Dear Investors,
The following chart depicts our returns viz BSE 500 TRI:
In this monthly update we plan to highlight the performance of our portfolio companies, their key characteristics and our risk mitigation for a downside.
Q3 was a healthy quarter for the portfolio as the portfolio companies demonstrated a YOY ~12% sales and ~27% earnings growth respectively.
Our portfolio also delivered a return of 18% during the Sept 2023-Jan 2024 period when compared to 14.5% for the BSE 500 TRI Index.
Our funds cash balance level is at 22% (on a cost basis).
As we speak, our portfolios trailing twelve months PE multiple is 28.2. Refer to the chart below where we compare our portfolios Trailing PE multiple to that of the BSE SENSEX.
Our portfolio has moved from trading at a discount to the BSE SENSEX index to trading at a premium to the same. The trend is indicative of the run the small and mid cap stocks have seen with respect to the Index.
The above thought may trigger a question on our capital deployment strategy for the near term. Conservative investors like us are first preserving capital and then deploying capital. We are exiting past investments which are expensive in valuation or are underperforming due to a delayed execution.
In the last 2 months we have exited the following portfolio companies:
JB Chemical (Exit at a TTM PE range of 45-50x),
Matrimony (slower than expected new customer growth),
SBI Cards (sector hitting a bad credit cycle),
Mangalam Cement (trading at mid-expensive valuation),
Amrutanjan (Exit at a TTM PE range of 45-50x)
During the same period, we have initiated positions in:
Bharat Bijlee: BBL is one of the leaders in the electrical engineering industry in India. The company has two primary business segments: Power Systems (~46% of revenue) segment that comprises Transformers and Projects divisions; and Industrial Systems segment (~56% of revenue) comprising Electric Motors, Drives & Industrial Automation and Elevator Systems divisions. There is a strong revival in the Indian capital goods sector, especially power equipment segment, owing to revival in private industrial capex, shift towards renewable power, govt. push on infra development as well as on power transmission capex, etc. We have initiated the purchase of BBL at a TTM PE of ~ 22x.
FDC Limited: FDC is a backward integrated pharmaceutical company manufacturing and selling both APIs (intermediates) and formulations in India and international markets. ~81% of its FY23 revenue came from manufacturing and marketing branded formulations in India. We have initiated the purchase of FDC at a TTM PE of ~ 25x.
Orient Electric: OE is a household name in consumer durables. It is the no.2 player in fans and the no.3 player in room coolers. The company stands out in its balance sheet prudence (ROCE of ~ 23%) and a negative working capital cycle. The performance of the durables sector has been lacklustre in the last 18 months due to: change in energy norms of fans, weak rural demand and a high cost inflation. The stock has corrected by ~ 50% from its peak and is attractively priced at a Market cap to Cash flow from Ops of ~ 22x.
Indigo Paints: Indigo Paints is the 5th largest paints brand in India. It has been the fastest growing (>20% sales growth) paints brand for the last 8-9 years and it’s on the ground execution stands out. The paints industry has strong branding and channel related entry barriers. Indigo has demonstrated the ability to create a recall and channel acceptance over the last 8-9 years. The stock is down by ~ 50% from its listing price. We have initiated the purchase of Indigo at a TTM PE of ~ 45x.
Some of you may rightfully have concerns about where the markets are and the rich valuations of the small and mid-cap stocks. Through this memo we also wanted to capture some key aspects of our portfolio companies and explain why the current portfolio is of high quality and is trading at a nearabout reasonable valuation.
Our portfolio has been demonstrating a 3 year sales and profit growth of 13% and 21% respectively. In the last quarter, the sales and earnings of our portfolio companies have grown at 12% and 27% respectively.
Our portfolio companies do a very good job of converting profits to cash flows, implying they are balance sheet efficient. They do not lock in capital in working capital and/or capex. Our portfolio companies convert ~88% of the profits into cash flow from operations. The closer this ratio is to 100%, the more capital efficient a business is.
Our portfolio is also low on leverage. The debt to equity ratio of the portfolio is 0.06. Typically low leverage is a sign of a healthy balance sheet. The portfolio has a net working capital days of ~ 50 days, implying capital doesn’t get stuck in debtors, raw material and finished goods inventory. Our portfolio companies convert Rs 1 of sales to Rs 1 of cash in ~ 50 days.
Our portfolio’s trailing 12 months Price to Earnings ratio is 28.2x and it has demonstrated an earnings growth of 21% in the last 3 years. Assuming the same earnings growth continues, the portfolio is trading at a PEG ratio of 1.5x. The PEG ratio highlights the PE multiple one is willing to pay for earnings growth. The closer this multiple is to 1, the more conservative the entry valuation is. As we speak, we have a portfolio that is nearabout reasonably valued. Having said this, we would want our portfolio’s PEG ratio to be closer to 1x.
One may also ask: Despite a strong portfolio, can the portfolio correct from hereon? The answer is “absolutely yes”. The chart below shows our portfolio's returns and drawdowns viz the index.
Since our inception 52 months back in Oct 2019, the BSE 500 index has given negative returns in 18 months and positive returns in 34 months. In these 18 months of negative returns, our portfolio has corrected less than the index in 16 of the 18 months. Implying our drawdown/correction has been lower than the index in 16 of the last 18 drawdowns/corrections.
In the 34 months of positive returns by the Index, our portfolio has beaten the Index returns in 17 months and it has underperformed the Index in the balance 17 months.
This implies that our portfolio has a more robust performance during drawdowns/corrections than during bull runs. The key reason for the same is our discipline of investing in great promoters at a reasonable price. During periods of correction, market participants tend to deploy capital in fundamentally strong businesses and hence these correct lower than the others.
We hope this data helps you understand how we have been building our portfolio to mitigate risk of a drawdown/correction in the future.
To conclude, investing is a longer term game and any investor has to bear a period of correction/drawdown to enjoy the returns thereafter. We too have faced periods of a drawdown of 10-18% across times. In the longer term, we however have been compounding capital at 36% since inception when compared to ~ 20% for the Index.
What makes the recovery post a drawdown more predictable is the earnings growth of the companies and the economy at the macro level. Per us, Indian manufacturing, housing and services are growing at a decent pace, and are expected to do well over the longer term too. The longer term outlook for most of the sectors in India look good.