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00:00 [MUSIC PLAYING]
00:03 Thanks for tuning into "The Portfolio Manager."
00:13 It's a show where we try and peek
00:15 into the minds of the portfolio manager
00:17 to figure out how she or he is positioning
00:21 the portfolio for creating alpha over the course of the next 12
00:25 to 24 months or longer.
00:27 My guest today is Naveen Chandramohan, founder and fund
00:31 manager at ITUS Capital.
00:32 Naveen, great having you.
00:33 Thanks for taking the time out.
00:34 Good afternoon, Neeraj, and good afternoon to everyone
00:36 on the show.
00:36 Thank you so much for having me.
00:38 The pleasure is entirely ours.
00:39 Now, I'd love to understand, how are you
00:43 thinking about the portfolio construct currently?
00:47 Is it more defensive than aggressive in nature
00:51 because of the valuations?
00:52 Or do you believe being aggressive might still pay out?
00:55 So I think, if you allow me, Neeraj,
00:58 I would like to tune out a bit before I then
01:00 go into the question.
01:01 I think I've always believed in the value of cycles.
01:05 And that comes, again, from studying history a lot.
01:09 So I think the cycle that we are in
01:12 is what I call a GDP beneficiary cycle.
01:16 It's quite contrary to what we saw
01:19 in terms of global markets as well as
01:21 Indian markets between 2010 and 2020.
01:25 So effectively, between '10 and '20,
01:28 you didn't see GDP expand, not just in India, but globally.
01:31 And post-COVID, post the inflationary regime
01:34 that we are in, which I think we will continue into
01:37 over the course of the next three to four years,
01:40 I do believe that GDP-facing sectors should show better
01:43 growth.
01:44 So within that broad framework, I
01:47 would want to position portfolios
01:49 towards those areas.
01:51 So if you look at the portfolio from a top-down perspective,
01:53 we would be overweight cap goods.
01:55 We would be overweight power, energy, auto and auto
01:59 ancillaries.
02:00 We have been underweight banking.
02:02 And we have been underweight consumer.
02:04 We don't have any IT exposure.
02:07 And effectively, that is how our portfolios are constructed.
02:11 So IT services--
02:13 So IT services, the only company that we have
02:16 is an ER&D services company.
02:18 So it's not the typical service-based company.
02:21 It's more so engineering R&D services-based company
02:24 that we own there.
02:25 OK, and I'll come to that.
02:26 But first, it still doesn't answer my question, Naveen,
02:28 about whether the portfolio is aggressive or is it defensive.
02:33 Even in power or even in auto ancillaries,
02:35 you can take aggressive bets or you can take defensive bets
02:37 by virtue of the nature of the businesses
02:39 that you're betting on.
02:40 So is your portfolio aggressive or is it defensive in nature?
02:42 So again, I don't know how we qualify
02:45 aggressive and defensive.
02:47 So for me, a portfolio construct where liquidity
02:51 is taken into effect and earnings growth
02:52 is roughly between 18% to 20% is what I would look for.
02:56 But even if it's coming at a higher valuation?
02:58 So the valuation, if you look at a trailing PE perspective
03:02 of our portfolio, it's roughly 12 months.
03:05 TTM is around 27 and 1/2.
03:07 So in order to get an 18% to 20% earnings growth,
03:12 you have to pay up a bit.
03:14 You're not going to be able to buy, at today's valuations,
03:18 a TTM of 10% to 12% PE.
03:21 That doesn't exist.
03:22 So the question is, how much are you willing to pay up?
03:25 You can go into the consumption space
03:27 where you have to pay up a lot more to own these businesses.
03:30 We're not willing to do that.
03:32 You can go into cap goods.
03:34 You can go into power, where I still think
03:36 the valuations are reasonable.
03:38 So we don't think about it in the traditional sense
03:42 of saying IT and pharma are conservative
03:45 and the rest of the businesses are aggressive.
03:47 To me, equity is aggressive.
03:49 So the question is, equity means volatility.
03:53 My job as a fund manager is to reduce that volatility.
03:56 If I can do that consistently across time,
03:59 returns are an outcome.
04:00 So we still own pharma.
04:02 We still have an overweight in pharma.
04:04 Does that mean that's a conservative bet?
04:06 I don't think so.
04:07 That's not a defensive to me.
04:08 That still is aggressive.
04:09 Yes, yes, most certainly is.
04:11 So because the market cap orientation of IT's capital,
04:14 large caps 47 and 1/2, mid cap about 19.2,
04:17 and small caps about 13% as of the last data that has come in.
04:23 Now, Naveen, would love to understand some of the bets
04:27 that you've taken.
04:28 And we'll get into the more obvious ones
04:31 in the second half of the show.
04:32 Right now, I'm trying to talk about the ones
04:34 where you are either large overweight or an underweight
04:36 related to the street.
04:39 Auto ancillary intrigued me, simply
04:41 because while people have been constructive on autos,
04:44 and you are constructive on auto as well with 7% weightage.
04:47 But 9.7% weightage on auto ancillary
04:50 shows that you are really constructive out there.
04:53 Now, give us your thought process here.
04:55 So end of the day, again, auto has and will
04:58 continue to be an extremely cyclical sector.
05:02 Now, if you go back 10 years in the past,
05:05 and when you study auto ancillaries,
05:07 you have very few scaled up businesses in auto ancillaries.
05:12 Auto ancillaries don't lend themselves
05:14 into pricing power at all.
05:16 So they always have been a cost plus business.
05:19 Margins are, if you can get to a 10% EBITDA margin,
05:23 that's like a dream come true, because you get
05:25 squeezed day in and day out.
05:27 Now, with manufacturing moving here,
05:30 there are a lot of technopreneurs
05:32 who have been in this business for the last 35 years.
05:36 They either have been playing on the back of import substitution,
05:40 or they have a unique niche R&D that they have established,
05:44 which has lent itself into what you call deemed exports.
05:48 These two put together tend to have characteristics
05:52 of giving you a high 10% EBITDA margin
05:56 with a sensible debt profile.
05:58 If you can get these, that's the space I would be over it.
06:02 So I'm not saying we own businesses across the board.
06:07 It's a technopreneur that we are backing.
06:09 It is R&D ability.
06:11 There is a lot of import substitution.
06:13 So you have the ability to expand your margins.
06:17 Your today's ROEs would roughly look at 16% to 17%.
06:21 Many of them have actually put up
06:22 gap picks on the back of import substitution orders, which
06:26 means they can expand from 16% to 17% to closer to 20% to 21%.
06:30 And that's the space that we are backing.
06:33 So again, just to clarify so that our viewers understand,
06:36 auto ancillary is a very wide bucket.
06:38 Forging companies, wiring harnesses, tires,
06:41 what have you, right?
06:42 And now the EV thing as well.
06:44 What have you chosen within this auto ancillary space?
06:48 What kind of themes--
06:49 I don't know if I have liberty to name companies,
06:51 but whichever way you can help our viewers understand
06:54 why is it that you're betting and what
06:55 are the kind of auto ancillaries that you're betting on.
06:57 So for example, if you go back in time,
07:00 let's say seven years back, and take an M&M,
07:04 when most of their powertrains that they manufactured
07:09 would actually stay in-house, because the machining
07:12 requirements of a typical ICE engine, the powertrain
07:16 that you manufacture, mostly are commoditized.
07:20 So end of the day, for you to scale,
07:23 there was no powertrain manufacturer in India
07:26 who was generating more than 1,000 final crores of top line
07:29 seven years back.
07:31 Today, you actually have companies
07:33 doing north of 5,000 crores in top line,
07:36 doing powertrain both for the deemed exports,
07:39 as well as as you are transitioning into an EV,
07:42 you cannot have the same machining requirements.
07:45 The machining requirements in terms of precision,
07:47 the torque transfer requirements are going to be a lot higher.
07:51 So you have niche components in the south
07:54 that we are backing, that we are heavily overweight on.
07:57 When I say heavily overweight, for us,
07:59 3% in a particular company would be overweight,
08:02 considering as you rightly pointed out,
08:04 auto ancillaries, by their very definition in India,
08:08 are low, mid, to small caps by nature.
08:10 The largest auto and company in India
08:13 is a market cap worth 24,000 crores.
08:17 So historically, auto ancillaries
08:19 haven't lent themselves to scale.
08:22 And as auto exposures go up, in terms of market caps going up,
08:28 you will see certain auto ands with an R&D component
08:32 behind it expand too.
08:34 Those are the companies that we would want to pick.
08:35 So it's purely bottom-up, it's purely balance sheet driven,
08:39 and that's what we would back.
08:40 It's a mix of both four-wheeler and two-wheeler as well.
08:43 - Okay, so you're shying away from calling,
08:45 let's say for example, for argument's sake,
08:47 a Samarthana mother-son with 80,000 crores market cap
08:49 as an auto ank, or a Bharat Forge as an auto ank person.
08:52 - I wouldn't call a Bharat Forge certainly as an auto ank.
08:54 They have a much wider portfolio.
08:56 And a lot of what they do is an EBITDA margin
09:00 of what they do as a machining plus precision.
09:03 - So that's not the space that I'm looking at.
09:05 - No, they should do well as well.
09:07 - Yeah, yeah, yeah, okay, fine.
09:09 Get the drift.
09:10 And you have a 7% addition in autos as well, that is state.
09:12 So you're constructive in autos.
09:14 Is it four-wheelers, is it two-wheelers?
09:16 You clearly have Maruti as one of the idea,
09:18 one of the overweights out there.
09:20 So you are bullish on four-wheelers that I can see.
09:22 Are you constructive on two-wheelers as well?
09:24 - I think if you look at the last 10 year volume growth
09:28 of two-wheelers, it's been 3.2%.
09:31 For a country that is actually relied on saying
09:35 that two-wheeler volume is the go-to market,
09:38 the actual data points tell you completely otherwise.
09:42 So today, for the first time in the last three quarters,
09:45 you're seeing two-wheeler growth after a 10 year period.
09:48 So the question then becomes where did,
09:50 let's say a Bajaj auto or a TVS Motors growth
09:53 come from in the last five years?
09:54 It came from two aspects.
09:55 It came from exports and it came from pricing power.
09:58 So many of these companies who actually upped the model CC
10:03 in terms of where they went up the value chain,
10:05 that's how their revenue growth came from.
10:07 Today, for the first time, after a period of 10 years,
10:10 you're seeing volume growth come through.
10:12 And I think that could last over the next cycle.
10:15 And I say cycle, I'm not talking more than three years
10:17 as we speak.
10:18 So I think two-wheelers can surprise on the volume side.
10:21 That's the space that we would want to own.
10:23 And four-wheelers, we continue to be bullish on.
10:25 - Yeah, and you're right.
10:27 Cycles too have gotten compressed in a big way, right?
10:29 I mean, these days, cycles by themselves
10:32 are very different from what cycles probably used to be,
10:34 economic or otherwise.
10:35 Just as an extension, you mentioned ER&D.
10:41 You're so constructive on autos.
10:43 Is the ER&D presence an auto-specific presence
10:47 or not necessarily?
10:48 - Auto is one of the components.
10:50 So engineering R&D will lend itself
10:52 into CAPEX-driven businesses.
10:55 It could be oil and gas.
10:56 It could be aerospace, auto, telecom.
10:59 So all of these sectors, if you look at it,
11:02 didn't have great volume growth between 10 and 20.
11:06 All of these sectors basically had degrowth.
11:10 And as the CAPEX cycle revives,
11:12 and it's one of the things that I keep saying,
11:14 I think we are in an inflationary cycle.
11:16 We are not in a rate-cut cycle.
11:18 Maybe you will see, because of political pressures,
11:21 one, maybe two rate cuts.
11:23 Two is already an overextension as far as I'm concerned.
11:26 But I think we are in an inflationary cycle
11:28 and not a deflationary cycle.
11:30 So end of the day, I think in an inflationary cycle,
11:34 GDP-facing sectors should do better.
11:37 You look at what happened in the US
11:38 between the '70s and '80s.
11:40 I don't want to use the India example between '03 and '09
11:43 because the base effect as well as the growth that you saw
11:47 was extremely nonlinear.
11:49 And I'm not sure you're gonna get that level of growth
11:51 in this cycle, but I think US between the '70s and '80s
11:54 is a better example of an inflationary-driven growth.
11:57 So metals, oil, energy,
12:00 these are the sectors that should do well.
12:01 - Which means, Naveen,
12:03 I'm taking that conversation forward,
12:05 that you are not seeing green shoots in IT.
12:09 I've been questioning now for a while
12:11 what is it that people see there,
12:12 but Accenture's numbers finally show
12:15 that amongst the largest companies
12:17 is not talking about any turn in demand.
12:20 So, is this the time to buy IT
12:24 or would you wait for some evidence
12:28 and say that it's okay to buy it 5, 10% higher,
12:30 but at least let the tide turn?
12:33 - So, Neeraj, I think rather than get into the price,
12:37 for me the question is, am I seeing visibility of growth?
12:41 And I don't see that yet.
12:43 Today, the reason margins look accretive
12:46 is because many of them have managed
12:48 their employee costs much better.
12:51 For me, as a core business,
12:53 what I want to see is top-line growth,
12:55 translating into operating leverage
12:57 and hence margin profile.
12:59 And you not just running efficiency
13:02 in terms of your cost base well
13:04 and getting an EBITDA margin expansion.
13:06 So broadly, for me, I would put my hand up
13:10 and say I would rather stay underweight
13:12 because I don't see any green shoots of growth.
13:15 If growth does surprise to the upside,
13:17 I'm happy to re-look at it.
13:19 But for this growth, I don't think the valuations are cheap.
13:22 - Okay.
13:23 There is, amongst the largest allocations that you have
13:26 is auto-ancillary, capital goods,
13:28 but when I look at your top 10 holdings,
13:30 I don't see auto-ancillaries there.
13:32 I don't see capital goods unless you classify
13:34 the ports company as a part of that,
13:36 but it's infrastructure and not ports.
13:38 So you obviously have spread out your capital good bets
13:42 across multiple companies in small measures.
13:44 - Absolutely correct.
13:44 - Where is the largest conviction within cap goods then?
13:47 - So cap goods with a power angle
13:50 is where the conviction is.
13:52 So a lot of capital goods which actually manufacture
13:56 for the power sector and the energy sector,
13:59 that's where the higher conviction is
14:01 because today, capital goods don't come cheap.
14:05 And your non-linearity has come in
14:09 between 21 and 24 in terms of growth.
14:12 So the growth from here is going to come on a higher base.
14:15 So I would pencil in a 15 to 18% growth from here,
14:19 which is not trivial growth either,
14:21 but the valuations that which you're paying up
14:23 for that growth is not cheap.
14:25 So I would want to build in starting exposures today
14:29 with the ability for me to size up higher over time
14:32 if I can get more volatility.
14:34 - So the likes of power cables, et cetera, come into play
14:37 or what's the exposure within cap goods?
14:39 - I mean, in terms of large caps, for example,
14:42 we own an ABB, we own Cummins, we own Thermax.
14:45 - You're not shying away from high valuations, I see.
14:47 - Again, so we use this word very loosely
14:52 in our conversations, Neeraj,
14:56 because let's take ABB for an example, right?
14:59 Again, I'm not saying someone needs to be buying ABB today.
15:02 It's not a recommendation at all.
15:04 But you go back to 21, ABB was available at a TTM of what,
15:09 from a PE perspective, assuming PE is the easiest metric
15:13 for someone to relate to, was at 65, right?
15:17 So was that cheap for a company
15:19 which actually had three-year growth of 11%?
15:23 Or are you going to say that when I'm getting a 23% CAGR
15:28 in growth with a future growth potential of 15 to 18%,
15:32 a 75 PE multiple is something that I'm okay to pay up?
15:36 So my question is not starting off by saying what is cheap.
15:40 My question is starting off by saying
15:42 where am I seeing growth
15:43 and where am I seeing sustainability of growth?
15:46 And for that, what is the valuation I'm paying?
15:49 I'm not saying these valuations are cheap.
15:51 But then the question is how do I position size this
15:54 in order to ensure if I'm going to pay up
15:57 at an overall portfolio level,
15:58 my portfolio construct doesn't get affected.
16:01 So it's not one name that's going to drive my returns.
16:05 It's basically saying for this valuation,
16:08 for the visibility of growth that I'm seeing,
16:11 do I want to be staying out of this sector?
16:13 Answer is no,
16:14 because that's where I see visibility of growth.
16:17 - Nice.
16:18 And in some sense, viewers,
16:19 a good way to follow this might also be
16:21 comparing the past valuations
16:23 or historical valuation cycles as well,
16:25 because a lot of times,
16:26 some stocks tend to trade expensive.
16:29 For the longest time, people question
16:31 why is Grow Finance trading at the valuations that it is?
16:33 And at some point, I'll find it correct, and it never did.
16:35 That is not to say that the likes of ABBs won't.
16:38 Maybe they might.
16:39 And remember, Naveen mentioned
16:40 that none of the things that we are speaking about here
16:43 are recommendations.
16:44 They are illustrative examples,
16:46 so please keep that in mind.
16:47 I mean, there's just that disclosure from our end as well.
16:51 The other aspect is power.
16:53 Now, tall targets, a lot of scope,
16:58 but a lot of people cite past execution misses
17:02 and execution risks not being factored in.
17:06 What is your sense around this?
17:08 - So, let me play both sides of the coin, Neeraj.
17:12 I'm going to make a fairly tall claim
17:15 by saying that you are going to see over the next cycle
17:19 maximum number of solar bankruptcies that you've ever seen,
17:23 because the cost at which, and the IRR at which
17:26 some of these projects are getting bid up,
17:29 and some of the smaller companies
17:31 are setting up solar capacity
17:33 doesn't make any sense on the ground.
17:35 So, end of the day, obviously there is going to be
17:39 enough and more supply that comes in,
17:41 because demand for the first time,
17:43 after a period of 12 years,
17:45 is growing at a cagger of 9%.
17:48 End of the day, power, in terms of supply side,
17:52 will and should grow at the cost of GDP.
17:55 Now, basically over 2010 to 2020,
18:00 when you kept setting up supply,
18:02 and GDP was at 3.5% over a good part of the decade,
18:05 you had excess capacity.
18:07 And hence, a lot of the companies
18:09 went into significant debt on their balance sheet,
18:13 and you saw a huge amount of value erosion
18:16 over the last 12 years.
18:18 For the first time, you are in a power deficit cycle.
18:21 And that deficit basically meant,
18:23 because you've not invested for a good part of 10 years
18:27 in an aggressive way, because demand didn't come,
18:29 for you to set up a green field in thermal
18:32 does take four years.
18:34 Whereas if you go into solar, it takes 12, 14 months.
18:37 So it's a lot easier to set up solar capacity
18:39 than it is to set up a thermal capacity.
18:42 So, and I don't, one of the reasons that India
18:44 is in a much, much better position,
18:46 is we didn't take this ESG tall-headed claim
18:49 of saying that we will not burn coal,
18:51 because coal is extremely essential.
18:53 And today, many of the countries in Europe
18:55 are realizing that.
18:56 They did that, and now they've gotten killed
18:59 on the other side.
19:00 So, if I am going to bet on power, which we are,
19:04 I would much rather bet on a large portfolio,
19:08 which has a good mix of thermal on one side,
19:10 and an element of renewables on the other side.
19:13 Because renewables, it's good, they will see growth,
19:17 but at the same time, I am not really as bullish
19:22 on renewables where the IRRs will be close to mid-teens,
19:26 on a sustainable basis.
19:27 Because these are all what you call plugging the gap.
19:31 Wind energy is not going to be self-sustaining.
19:33 Solar energy can be, but the kind of bidding
19:37 that is happening on the ground is not very comforting.
19:39 So, I would still back a thermal-led portfolio
19:43 into renewables, rather than a renewable-led portfolio
19:46 into thermals.
19:47 - But effectively, then you're telling me
19:48 about the power generation companies.
19:51 It's a wider bucket out there, below that, too,
19:54 power financiers, power ancillaries, so on and so forth.
19:58 Anything in that bucket, or is it only generation?
20:00 - I mean, I think we don't own power financiers.
20:03 Today, we find them a bit expensive.
20:05 They still can do very well, right?
20:08 But that's not the space that we are looking at
20:10 from a lending perspective.
20:12 Power generators is one space we are bullish on,
20:14 and hence, that will translate
20:16 into a power transmission also.
20:18 Because end of the day, in order for power
20:21 to get into the grid, the transmission capacity
20:24 has to go up in a significant way.
20:26 So, I think transmission and generation
20:29 is going to benefit as a result of this.
20:31 Financiers could, we don't own them,
20:34 so I don't have a very strong view.
20:37 Easy thing to say is valuations are expensive,
20:39 but I don't think that's a prudent statement to make.
20:42 - Last question.
20:43 You have an outsized position in pharma,
20:46 relative to markets, again.
20:49 One of your top holdings is not a traditional pharma firm,
20:53 but a pharma company, CRO, CDM, or what have you.
20:56 What bucket of pharmaceuticals are you most constructive on?
21:01 - I think today, many fund managers
21:06 have dissected pharma in a beautiful way, right?
21:08 So, I'm not going to break it down.
21:10 Indian pharma pretty much works like an FMCG business.
21:15 It's a branded business.
21:16 Everyone would want to own that.
21:18 No one wants to own US Generics,
21:22 for all the right reasons, because it's a commodity play.
21:24 You don't have pricing power.
21:26 But I also feel that that cycle,
21:30 in terms of the rate of change of price,
21:33 erosion is reduced.
21:34 You still don't have price increase,
21:36 and I don't think that's coming back anytime soon.
21:38 So, in terms of what we like in pharma,
21:42 we like product portfolios with an Indian-facing angle,
21:46 as well as CDMO manufacturing.
21:48 That's a space that we think has significant tailwinds.
21:52 You're seeing businesses which have no background in CDMO,
21:57 acquiring, deploying capital, and getting involved.
22:00 Capital misallocation does happen at a time
22:03 where capital is abundant,
22:05 and free cash flow of many of these quality corporates
22:07 is abundant, so you're going to see
22:09 a lot of capital allocation into those spaces.
22:11 So, the company that we want to be owning
22:13 are those that have 10, 15, 20, 25 years of track record
22:17 in manufacturing.
22:19 They've done this, they have sticky B2B businesses.
22:21 We also do have businesses
22:23 which have a US generic component as well,
22:26 because that cycle has not played out,
22:30 could play out in the next two, three years.
22:32 It has played out from a margin expansion perspective
22:36 in the last year, and I think in the next six to eight
22:38 quarters, you could see more runway for that.
22:41 So, broadly, we have a mix of CDMO manufacturing,
22:44 Indian branded play, as well as a US portfolio as well.
22:47 - Great.
22:49 Naveen, on that note, thanks so much for taking the time out
22:51 and being with us, and for coming to our studios.
22:53 Really appreciate you taking the time out.
22:54 - Thanks a lot, appreciate this, Neeraj.
22:56 - And viewers, thanks for tuning in
22:58 to this edition of The Portfolio Manager.
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