A portfolio manager for rich investors from Kotak has managed to deliver a decent return to investors since the inception of the portfolio Special Situation and Value Series I (SSV) in July 2012. Data showed that the fund has turned an investment of Rs 1 crore to over Rs 3.26 crore at present, indicating a growth of 3.26 times in 9 years. Investors need to put minimum Rs 50 lakh to invest in SSV. The benchmark BSE Sensex advanced 3 times during the same period. Meet the commander of the fund Anshul Saigal, portfolio manager and head- PMS, Kotak Mahindra Asset Management Company. In an interaction with Money9.com, Saigal shared detail about how special situation funds works and how they managed to outperform the market. Edited excerpts:
We look for stocks where the “Earning-Power” of a business is mispriced. This mispricing is reflected in the street’s expectation of lower margins or sales or both, versus the true potential of the business. We look to identify such underappreciation of companies’ prospects. Stocks typically offer favourable prices, when their prospects are underappreciated.
In addition, we also look for changes in the running of businesses which have the potential to improve its prospects. These changes could be of management, capital allocation, business restructuring or balance sheet improvement.
For instance, in 2013 Britannia traded at 20 times price to earnings (P/E) on one year forward earnings. The prevailing EBITDA margins of the company at the time were 6% and ROCE was approximately 38%. This was at a time when raw material prices (Sugar/ Flour) were at their peak. These commodities being cyclical, had little room to rise and much room to come down. Further, the company had over the previous two years added 2% to gross margins due to premiumisation. Incremental gross margins had not flown to the EBITDA line due to heightened advertising and promotion (A&P) costs. At prevailing levels, A&P costs as a percentage of revenues had little room to rise.
With revenue growth of 12-15% and raw material prices easing, operating leverage was likely to take EBITDA margins higher. Prevailing margins of 6% did not reflect the true earning power of this business. Around the same time, the company’s CEO changed. The new CEO had past experience with Pepsi and had turned around Pepsi’s snacks business. Amongst his first projects at Britannia was to realign incentives of the company’s distributors ie reward the achievers and dis-incentivise underperformance. The new energy was instilled into the system and over the next two years, margins far surpassed street expectations to reach 9% levels. The stock rallied 8 times in this period.
A special situation, put simply, is a value opportunity with a trigger. In special situations investing an investor seeks to not only identify strong businesses but also the triggers for value unlocking.
These opportunities typically fall under the ambit of corporate restructuring, demergers, asset sales, IPO’s of subsidiaries. Since these are not plain-vanilla long only opportunities, they attract relatively lower attention from the analyst community. Hence chances of favourable valuations emerging here are relatively greater. Additionally, the endeavour in special situations investing is to identify opportunities that have a relatively low correlation to market moves. Given the same, these opportunities offer favourable risk-reward metrics, which have the potential to unlock value in a time bound manner.
There are multiple reasons to churn stocks:
– Maintain position size i.e. if a stock rallies 2x and position size in the portfolio rises to 10%, we would trim it down to ensure that position is not outsized
– If our thesis on a stock does not work, we acknowledge that the thesis has not played out and exit the stock
– If we identify a more lucrative opportunity than our portfolio holding, we sell our position to release capital for the attractive opportunity
– We churn to build cash, at times when the markets have risen meaningfully and we anticipate a general market reversal as a result
The current market rally has been built on two key pillars: Strong liquidity conditions and Robust earnings growth.
While liquidity is a function of global easy money policy, key policy reforms undertaken over the last few years (GST, RERA, PLI Scheme, etc.) are catalysing earnings growth. We believe this earnings growth cycle has legs. Systemic consumption demand is on the rise, leading to investment in building capacities, which in turn is raising expectations of enhanced employment demand. This virtuous growth cycle is in its nascent stages in India. Since liquidity chases growth, there is a high likelihood that India will see continued inflows over the ensuing few quarters and years. Hence, markets should remain strong on the back of twin pillars of liquidity and growth.
In every bull market, there are intermittent valuation led corrections. It will be no different this time, but such corrections typically form the platform for subsequent rallies.
We believe a strong broad-based economic recovery is ahead of us. Most sectors will participate in such a recovery. However, we are focusing on a few trends/pockets which includes:
-China+1 – over the last few years geopolitics has catalysed changes in global supply chains. These changes have been accelerated post the Covid 19 breakout and companies are looking to augment material supplies from countries other than China. India is likely to be a key beneficiary of this multi-year trend. Sectors that will benefit as a result are Chemicals, Pharmaceutical APIs, Electronics, Auto Components, etc
-Real Estate – Affordability of residential real estate in India is near 2003 levels. In addition, mortgage rates are at the lowest ever. These factors, among many others, bode well for a revival of the RE cycle. We anticipate that Building material manufacturers, RE Developers, Consumer Durable Companies, Electrical Companies, etc. should benefit from this trend
-Domestic Consumption – Out of a total GPD of $2.9 Trn, nearly $1.7 Trn is contributed by Consumption (Source: CEIC, Morgan Stanley Research). Further, Retail sales comprising of segments like Grocery, Electronics, Apparel & Footwear, etc. are approximately $ 700 Bn. As vaccinations rise, we expect consumption to get a fillip, given that excess household savings have been in the range of $140 Bn by some estimates.
-Domestic Capital Expenditure-With enhanced consumption, capacities are getting filled fast and companies are thronging to set up new capacities. Nearly Rs 6 Tr capital expenditure has been announced by the Indian private sector since March ‘20. Including government announcements, total Capex announcements are now at approx. Rs 10 Tr (Source: Nirmal Bang Research). This will give wings to India’s capital spends. Capital goods, manufacturing, infra companies stand to benefit from this trend.
A few risk factors for the markets are as follows:
-Resurgence of new variants of Covid and inefficacy of the vaccine against the same.
-Inflation rises due to easy money policy of central banks. This leads to a tightening cycle, ahead of the anticipated time.
-Banks head back into an NPA cycle and growth takes a backseat.
-Earnings cycle abates due to demand setback.
Q1 earnings season has gone better than street’s expectations, with PBT growth (ex-financials) of 100%. The base in Q2 is high given that earnings in same quarter last year had recovered handsomely. Further, this year some expenses like advertisement/ travel have come back to some extent. These expenses were negligible last year. Realisations and margins will see the impact of rising raw material prices as well. Hence, we could see a muted profitability growth number in Q2 while revenue growth could be strong on the back of both volumes and realisations.
Mornings start with reading analyst emails detailing the previous day’s developments, research on companies or macro reports. We try and analyse at least one company in detail during the day. This involves going through annual reports/ con calls/ presentations and having meetings with management/ stakeholders. We also constantly keep track of developments in our portfolio companies. Periodically, we speak with management to figure if performance is in line with our thesis.
Numbers are important in our analysis of businesses, but equally important is understanding softer aspects of business and what market expectations are built into the stock. Number crunching is important in understanding objective business factors like profitability metrics, capital efficiency, balance sheet ratios, etc. It is equally important to understand softer aspects such as relations with stakeholders (employees, suppliers, customers), competitive advantages or economic moats and operational efficiencies. Accordingly, we decide whether to invest in a given opportunity or not.
My advice is two-fold:
-Many great investors have written extensively about their experiences. Any investor with interest in the markets can read and learn from this wealth of knowledge. New investors should read these writings extensively. These help to minimise errors and guide investors toward parameters that are critical in researching stocks.
-Try to read one annual report per day and go through publically available information about the company i.e. websites, journals. Using these, try to build excel financial models. This helps in deconstructing business models which is critical to analysing companies.