do the money, percentages were sort of forgotten. I don't think that type of a market will get into those 2024. The rally probably would narrow down a bit. It would be a bit concentrated. It's not the entire broad spectrum of the rally or the market that would not participate. That's the only thing that can happen. 

Mehta: Sure. So non-discretionary PMS is something where we call it a driver navigator type of model, where we work very closely with the clients in sort of establishing the investment policy statement with them. We also sort of again, get into the portfolio construction or portfolio management or portfolio advising in terms of how the clients want that portfolio to be like, for example, is it a diversified portfolio? Is it a concentrated portfolio, whether the portfolio needs more of a flexi-cap or a multi-cap approach? Whether the portfolio is only large cap, mid cap, small cap or micro cap, that's the type of portfolio differentiation in terms of portfolio.

Second, I think mutual funds PMS, AIFs have a model portfolio. Here we have a certain universe of businesses, but there's no model portfolio. The client itself is a model where we sort of design the portfolio around his requirements. So that's in short and NDPMS, we currently have around (Rs) 500 crores of pureplay AUM and around say (Rs) 400–500 crores of family office type of in terms of my non-discretionary PMS, which is called bespoke investment ideas is what we name it.... That's the type of NDPMs we run and here we customise tailor-made, make it a sort of a scientific holistic approach towards construction of portfolios, and this is purely for a long-term horizon, anywhere between three to five years.

I would love to talk for 10 years but I think the horizons are increasingly shortening. So three to five years is, I think, a decent time frame where one can probably compound what we call it a wealth creation, or more importantly, preservation and senior/saner multiplication strategy. 

Mehta: Yes, good question. So basically, the newer portfolios where we receive AUM in terms of cash ideally are anywhere between say 10 to around 18–20. If I can put a broader number or the average would be somewhere around 12 to 15 types. There are certain even legacy portfolios or family portfolios, which are probably having even 80–100 stocks to begin with. They also sort of take these portfolios and over a period, we try and trim them down to two businesses which should be sized up.

For example, today, the bulk of the returns will be become when you size your portfolio to a certain extent. Buying 50 stocks with 2% sort of allocation. Everywhere will not take you anywhere. Having 15 businesses and making 5%, 6%, 7% and letting them also mature in the next three five years, where the stocks can become 2x, 3x as well and 4x as well somewhere and to hold that is an art and science according to us.

Mehta: Interesting. So I think just a classic example is, again, these businesses that I hold in the portfolio, not recommendations, they are holdings for our clients, that there was a business called Varun Beverages. So it's sort of done extremely well since listing in 2016. It is 18x some of the portfolios from 2018–19 The stock would have given around 10–12x type of returns. Now for example, if we had bought this 4% in the portfolio, 5% in the portfolio, some of these portfolios after trimming down also would have 15–18% type of holding in the portfolio.

Now this is as I said, it's a very concentrated portfolio where we also engage with the clients and say that we feel this business is going to do increasingly better, it's (Rs) 2 lakh crore in terms of market cap, but whether probably it can touch in the next three years, (Rs) 4 lakh crores of market cap, the answer seems to be yes. Then we sort of take a whole decision on even this large position.

So yes, some of these businesses are large, some of these businesses that do not perform. Probably, you also say that no, this is the time that there are better meritorious candidates sitting outside the portfolio. Why not look at that, if this company does not deliver for the next say one and a half, two years, you give ample time to the management and the promoters to perform very well but if the business and the commentary is not great, we sort of then get out of this business. 

Mehta: So I think clearly, the three sectors or three themes, which we feel will do very well in this I've been talking about for the last six months, seven months are the three C's. For operational ease, I call them three C's, the first is capex, and I know everybody talks about the capital expenditure. India has gone into this cycle after hibernation of around say, eight–nine–10 years and we are increasingly seeing government capex one which has spurred the entire I can say infrastructure sector, power, defence. I think all this has done very well if I count this as a part of capex, even certain building materials, home improvement, all this part of capex capital goods.

Capex is a theme one, from the government side second, even the private side now seems to be jumping on the bandwagon. There are announcements of greenfield projects, brownfield projects. So I think this theme is capex, which includes a lot of capital, good businesses, a lot of ancillary businesses of capital goods, transformer businesses, energy efficiency. I think this as a theme, if you probably hold say three, four or five businesses in the portfolio, this theme will do well.

The second C is credit growth. Now we all know that we are again into a historical credit growth type of an environment which we saw somewhere during 2004 to 2008. So credit growth again, by credit growth, I don't mean the run of the mill banks, but there are certain banks, there are NBFCs. Again, credit growth is a theme that a lot of microfinance institutions, a lot of such themes can come to the fore in smaller banks, where I think lending is going to happen very fast.  Right now, if I'm not wrong, the credit growth is somewhere around 15–16–17% in the mid and the late teens. So this also has to be an integral part of the portfolio.

The third C's which I call consumption, but by consumption, I mean more of discretionary consumption, the premiumisation trend, the aspirational Indian coming to the fore. So wherever there is, even Maruti talks about this, people don't buy hatchbacks more, SUVs are a larger part. There are waiting lists for the Mercedes and the BMWs of the world. So I think that also discretionary consumption is a theme where people are moving towards luxury, what was luxury earlier, is now becoming a necessity. That theme also probably there–four-five businesses over there. This can be a portfolio construct and, of course, then there are niche IT companies, niche technology companies, pharma companies, probably these four or five sectors along with 12 businesses should be the order of the day.

Mehta: I think again, that depends upon the asset allocation, like you rightly talked about for example, the private banker normally does an asset allocation himself. So, a second thing if I also get into asset allocation or increasingly investing in equities as an asset class. There are two things, one, we say that if you are really meaning for the longer term, if you really talk about the next four, five years, I think you can probably do it at one go as well.

But yes, if you're a bit sceptical about the markets and that everybody is because this will be an eventful year for sure. Being U.S. elections, Indian elections, the narrative around inflation interest rates in the U.S., so I think yes, probably you can phase it out over the next three, four months. Probably volatility will come and disturb you, but it will become a friend if you're a long-term investor. So you can do it in a couple of tranches, three tranches if you're a conservative investor, but probably if your horizon is three, five years and if you are trusting that the Indian economy and Indian markets or rather the businesses that we're picking with a lot of conviction would bear fruits. I think we can probably do it at one go as well but ideally it has to be safe. A couple of tranches that at this level of the market or at this valuations would be a little bit more comfortable for everyone. 

Mehta: So this business has already seen around four–five–six times from our buying prices over a period in the last three, four years. The biggest trigger for this company in history is that there was a company called ABB which is still there. This company demerged as an entity called ABB Power Product. Hitachi, a global giant, came and took it over. Now this company's into everything right from power automation to grid integration, to transformers, to power data centres, and it's an annuity model.

It's a high niche type of business that it is into and you can call it a power ancillary business or an energy efficiency business. It also sends robots to the transformer and check the oil efficiency and when the oil is getting over, it also does something which is very interesting that today there are so many different types of power, for example, solar or wind power, or even your thermal power. It differentiates between what power is getting generated. What is the unit per power cost? There's a software called Lumada, which it uses for doing this. Now I'm talking a lot about this.

The EPS somewhere right now would be around 35–40 rupees. In the next two three years, the EPS probably would reach 140–142 types of level. All the orders of the larger companies, capital goods companies, infrastructure companies flow into Hitachi Energy. So this is again as a proxy play a big theme to play the capex or the power efficiency story or even a renewable story. Somebody playing an EV, this lays down the infrastructure for electric vehicles as well, along with BPL, IOC and HP. 

Mehta: So ideally on the large cap side, if there is an investment which is to be made, we are very comfortable with this company. It started off just as a Pepsi bottler in north India and now as you know, it's sort of become a completely national player in terms of PepsiCo products, even in the snacks of PepsiCo as well, they are their sort of leading players. They also just went to South Africa just hunting there as well and some other countries as well.

This company continuously uses great earnings, great revenues, implementing margins plus the management comfort is also big. Somebody wanting to invest in the large cap portfolio, we still go ahead with the warm beverages. We feel this company is slated for a multi-year growth period and also this is part of non-discretionary consumption. Of course, this is not discretionary because it's a low-ticket consumption, where India also gets into the habit of sort of consuming certain snacks as well as getting into sort of consuming certain beverages as well. So I think this is one proxy play for that beverage and because you will probably find Nestle and Britannia doing very well. Whether this company can be an Indian MNC going forward, the answer seems to be yes at this point of time.

Devang Mehta: So, what happens is that you build a company completely which is I can say a Abrukabagru operator which is sort of renowned in the South and you get to have exposure into six, seven industries when you buy Tubes. They are into metal tubes, they are into cycles, like from Hercules to other brands. This also is a holding company if you know about CG power and Shanti Gears. CG power just took out from NCLT and how it transformed it to a 70–80,000 crore market cap from 2,000 crore. The promoters are renowned to sort of get into this type of businesses and sort of turn them around. That's also one bigger part. They're also incubating a lot of new age businesses, like the optical fibre business, as well as some other businesses as well.

So I think it seems to be a proxy play for capex for a bit of consumption and I think the group has to be trusted. It's, as you rightly said, it's not very expensive in terms of its and they're reducing debt. The ROEs are also sort of expanding. So we feel very comfortable when we buy this type of it's around 70–75,000 of market cap again for a large cap portfolio. This suits the bill.

Mehta: I think this is a business where a lot of people still feel and compare whether this is the model which Infosys, TCS or L&T Infotech has. No, it's not, as you rightly said, it's into engineering research and development space, into AI, into sort of robotics. They do a lot of high-end work. The best part about this company is that you would require it everywhere. If you want to improve productivity, if you want to improve efficiency, the numbers are sort of a bit patchy.

Earlier, we picked this stock a long time back. We want to write a lot of portfolios and I think this is a bigger proxy player if you want to get into automation or technology or sort of something, which has to do with pure play and robotics. So I think it's a company probably from Iran, if you asked me at 25% type of earnings growth in three and a half years, can the earnings double? Yes. And ditto with the stock price as well.

Mehta: So sort of that would be difficult to talk about and in terms of what we are sort of getting into, but I think some of the themes are just an example, which we hold in the portfolio, which are still studying is pharma. So pharma has started to do very well, something like Abbott India has always been a part of the portfolio and then the numbers were fabulous. Now this company works with a negative working capital cycle. You can just imagine that it's like... something which also gives you good night's sleep and stress adjusted returns, which has been the sutra for our type of portfolios.

If you get into mid cap, small cap, these are companies which will give you a great exhibition of returns. There's even a company called Gufic Bio, which is a relatively smaller company. This is a smaller company with a (Rs) 3,500 crores of market cap.... So it's a complete innovator. Now the company is the market leader in localisation.

Now localization is something called you have drugs, you have medical medicines in terms of either liquid or tablets or through the IV fluid. Now, this is a powder form, which is sort of very easy to consume as well and which is for the children, if there is an antibiotic dose being given, it's in powder form and you mix it with water, just do it for the next five days and just give it to the three of them so that they are market leaders in there.

They're also innovators in terms of also finding out a lot of new drugs they used to produce this remdesivir and a drug for black fungus during the Covid times and is right now in a lot of other geographies. They don't have the sort of capacity right now to go and penetrate the U.S. But it's done extremely well, the last 10 years the compounding will be at least if I'm not wrong around 10–15 times. In the last 10 years, it's about (Rs) 3,000 crores market rate. 

Devng Mehta: So ideally yes, for example, now, there is a portfolio company called Timken. A lot of people identify it with bearings, but this is more into motion management. So, it applies everywhere, right from your missiles to your rocket to your defence, there are specialty bearings, which are required which also have automatic lubrication, which is required for them. So this is another company which does a lot of such work. It does customised bearings, specialised bearings, right from space to automation to automotive industries. So this is another place where you can play a proxy or an NC replay.

We like certain PSU banks, which are on the cusp of a turnaround and actually they already turn around and a lot of these power companies also we sort of rode them, but to buy it current juncture after they become 5x 8x, they are on the watch list. Of course, they have some of our portfolio stocks, but to buy them immediately is not something which will come to me naturally.