We should see relief rally sustain, though with interruptions: S Mukherjea

Saurabh Mukherjea, Founder & CIO, Marcellus Investment Managers
Last week was almost a one-way street for the markets, which even took Moody’s India downgrade in their stride. SAURABH MUKHERJEA, founder and chief investment officer of Marcellus Investment Managers, tells Puneet Wadhwa that as a strategy, the focus is not valuations, but companies with clean accounts that sell essential products to 1.3 billion Indians and have immense entry barriers. Edited excerpts:

Is the worst over for the Indian equity market?

Given the overreaction to the Covid-19-related panic in the three months ended March 2020, it was inevitable that the Indian market would see a sharp recovery as investors got over their initial panic reaction. As India gradually emerges from the lockdown, demand should steadily normalise for most products. This will be especially true for day-to-day essentials. Moreover, as labour shortages and supply-chain issues kick-in in the wake of the lockdown, stronger companies — with better-managed supply chains and labour forces —will gain market share.

In addition, the three-pronged stimulus that India has been subjected to — massive monetary easing by the Reserve Bank of India (RBI), a modest fiscal stimulus from the government, and a 60 per cent drop in the price of crude oil — should help the economy get back on its feet in the second half of the financial year. Therefore, as the ‘recovery’ narrative plays out, we should see the relief rally sustain, albeit with interruptions as we get to hear about heartbreaking stories of distress from various parts of the country.

What’s your reaction to the recent downgrade by Moody’s? Can Fitch and S&P follow suit?

I have always found narratives that rating agencies put forth to be very powerful contra indicators. So, whenever global rating agencies upgrade India, I tend to get really worried about the equity market. The opposite obviously applies in the case of a downgrade.
How much importance will the markets now attach to global events?

India accounts for a mere $3 trillion of economic activity in a world with nearly $80 trillion of activity. Despite this, the Indian market always has been — and always will be — subjected to global influences. There is nothing new here vis-à-vis the level and intensity of global influences on India.

What has been your investment/ portfolio strategy since March lows?

Our investment strategy is always the same — look for companies with clean accounts, which sell essential products to 1.3 billion Indians and have immense barriers to entry. Such companies tend to have the pre-tax return on capital employed (ROCE) ratio of 35-45 per cent, which, in turn, allows them to generate free cash flows equivalent to 30 per cent of capital employed. 

They then proceed to reinvest two-thirds of this free cash flow, and thus compound consistently at 20 per cent. This is what we have always done regardless of what is happening in the economic or political or cultural spheres — and Covid-19 hasn’t changed that. Some of these companies are domestically focused; for example, Asian Paints and Bajaj Finance have large allocations in our portfolio. And some of these companies are export-focused, such as Divi's Lab that exports its entire output.

What’s your view on the big-ticket, discretionary and aspirational categories of consumption as the economy opens up?

A gradual demand pick-up is already underway and we are not even out of the lockdown! Clearly, the demand normalisation is likely to be far quicker in sectors which are small-ticket essentials. And the demand recovery might take longer to set in sectors that are big-ticket purchases. What’s interesting in this context is that globally, auto demand seems to roar upwards when a country emerges from lockdown. In India, too, our channel checks suggest that auto demand could come through nicely after Covid-19.
Financials have seen a good run last week. Your view?

As a house, we are not particularly focused about valuations. In the context of financial services, unfortunately, only a small handful of lenders meet our investment criteria; the rest fail on accounting or on barriers to entry. These lenders include HDFC Bank, Kotak Bank, and Bajaj Finance. We have been invested in these stocks for a long time now and plan to be invested in them for many years to come.

Do you expect the government and the RBI to dole out more fiscal measures?

Given the fiscal relief that India has got from the price of crude oil going from $85 to $30 per barrel, the government has more room to provide fiscal stimuli. I suspect that both RBI and government will provide one more round of stimuli once the economy emerges from the lockdown.

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