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Portfolio Commentary

Apr 26, 2024

The year gone by

• Markets continued to touch new highs in the quarter gone by.
• Close to two-fifths of the index’s annual return can be attributed to the Public Sector Enterprises (PSEs).
• The past year witnessed low-quality businesses outperforming high-quality ones.
• A year of underperformance by itself isn’t sufficient reason to rethink our investment philosophy.
• We have made specific portfolio changes within structural themes over the last few months.
• We remain confident in our investment philosophy and stated portfolio objectives of achieving superior risk-adjusted returns in the long run.

The markets continued to touch new highs in the quarter gone by, with midcaps emerging as the best performers, followed by the Nifty and Sensex. Small caps experienced a particularly eventful quarter, marked by bouts of selling triggered by various factors, including cautionary remarks from the market regulator. The index, however, managed to close in green for the quarter.

The concluded financial year saw low-quality businesses outperforming high-quality ones in terms of price performance. Our portfolios are largely invested in high-quality businesses, which have consistently delivered superior performance both in terms of business operations and stock price returns across market cycles. Close to two-fifths of the index’s return for the year can be attributed to the PSEs, a segment that doesn’t align with our investment philosophy’s filtering criteria.

Despite the temporary lag in performance, we remain committed to our investment process – investing in quality companies clocking high return ratios and high structural growth. A year of lower returns in such companies does not warrant a rethink of our investment philosophy. A significant portion of our portfolios is represented by structural themes or trends likely to deliver superior growth over the next few years. Instead, we have taken stock-specific calls wherever required, a routine part of portfolio management. We firmly believe that, over the long run, our approach will yield superior returns commensurate with the risk borne by investors.

Here is how our flagship strategies performed over the year and across other timeframes. The changes made have started to positively contribute over the last couple of months.

The detailed performance can be viewed and compared with other PMS performances on this webpage. Performance is calculated using Time Weighted Returns, net of fees and expenses. Returns over one year are compounded annually; returns for less than one year are absolute. Please note that SEBI does not verify the performance information provided above. Please note that past performance is not a guarantee of future performance.

The current trends that are evident and likely to persist over a few years are as follows–

Consumption – mass to aspiring / affluent shift. The increase in wealth among Indians has led to a rise in consumption of high-end and premium segments. The rapid growth in affluence over the last few years can be seen in the following segments of consumption.

  • High-end residential houses: Recent property registration data across big cities indicates that approximately 50% of registrations are for premium residential properties, a significant proportion compared to overall housing data. While we have been positive on the real estate sector for the last four to five years, we have played the sector largely through ancillary themes. To further capitalize on this theme, we made fresh investments in an upcoming premium real estate player.
    • Century Textiles and Industries – Birla Estates which is aggressively expanding its premium real estate offerings by acquiring projects in all major real estate markets of the country. With a combined gross development value (GDV) potential of Rs. 45,000 crores across its projects, Birla Estates has received better-than-expected responses from recently launched projects and aims to add real estate projects worth Rs. 20,000-25,000 crore in FY26.
  • Demand for big / premium cars outstripping small cars: In FY24 overall passenger vehicle sales grew 8.5%, within which small car segment was down 11% while UV segment was up 25%. We have played this trend through Mahindra & Mahindra, which remains part of our Indian Olympians portfolio.
    • Maruti Suzuki– is one of the late entrants in the UV and premium space, as it was always considered as an entry-level player. Over the last year, the new product range in premium and UV segments like Grand Vitara, Fronx, and Jimmy has led to a ~700bps market share gain in the UV segment, resulting in an overall market share of 41.7%. Post launch, Grand Vitara became the fastest mid-sized SUV to clock the 1 lakh sales milestone. Also, a favourable tax policy in works for hybrid vehicles will immensely benefit Maruti as it will make Grand Vitara – already a big success – much more affordable. We have added the name in both the portfolios.
    • Samvardhana Motherson International – is well-placed to benefit from a well-diversified product base and strong market presence. It is one of the beneficiaries of a rising trend in content per vehicle led by premiumisation and electrification. Moreover, its recent acquisition in the aerospace segment has enhanced revenue visibility and diversification. With a global presence, expanding portfolio and a wide customer base, the company presents a multi-year growth opportunity.
  • Surge in air travel v/s railways: The aviation industry in India is undergoing changes as the market is underserved and is one of the least penetrated of the 20 largest markets despite its rapid growth. While domestic air passenger traffic has witnessed 13% increase from last year and has already crossed the pre-covid figure, railways passenger traffic is still far below the pre-covid levels.
    • Interglobe Aviation (Indigo)- As the largest domestic low-cost carrier, Indigo is the biggest beneficiary of improving regional air connectivity in the country, as reflected in the doubling of airport numbers over the past decade. Further, it also benefits from the consolidation in the industry as smaller players have either shut down or significantly reduced their flying routes in recent years, which has lowered competitive intensity and brought price sanity to the market. Amid better prospects, the company ordered 500 planes from Airbus last year, the single largest order Airbus has received from any airline worldwide. To put this in perspective, the entire domestic aviation industry had a little over 700 planes at the last count, of which Indigo had 358 planes. The Airports Authority of India is planning to invest INR 300 billion over the next five years to build and revamp airport infrastructure.
  • New age consumer businesses: Scalable businesses that focus on behaviour change led by technology. While these businesses are disruptors, they are not immune to disruption themselves. Many new tech-enabled businesses are on the anvil.
    • Info Edge India – Currently, we are playing this theme through this name, as it’s an investee company in Zomato and PB Fintech (Policybazaar). It holds ~13% in each of these companies.
    • • We are also contemplating an opportune time to take direct exposure in some of the names.

Manufacturing – Atmanirbhar Bharat, PLI scheme & China+1 across various sectors (including capital & industrial goods) – India has undertaken many initiatives in recent years to boost its manufacturing sector’s share of the economy. These initiatives have started to bear fruits as structural advantages vis-à-vis China, such as lower wages and carbon emissions, are becoming apparent. Further, Indian corporates have the lowest debt/GDP, and there is a notable shift evident in the rising share of FDI flows.

  • Chemicals – India is the 6th largest chemical producer in the world. The growth in the sector in the coming years will be driven by various factors, including domestic consumption (import substitution) and export opportunities. The sector seems to be emerging from the destocking phase it experienced in the last couple of years.
    • Deepak Nitrite – is India’s largest player in the phenol-acetone value chain and has been a dominant player in phenol (~56% market share, remainder largely imports). The company has market leadership across many products in the value chain since phenol and acetone are basic chemicals with a wide range of applications across multiple end-user industries. Company is gearing up to address the large import substitution-led opportunity of Rs ~150 bn in downstream value-added derivatives as it capitalises on its expertise in existing and new chemistries. The company is also focusing on backward integration for value-added downstream derivatives, enhancing its overall competitive positioning.
  • Defence & Power – aim to reach 3 lakh crore (2x) annual defence production by 2028. Share of non-fossil fuel-based capacity to increase by ~50% in the next five years.
    • Bharat Electronics – Driven by its deep expertise in software and electronics, along with its steadfast innovation capabilities, it is at the forefront of providing cutting-edge solutions to India’s defence vision. Revenues contribution from defence ~90% with a strong order book of INR 760bn (3.9x TTM sales)
    • Solar Industries – is the direct beneficiary of infrastructure spending in the country as it gets close to a fifth of its revenue from the infrastructure sector. The rest of the revenue comes from other booming sectors like mining and defence. It is also a large exporter of explosives and initiating systems. The company’s defence revenue is expected to rise exponentially as it has bagged significant orders domestically and from export markets. Its current order book from defence stands at Rs. 2,200 crore, and its current defence revenue is around Rs. 135 crores annually. The company is also in the final commercial negotiation stage for Pinaka rockets, which can add another 1,500-1,800 crores to its existing order book. In the 9MFY24 it has clocked volume growth of 18%.
    • KEI Industries – 2nd largest player in the cables & wires segment in India with market share of ~13% in the organised cables & wires industry and ~9% of the overall market. It is among the few companies in India to manufacture EHV cables above 220KV+ which are used in power transmission.
  • Semiconductors / Electronics – significant investments are being made in these segments by corporates. We are looking to add names in this segment at an opportune time.

Financials –

  • Financialization – The rapid growth in affluence has also meant a sudden increase in financial assets and growth in services related to them. This has gotten further accelerated by formalisation and deep digitalisation of the economy. Corporate India has also seen massive deleveraging with debt-to-EBITDA expected to fall to 2.4x in FY24 from 4.3x in FY20. As the capital expenditure is on the rise, the demand for corporate credit will also help shore up the lending books at banks.
    • Aditya Birla Capital – The company has a diverse business profile, providing a gamut of financial services, including lending, insurance, and asset management. The business is firing on all cylinders with 35% YoY growth in the lending portfolio in the nine months ended December 2023, an 8% growth in equity asset under management (AUM), a 10% YoY growth in life insurance premium and a 30% growth in health insurance gross written premiums. With a new CEO, Ms Vishaka Mulye, at the helm, the company has strategized well for all its businesses, inducing data and analytics at all levels, from sourcing and underwriting to collections. The stock is relatively cheap in valuations compared to its peers.

Amongst the major portfolio trims were APL Apollo, Craftsman Automation, KEI Industries and Uno Minda. In all these cases we booked profits as the run-up in price made these names expensive on valuations. However, we still believe in the structural opportunities in these names and continue to hold them. As a routine, we will consistently monitor these names on business delivery to take further portfolio actions.

We are confident that the recent portfolio changes will help us deliver on our stated portfolio objectives of achieving superior risk-adjusted returns in the long run. We also believe that the quality bias in the portfolio will show up in the returns once the euphoria in certain market pockets neutralises. We have a good mix of leading themes and exposure to robust companies across the market capitalisation.

FY25 Outlook

We remain constructive on the India story, but few headwinds are creeping up on the sidelines which investors need to take into consideration and return expectation needs to be recalibrated for the year ahead keeping the following in mind.

• Domestically, the general elections outcome is well discounted in favour of incumbent government.
• Domestic economic activities are showing steady momentum.
• Earnings for Nifty50 in the last 2-3 quarters are decelerating sequentially, but broader market are still growing.
• Nifty50 trades at price to earnings of 23.5x TTM earnings – which is closer to historical highs.
• Globally, geopolitical tensions are rising incrementally as we write.
• Commodities have started to move up across the spectrum. Inflation remains sticky.
• Interest rates globally are likely to stay elevated vis-à-vis earlier expectations.

As investors, we have little control over the macroeconomic factors that impact the markets. Therefore, the best we can do is to minimise the micro risks by formulating robust investing processes and following them diligently to achieve superior risk-adjusted returns.

As the legendary hedge fund manager George Soros puts it, “The markets generally are unpredictable, so that one has to have different scenarios. The idea that you can actually predict what’s going to happen contradicts my way of looking at the market”.

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