My note: Throughout the note, Kenneth Andre repeats the importance of capital efficiency in running a business. Even Rakesh Jhunjhunwala talking about Indigo investment once mentioned that with 50 crores capital, they achieved 10,000 crores sales and with the same 50 crores capital, they achieved 15,000 sales. Basically, they grew without raising additional capital. Such 'capital efficient' businesses are what make great stock eventually.
Notes from Andre's PMS presentation
1. Investment philosophy
- Identify businesses early into a cycle
- Companies in industries that are consolidating,
- Companies that demonstrate leadership skills
- Companies that have financial discipline
2. Investment Strategy
Create a portfolio of companies which meet the criteria of
- Capital efficiency
- Low leverage
- Profit making with low capex scheduled
- Low valuation
Companies in valuation range of $50mn to $2bn
Portfolio may not necessarily be diversified across industries.
3. Stock Selection
Capital efficient nature of business
- companies moving to higher ROE
- idea is not to predict growth but to look for capital employed to be controlled
- cash flow prositive nature of business with low gearing are critial elements required for this transition
Monopolistic / Consolidator of the industry
- preference for consolidating businesses
- identify companies gaining market share with corresponding change in capital employed
- identigy companies with lowest cost in their industry
- companies need to profitable in this transition
- leadership at the end of the cycle usually results in higher market share and pricing power
Low financial leverage
- preference for companies with negligible debt
- prefer businesses leveraging into an economic up cycle & deleveraging at the top of the cycle
Low valuation
- look for 'out of favor' businesses whcih currently reflect current depressed earnings
- EV/Sales
- Market Cap/Cash profit (flows)
Performance
- Kenneth Andr's IDFC Premier Equity fund gave a return of twice the benchmark index over 10 year period from 2005 to 2014.
IDFC Premier Equity - 24%
S&P BSE 500 - 12.8%
CNX Midcap - 13.7%
CNX Nifty Index - 13.2%
(Note: Nifty Index gave a better return than BSE 500, although BSE has more stocks).
Insights from BSE 500 data (slide no. 25)
- Between 2005 and 2015 - Sales grew at 20%; but profits grew at only 11.5% (i.e. half the growth rate of sales). It means competition is high, capitalism is alive and kicking in India.
- ROE at 11% is low. The spread between ROE and govt securities (yield - 7.7% in 2015) is only 3%. At such low ROEs, it may make sense to invest in govt securities than take the risk of equities. These are average numbers and stock-selection of high ROE businesses can lead to better spreads.
- Profit margin is only 5.5% for BSE 500 companies, not much different from US S&P 500 companies (approx 6%?)
- BSE 500 companies had ROE as high as 20% between 2005 and 2008 and as high as 15% from 2009 to 2012.
- Note: The ROE% is twice the Profit margins%
- Total Debt to equity is less than 1. The total debt to equity is only about 50% higher than average/median. So, this should be manageable, right? Although, Andre seems to say that debt levels are quite high.
Insights from Small Cap Index 685 companies data (Slide no. 26)
- Small companies index of 685 companies are making only 5% of the profit of BSE 500 companies, although their turnover is 30% of the BSE 500 companies. It means their margins are very low. Since most of these companies must be supplying goods/services to large companies, the large companies must be squeezing them on pricing and margins.
- Small companies's profit margin is less than 1% of their sales.
- Small companies ROE is only 2%. Although between 2005 and 2008, they had an ROE of 15% and ROE of 10% between 2009 and 2012.
- Total Debt to Equity at 1.6 is higher than BSE 500 companies.
- So, in general the economics of Small Companies seem to bad compared to large companies. So, one has to be careful while investing. The economics of small companies seem to be especially bad during bad economic conditions. Conversely. no wonder small companies' economics improves dramatically during better economic times as they are coming from a very low point. Hence, small cap stock performance improves dramatically during good economic times / boom times / bull runs.
Credit in India (as on March 2016, non-food credit)
Industries - 44%
Services - 23%
Retail - 20%
Agriculture - 13%
Corporates / organized sector account for 65% of credit
Retail accounts for only 20% of credit
(Note: This means unorganized sector and retail doesn't have adequate credit facilities. Companies/NBFCs servicing these segments will likely do well over many years. Hence, stocks should also do well in these sectors.)
- In India, retail credit is 20% of total credit and 10% of GDP (which is quite low relative to other developed countries). But perhaps, is likely is remain low due to non-availability of social security and other safety nets in India.
- Housing loans account for 50% of retail credit (Note: the high contribution of housing)
Trends to play out
Easier to grow retail credit than corporate credit. Retail credit could grow at even 30% cagr.
Retail credit rates will have a secular down-trend.
Availability of credit will release equity employed in SMEs.
Consumption could be a secular trend (from growth in retail credit and increase in cash with SME owners).
Rural Rush - direct benefit transfer, cutting of middlemen in marketing, increased crop insurance coverage, etc., could lead to increasing rural incomes and their spending levels.
https://docs.google.com/viewerng/viewer?url=http://alphaideas.in/wp-content/uploads/2016/08/Old-Bridge-Capital-Kenneth-Andrade27s-Equity-PMS.pdf&hl=en_US
No comments:
Post a Comment