Investor Memo Nov 2022

Dear Investor, 

Hope you are doing well. Below is a chart depicting our returns viz BSE 500.

In this monthly update we will discuss the following: 

  1. Our current portfolio construct and the rationale for the same

  2. The valuation of our portfolio viz the BSE 500

  3. Performance of our portfolio companies in Sept 2022 and their near term outlook

Portfolio Construct

The chart below depicts the current construct of our portfolio. Your individual pie chart may vary based on your vintage with us. 

We have a high allocation to: Auto/Auto ancillary, BFSI, Branded Consumer goods and Manufacturing. These are four segments where we have deployed ~ 65% of your capital. Our core investment thesis in these 4 segments is as follows: 

Auto/Auto Ancillary

The auto industry is coming out of a 4-5 year period of demand contraction/stagnation. We are now seeing: a.) strong sustainable demand for passenger vehicles, refer chart below b.) steep rise in adoption of 2 & 3W EVs, c.) cyclical revival for commercial vehicles, d.) easing of supply side bottlenecks like semiconductor shortages. We are currently investing in OEMs which are segment leaders or in ancillary vendors of these OEMs. 

Source: SIAM, Vahan Dashboard

BFSI

The BFSI industry has weathered the COVID asset quality storm reasonably well. With rising interest rates and a strong demand across all segments of lending: housing, personal, corporate, MSME, vehicle and micro-finance (in that order) are segments we are interested in. We have been tracking the most conservative/high quality managements in each segment and building our position at reasonable valuations. A lot of research reports have been written about strong demand in BFSI and one should be less concerned about asset quality as the same will improve for the sector as a whole. There is a temptation to pick an asset at dirt cheap valuation as the whole sector will do good as a whole. We have however, seen that the culture of conservative lending is like reputation/trust: takes long but evaporates with one mistake. We therefore like to back only the best quality lenders at a reasonable valuation. Building a position at a reasonable valuation is possible only by investing in a sector before it becomes a hot sector.  

Branded Consumer

Core demand for consumer goods remains subdued due to either the high base effect of COVID or steep price rises taken to pass on inflation in prices of commodities. We have been investing behind players who are a.) breaking out from being small/regional players to multi region players, b.) Or are dominant players in their core verticals and are expanding into adjacent verticals. This thesis is playing out well, given that in the last 10 years FMCG distribution has been democratised. 

Manufacturing

Leading sectors in India: power, tyres, cement, pharma and chemicals are currently investing in expanding capacity and/or optimising their energy consumption. Refer to the Gross Fixed Capital Formation chart given below. The Russian-Ukraine war has also triggered discussions of energy self reliance around Europe. Indian companies which are globally competitive in manufacturing of power equipment are expected to gain from this trend. 

NOTE: Figures in INR Bn.

Portfolio PE Multiple and Performance

We are comfortable with our Portfolio’s PE multiple. We however have become cautious in the deployment of fresh capital given the background of rising markets. The current cash balance of ~ 12% on average is an indicator of the pace of deployment. 

Q2 FY 23 was a tough quarter due to rising input/fuel costs and weakness of demand in some pockets and high volatility in global currencies. 

  1. In Q2 FY23, our portfolio as a whole grew sales and profit by 18.8% and 17.5% y-o-y respectively. 

  2. 20% of our portfolio companies demonstrated subpar topline growth (less than 5% sales growth YoY). 40% of our portfolio companies de-grew their profits YoY in Q2 FY 23.  

  3. We are closely watching these companies for their near term outlook and building subsequent positions accordingly. 

  4. In situations like these, we focus on the metrics that are under the control of the management and eliminate short term blips due to external factors such as freight/supply shocks/currency/fuel as these external factors reverse equally fast.   

  5. We are already seeing commodity/metal prices and currency fluctuations taper.

  6. The balance 60% of the portfolio demonstrated a median sales and profit growth of 24% and 32% respectively. 

  7. We continue to allocate more capital towards names that can deliver a sustainable IRR of ~ 25% for the next 3 years. 

  8. We continue to find opportunities at reasonable valuation in Cement, BFSI, Auto Ancillary and Domestic Pharma.   

We have exited from R systems due to its sale and delisting from the exchanges. We believe that we can deploy the capital in other interesting ideas.

Thanks 

Prescient Capital

sonal minhas