Mr Kenneth Andrade, Vice-President-Equities, Standard Chartered Asset Management, is known for his stock-picking skills in the mid-cap segment. He manages the Standard Chartered Premier Equity Fund, which is the top performer over a one-year period. In an interview with Business Line, Mr Andrade makes a strong case for buying mid-cap stocks in a growth economy.

Excerpts from the interview:

Mid-cap stocks were trading at a premium valuation over large-caps before this correction. They have now moved back into a discount. But is the valuation gap between mid and large caps sufficient to provide comfort?

If an economy continues to expand, the bottom of the pyramid has to do well. In fact, if the top end is growing, the bottom end has to grow faster. To build 20,000 MW power projects, you need so many more vendors. Five years ago, you had NTPC making power plants in India. They would call for tenders. They used to send five tender documents, 30 bidders used to turn up. ’

Today, they send the same tender and two bidders turn up. What has happened to the others? Today, the generation companies are many — there is Reliance Power, Tata Power, the Jindals, the Essars, Jaiprakash, GVK and GMR. The top end of the market is completely fragmented.

So bargaining power has transitioned from the top to the bottom. Who are your vendors today? You still have ABB, Siemens…it is still the same set of people. To make sure that the economy moves ahead, you have to create capacity at the bottom end.

If you are buying growth, you need to understand where you are. Why do you want to live in a growth economy and be satisfied with a 15 per cent growth? Mid-cap stocks are volatile. But mid-cap businesses are not volatile. Finally, when I analyse cashflows, I am not concerned if I underperform over one or two quarters. I am playing an opportunity that gives me as much upside as the risk I am taking. But if I believe that the economy is contracting, I have no business being in this asset class.

IT stocks have been sharply de-rated. What is your view on the sector?

IT companies have their challenges. They address the weakest part of the globe in terms of capital spending. While saying that, what you have on your side as an investor is the valuation.

You have never got IT stocks so cheap. At this point, it all depends upon the execution. How well the environment stays up. One thing we need to understand is that IT companies need to go back to the drawing board once in every five years to redefine their business model.

Several stocks were bid up in the recent rally on the back of “value unlocking” from subsidiaries and other sources. Your comment on this trend.

The ‘value unlocking’ argument has its merits. But the value that you unlock has to also grow. It has been a merchant bankers’ market for the last six months. We have been creating enough opportunities to raise capital and grow our business. I think from an industry perspective it makes sense.

But we are creating companies on the ground that do not have adequate track record. The execution is going to be a challenge. At the valuations at which the markets now trade, the biggest challenge for corporate India is to execute well…. because you are being paid a very fancy premium for that.

What is the earnings outlook for Indian companies now? We already have a high base…

We are getting into a high base. We are running at full capacity utilisation across industries. We are looking at another round of capex and that new capacity has to enter the system.

There are also challenges in execution of the new capacity coming into the system. We need to transition into a consumption-led economy. The supply has to eventually create demand. We are through with demand creating supply now. Here onwards, the supply has to create demand. But there are plenty of opportunities.

StanChart’s open-ended Premier Equity Fund is among the top performing funds because of its mid-cap focus. You are now launching a new fund with the same theme. How will they differ?

Premier Equity Fund happens to have a portfolio composition that is skewed towards small and mid-caps. But in the new Small and Midcap Equity (SME) Fund, we are starting out by saying it will be a small and mid-cap fund. With Premier, we have put together a diversified portfolio of stocks that will be ahead of the market. The idea was to give investors a product that is slightly venture capital in nature, in the listed space.

If you look at the portfolio of Premier Equity Fund, several of these businesses are in the incubation stage. The top 10 stocks in the portfolio will be young companies/entrepreneurs operating in markets that are establishing themselves as industries. So the very nature of the product is that you hold a lot of risk in terms of the business plans panning out. While it has done well for the past two years, the bigger part of the challenge is now — when companies actually start executing those business plans.

In the Small and Mid-cap fund, we are taking off that risk of incubating new ideas. We are in the midst of an economic expansion, we have a number of sectors that will consistently do well. We want to participate in the meat of the market.

In Premier Equity, we are absent in real-estate, we have very little capital goods, infrastructure and technology is not a core part of the portfolio. We want to plug that gap. As India goes through capital building, infrastructure will do well. In SME, we look at existing spaces where companies are scaling up significantly. We will not duplicate the Premier Equity. The philosophy is slightly different but the style is the same. The number of stocks will not be too many, may be about 40. That’s enough diversification.

You were talking about incubation. But companies such as 3M India, Educomp Solutions or Pantaloon Retail that figure in the portfolio in Premier Equity Fund have gone beyond the stage of incubation. Will they still figure in the portfolio?

With incubation, you are essentially looking at a bulk of the assets in your books that are not productive. Look at the retail space. Organised retail is 1-2 per cent of the total market. Look at the new companies that are coming, they are attracting the biggest money available — Reliance, Birlas, Tatas, Wal-Mart. The industry is doing the incubating. Look at Suzlon Energy. It is a $15-billion business. By no stretch of imagination is it an industry; it is a theme. Market capitalisation is ahead of the business. So, as a business, it is still in the incubation stage. Take Educomp. We bought the stock when it was at Rs 20 crore EBIDTA, this year it will be Rs 120 crore at the EBIDTA level.

You made the point that market cap is ahead of market potential in infrastructure, capital goods space. Is it your view that these stocks are expensive?

In the infrastructure/capital goods space, you are playing an opportunity that is established. So when you say growth, you will not get them cheap. I will never want to buy a capital goods stock that is cheap, because then intrinsically, there will be a problem with the company.

I think the way to play an established opportunity, where there is a lot of momentum, is not to buy a company that grows 30 per cent every year. It is about buying a company that starts at number 9 and finishes at number 2.

In the technology sector, there are lots of companies growing at 30 per cent, but the ones who have survived are those that moved to leadership positions.

More Stories on : Interview | Investments

Article E-Mail :: Comment :: Syndication :: Printer Friendly Page