With domestic consumption under a cloud, Kenneth Andrade, Chief Investment Officer of OldBridge Capital makes a case for scouting for Indian companies that can expand their foothold in global markets.

When it comes to demand, there are two views about Covid. One says that the world will completely change after it. The other says people are very resilient and companies will be back to business as usual. So are you changing your sector choices and portfolio strategy because of Covid?

The pandemic I believe, has only accelerated the trends that we were already seeing before it. Before Covid, the economy was slowing down. At the end of 2019 and 2020, all indicators showed distress in the Indian banking system, leverage building up across the economy. Household debt as a percentage to GDP was at an all-time high and the savings rate at an all-time low. Consumption data was not very encouraging be it automotive sales or appliances. Then, Covid struck.

From a portfolio management perspective, we were already positioned for the slowdown. Post this, incomes have taken a further setback and we believe wage inflation is not going to come back for some time.

So, we did not own any consumer facing business or consumer-facing liability business. Post Covid, we see further reason to stay away from them. The rest of what we have in the portfolio is working in our favour. In the decade from 2001-2010, you had a bull market led by materials, infrastructure and corporate banks, before the valuation bubble burst. In the latest decade (2009-2019), you had consumer businesses and consumer finance trading at pricey valuations. We expect a similar trend to play out.

Financials have come to occupy a very large proportion of the index today at over 40 per cent weight. What do you think of this polarisation and will there be a reset?

This happens in every bull market. Technology stocks did something very similar in 1999-2000. The investment economy and corporate banks did it in 2007-08. This time around 65 per cent of the index is weighted towards consumer-facing stocks, including retail banks. Every time a sector delivers high growth, there is usually a polarisation of capital. Lenders and investors flock to that sector and move their entire balance sheets towards it and fuel that growth. Capital usually goes into places which offer optically high level of growth adding to the bubble.

Given that consumption may not pick up to previous levels given lower incomes, can the rest of the economy still do well? After all 57 per cent of India’s GDP is private consumption.

My view is, don’t look at investing from the Indian consumption perspective. India is just 3 per cent of the world GDP. When the opportunity in India shrinks, the better-managed companies from India will look outside for growth. We haven’t had the 90s kind of trend, export-driven growth, for quite some time. If you recall what Indian technology companies did, what pharmaceuticals did and what chemical companies are doing, we have the ingredients to scale up strongly.

So, why can’t we go ahead and find these opportunities?

But we can’t expect a linear improvement. Any company getting into the international space, first has to prove its ability to deliver a quality product at a very competitive price and create a very efficient back-end. Then, they need to prove their ability to scale. You can’t break into a new industry and own it instantly. No one changes their vendors overnight. But it is possible. In the US, India controls 45 per cent of generic pharma market and this is because Indian companies have been able to prove their capabilities over last 15 years. They have gone through multiple regulatory challenges but still got there. The IT sector proved itself in the late 90s and early 2000s. So, this is an opportunity out there. A weak domestic economy does not mean stock opportunities are finished.

So what stock themes are you looking at?

We are looking at domestic manufacturing with a larger market format. I can see three big themes that may play out over the next decade. One is that the cost of energy wills sharply come down.

Two, wages are not going to rise. There is also a third one -- the onset of automation that will also keep manufacturing costs down.

How efficiently an Indian entrepreneur can use those will decide his ability to scale profitably. I will be looking at companies that can do this with both capital and cost efficiency.

Right now, the E in PE is quite uncertain. So how are you assessing stock valuations while deciding where to invest?

I think the Price to book value ratio is a good way of doing it. A second way is to take earnings as of FY20 and work with that. It is always possible to gauge the earnings potential of a business based on past data. There is enough data out there.

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