- How to bet on capex beneficiaries?
- Can capital goods trade at FMCG valuations?
Niraj Shah in conversation with #OldBridgeMF's Kenneth Andrade on 'Talking Point'.
- Can capital goods trade at FMCG valuations?
Niraj Shah in conversation with #OldBridgeMF's Kenneth Andrade on 'Talking Point'.
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TVTranscript
00:00 (upbeat music)
00:02 - Thanks for tuning into Talking Point.
00:15 I'm your host, Neeraj Shah.
00:16 The case for the chat today,
00:19 we try and talk about economic cycles versus earning cycles
00:23 and where do the two have a confluence or divergence,
00:26 if you will, because our guests can give us
00:28 some really strong perspective on that.
00:31 How to bet on CapEx beneficiaries,
00:35 especially if the belief is that we might be
00:39 in the first half or the beginning of the CapEx cycle.
00:44 And of course, can capital good companies continue to trade
00:48 at FMCG valuations, at least some of them are,
00:51 can that continue in a potential long-term CapEx cycle?
00:56 To talk about all of this and more,
00:58 our guest today is Kenneth Andrade,
01:00 CIO of Old Bridge Mutual Fund.
01:02 Kenneth, such a pleasure having you.
01:04 Thank you for taking the time out.
01:06 - Thank you, Neeraj.
01:08 Thanks for inviting me on the show.
01:10 - Now, the pleasure is entirely ours, as you know.
01:12 Kenneth, let's start off with this.
01:14 I would love to understand from you the perspective
01:16 of this whole conundrum that people have
01:19 about whether earnings can match up
01:22 to the kind of valuations given the economic cycle
01:25 that we have, both globally and locally.
01:27 What's your sense about this tug-off or the push
01:31 between the economic cycle versus the earning cycle?
01:33 - Well, as we've always seen in multiple cases,
01:39 the earning cycle is usually back-ended
01:41 and stocks actually represent, or price-earning multiples
01:44 usually represent the opportunity
01:46 that is there in that exact space.
01:48 And that's essentially what's playing out
01:51 at this point in time.
01:53 So you'd have to map that entire value chain
01:58 from the developer, and when I say this,
02:00 on the CapEx or the infrastructure cycle
02:02 like we're talking about, from the developer
02:05 right to the raw material provider,
02:06 which is the commodity players.
02:08 And see essentially where the opportunity lies
02:11 and which part of that value chain can be extremely,
02:14 extremely valuable to own over a long-term perspective.
02:21 So every investor has got its favorite allocation, right?
02:25 Now, there is an investor who likes CapEx businesses
02:28 or developers, but then the balance sheet size
02:31 act consistently continues to expand.
02:33 These are companies or these are businesses
02:37 which attract a lot of bondholders.
02:39 So obviously their return on capital employed
02:43 is very close to the cost of capital,
02:45 or it's an arbitrage between return on capital employed
02:48 and cost of capital.
02:50 So that's a developer.
02:51 Then there is the CapEx code manufacturers
02:53 and then the commodity manufacturers.
02:55 And I think that entire cycle is going to play out
02:58 as we go through the course of the next couple of years
03:02 and next, I would say all the way to 2013.
03:05 And this is just not just in India,
03:07 but it happens across the world.
03:09 And you can see the Western world also trying to put
03:11 serious CapEx into play.
03:13 And that CapEx in inverted commas is largely linked
03:17 to power CapEx or energy CapEx that is taking place.
03:21 So I think that's where we are,
03:23 that's the position that we are at at this point in time.
03:27 And every part of this entire value chain
03:29 is going to benefit quite substantially.
03:33 - So Kenneth, would it be fair to assume
03:36 that this could be a multi-year CapEx cycle?
03:40 We might not be at the very beginning,
03:44 but we is definitely far away from this CapEx cycle ending.
03:47 - Some of these numbers are a little hard to believe,
03:52 but let me give you a small perspective
03:54 from 2009 to 2017.
03:57 And that was probably a cycle that we've seen
04:00 or probably I've seen it in my career, right?
04:03 And I'll talk about just one cycle out there,
04:05 which is the energy CapEx,
04:07 which is power and the kind of power capacities
04:10 that we put at work out there.
04:12 Between 2001 to 2015, or maybe 2016,
04:17 India invested one time as GDP of year 2001.
04:22 So the day we started our CapEx,
04:24 it was one time GDP over the next 15 years
04:26 that we invested in our power capacities.
04:28 Now think about it this way,
04:31 for the next 15 years,
04:32 the next 15 years,
04:33 if we have to replicate that cycle,
04:35 the size of opportunity is significant.
04:40 And how do you capture that and where do you capture that?
04:43 And that's what everyone's,
04:45 and that's what some of the valuations
04:48 or stocks are foretelling.
04:49 So we've gone beyond the value phase or valuation zone
04:55 to actually mapping some of these companies
04:57 on the opportunity or the total addressable market
05:00 that is there.
05:01 And that makes it very difficult in an environment
05:03 like this for investors like us
05:05 to try and pick the right businesses
05:06 and the right valuation.
05:07 So that's where we are at the cycle.
05:10 We are just about probably starting.
05:12 And there's one large industry that always leads it.
05:15 It's not just in India,
05:16 but anywhere in the world.
05:17 It's basically the energy cycle.
05:19 And I'll give you a small structural size
05:23 of how big this opportunity could be.
05:25 - Okay, so can I just to clarify,
05:29 just to get this clarification,
05:30 you are saying that the way it happened between 2001 and 16,
05:34 if the same thing gets replicated from 2024 or 2023
05:39 for the next 15 years,
05:41 then the size of the opportunity is very large.
05:42 And as a result of which,
05:44 you're not getting businesses at the right valuation.
05:47 Some of the valuations have gone up.
05:49 - That's right.
05:50 That's right.
05:51 - Okay, but if the cycle is so long, Kenneth,
05:53 would you go out and buy some of these businesses
05:56 even at higher valuations?
05:57 Because the opportunity size,
05:59 I mean, say for execution risks,
06:00 the runway is very long.
06:03 - Yes, it depends upon what you want to choose
06:06 and what you want to participate with.
06:08 So obviously we are part of the cycle.
06:10 We like the way the environment's playing out.
06:13 And I would say we are very loaded
06:15 onto some of these businesses,
06:17 but yes, we've got a fair representation
06:19 of some of these companies in our portfolio.
06:21 - Just one quick follow-up question
06:23 since we dabbled upon energy.
06:26 It's again a very wide bucket,
06:28 the traditional energy, new energy,
06:31 power financiers, ancillaries.
06:33 It's a wide bucket.
06:34 I'm just trying to get some sense for our viewers
06:36 as to what within this whole gamut,
06:38 maybe I missed something also,
06:40 but what within this whole gamut
06:41 do you like more than the others?
06:44 - I think the contractors, the capital goods companies,
06:47 and obviously the commodities.
06:50 And commodities is my favorite for now.
06:52 - Sorry, did I hear you say
06:53 commodities is your favorite for now?
06:55 - Yeah.
06:57 - Okay, and by commodities you mean fossil fuels,
07:02 come other aspects which are going into the energy sector?
07:06 - May not be fuel inputs,
07:10 but everything else that goes into building out the capex,
07:13 that's probably where we are.
07:15 - Oh, okay.
07:16 - So everything in the metal cycle
07:17 seems to be fairly large
07:21 and quite reasonably priced, I would say.
07:26 - Got it.
07:27 Just one follow-up.
07:29 So say for some special metals,
07:31 which might be going and which might be hard to get,
07:34 the base metals, and both ferrous, non-ferrous,
07:38 would there be an overhang of a lack of clarity
07:43 around China demand,
07:45 which might be stronger than the longer term
07:48 demand out scenario for these companies on the capex side?
07:51 - So it's a little complicated
07:54 to really bring in the Chinese environment
07:56 and why they supply deflation into the economy.
07:58 Now this is a complicated statement by itself,
08:01 but if you notice what's happening globally, right,
08:06 there is reasonable amount of inflation
08:08 which is there in the West,
08:09 and the same holds true for even India
08:12 or other parts of the world.
08:14 Now the only country that's providing cheaper products
08:18 into the marketplace right now
08:20 is companies from the Chinese economy, right?
08:24 Now when you link that,
08:27 they are providing cheaper products
08:31 into the global environment.
08:33 If you link that to the Chinese stock market, okay,
08:38 so lower prices is lower profits for the Chinese,
08:41 which leads to lower market capitalization.
08:43 And that's what the entire Chinese economy is stuck with.
08:48 So our sense is that this may not be,
08:51 we may not continue this scenario in perpetuity,
08:54 and that way there may be a cycle somewhere,
08:57 maybe a year, two years, where this actually reverses.
09:01 So in our limited understanding of capital cycles,
09:08 the deflationary impact or the low prices
09:14 that the Chinese have been supplying the world with, okay,
09:19 may not last into maybe for maybe another one year,
09:25 maybe maximum two years.
09:27 And that will bring back pricing
09:29 into virtually every product that is there on the ground.
09:34 And it could be inflationary,
09:37 but it's very good for corporate profits.
09:40 And I think that's what our take,
09:43 and that's why we like some part
09:45 of the commodity basket extremely well.
09:47 - Got it.
09:49 And can I do a follow-up before we take that break?
09:51 And therefore, how does that auger
09:53 for the end user segments, Kenneth?
09:57 For now, or at least the better part of 2023,
10:01 some of these companies have benefited
10:04 or shown earnings growth,
10:05 not because of volume growth necessarily,
10:08 but for margin expansion that has happened,
10:10 presumably because of low costs as well.
10:12 Does that change?
10:13 - Of course it will change.
10:16 So if you essentially look at the way
10:18 the environment keeps moving,
10:20 margins keep moving from one part of the value chain
10:23 to the other part of the value chain, right?
10:25 So when you had a commodity boom in 2020 and 21,
10:29 the converters suffered, okay?
10:33 And then you had the users or the converters
10:36 who did well in the last year or two
10:39 because the commodity prices came off.
10:40 Okay, so margins will be always transitioning,
10:45 but over the longer term cycle, both benefit.
10:48 And that's why you'll have an economic expansion.
10:52 (audio cuts out)
10:56 - Okay.
10:57 Kenneth, the other argument, and I'm just rounding off,
11:02 or maybe we'll talk about the other aspect
11:04 on the CAPEX side, on the other side of the break as well,
11:07 but just one quick follow-up on this,
11:11 and which is, you've constantly told me, right,
11:17 about the deleverage corporate balance sheet
11:20 and how that augers well for India Inc's capability
11:24 to undertake CAPEX.
11:26 Hitherto, say for select sectors,
11:29 and please correct me if I'm wrong,
11:30 but we haven't seen the advent of private CAPEX
11:32 in a meaningful way.
11:34 Does that change in FY25 or calendar year 24?
11:39 - I think 2025, you'll definitely see
11:44 the advent of private CAPEX.
11:47 - Why that belief, Kenneth?
11:50 - All of us, I mean, if you get on the ground,
11:53 everyone's running out of capacity,
11:54 and if you have the government continue to spend
11:56 and incentivize CAPEX, you will see that come back
11:59 very, very strongly, private CAPEX.
12:02 - So we were talking about CAPEX,
12:03 couldn't quite ignore what's happening
12:05 to some of the high-flying movers in the session today,
12:08 one of them being ABB.
12:09 UBS has come out with a note there
12:12 talking about why the valuations could be premium
12:15 for ABB going ahead.
12:16 Anushi Johnson, for a very quick perspective there.
12:18 Anushi.
12:19 - Right, Neeraj, so if you look at ABB India,
12:22 it is trading at its life high today,
12:23 seeing about more than 6% to 7% of gains.
12:25 This is on the back of the UBS note,
12:28 which has implied a price target of about 7,550,
12:32 so which showcases more than 20% of an upside over here.
12:35 Again, a couple of reasons that they have cited.
12:37 ABB first is the motion and the electrification.
12:40 The largest segments are expected
12:42 to drive growth going forward.
12:44 Also, the focus now remains
12:46 on its low-medium voltage portfolio,
12:48 which is also expected to remain in the key focus area
12:51 where there's a lot of scope for ramp up.
12:53 Again, now if you had to look at the export products,
12:56 a portfolio as well,
12:57 now this will be driven by a more premium mix,
12:59 which will support the margins going forward.
13:01 And with now the improvement in margins,
13:03 that supports the higher premium valuations as well.
13:06 So these are the couple of reasons
13:08 why ABB is in focus today
13:10 and has been gaining about 7% to 8% of gains in trade.
13:14 - Thanks, Anushi.
13:15 Thanks a lot for that.
13:16 Kenneth, just one last question on this whole CapEx thing
13:19 and the valuations that some of the stocks are trading at.
13:21 And now, clearly, different reasons
13:24 for why different stocks might be doing so,
13:26 but earnings growth, margin accretion,
13:29 and the long cycle seem to be the common points
13:31 amongst all the expensive CapEx beneficiaries,
13:33 capital goods space.
13:35 You believe these valuations could stay elevated
13:37 for some of these businesses?
13:39 - Usually when these cycles last,
13:42 I think valuations will remain elevated
13:45 for a very long period of time.
13:47 - Okay, so that's a clear missive.
13:54 Maybe some of these stocks may continue to remain expensive.
13:58 The only reason why I specifically thought
14:00 of asking this to you, Kenneth,
14:01 was because I believe in one of the forums,
14:05 you mentioned that some of the CapEx beneficiaries
14:08 are trading at FMCG-like valuations.
14:10 So I was trying to wonder if that could continue or not,
14:13 but you gave the answer.
14:14 - Yeah, this is the new norm.
14:16 - This is the new norm, okay.
14:17 Is lower valuation and low growth a new norm
14:20 for FMCG companies in the bargain, Kenneth?
14:22 We've just not seen them perform.
14:24 I'm moving tracks now.
14:25 - I wouldn't say low valuation.
14:29 These are very sustainable businesses that are out there.
14:32 So they will consolidate around these levels.
14:34 And I mean, if you look at typically capital cycles
14:37 or the way money actually works,
14:40 money is always directed towards faster growth, right?
14:44 And you've got a situation
14:47 or you've got an inflection point
14:48 wherein traditionally all FMCG and consumer names
14:51 have always grown double digit, okay?
14:54 And the highest earnings growth
14:58 has been probably closer to 20%,
15:01 but that's no longer the norm right now.
15:03 And you've got a shift in the way investors
15:07 actually think about growth.
15:08 They're moving to something
15:09 which is much more scalable, larger, et cetera.
15:11 So that's how capital moves
15:14 from one part of the market to the other.
15:16 And the other part of the market,
15:17 because there's so much of visibility that is out there,
15:20 whether it is infrastructure, whether it's power,
15:22 or whether it's the CapEx cycle,
15:24 there is a rationalization
15:26 in how you see portfolios actually change.
15:29 So 2010 to 2020, it was all about consumption
15:32 because infrastructure, capital, CapEx, et cetera,
15:35 fell off the cliff.
15:36 I think you're seeing a reversal of that entire cycle
15:38 between 2022 to 2013, maybe beyond that for a while.
15:43 And there's gonna be some losers,
15:45 or there's some businesses.
15:47 And those businesses are not losers,
15:48 not because they're bad companies,
15:50 but they just have to go through a consolidation zone.
15:53 I think that's what will happen with consumer businesses.
15:57 They don't fall off the cliff.
16:00 There is a reversal to mean,
16:02 if I remember this right, in 2006, '07, '08,
16:06 most of the FMCG businesses, including Grievers,
16:09 came down between 24 to 35 times earnings.
16:12 So that's how you will see this environment also play out.
16:17 I don't know what number they'll settle at,
16:19 but it could be a stagnant situation
16:22 for companies like this.
16:24 - Got it.
16:25 And viewers, what I meant by lower valuations
16:27 was relative to history.
16:29 FMCG companies still don't trade particularly
16:32 low valuations in the strictest of senses.
16:35 Kenneth, since you talk about cycles,
16:38 I would love to talk to you about two pockets
16:40 which have kind of stagnated for the last,
16:45 maybe couple of years.
16:47 Maybe the, so one of them is speciality chemicals.
16:50 The toast of town until 2020, '21,
16:52 suddenly has gone into hibernation as a bucket at large,
16:56 say for maybe one or two specific pockets.
16:59 What's the sense here?
17:00 Do they make a comeback at some point of time?
17:03 Or the survivors particularly of this current cycle?
17:08 - Of course, you will see them revise themselves.
17:11 When is the big question mark?
17:13 And obviously we're going to a supply that is there
17:16 in the international market,
17:17 obviously driven by one particular country.
17:21 So you'll have to see how that environment plays out.
17:23 But these are situations that come through.
17:27 So what happened in 2000,
17:29 what happened in the early twenties
17:31 is that you democratize capital for this industry.
17:35 This industry got capital,
17:37 they've been able to set up capacities.
17:39 Now they have to work on costs
17:41 and they have to go out and get market share.
17:43 So this is a period of time
17:45 where they actually consolidate their business
17:47 and they actually, and drop costs,
17:49 go out and get incremental new consumers and customers.
17:54 And there is a lead time to all of this happening.
18:00 I think we are going through that lead time.
18:02 I'm pretty much sure that the next cycle
18:04 that they come through, they'll come through faster.
18:06 So another industry that went through the cycle
18:09 is pharmaceuticals, 2015 it hits its top.
18:12 And 2021, '22, '23, we saw a number of companies
18:16 take out their previous cycle.
18:17 That was a seven year cycle.
18:18 So you've got to give these companies time.
18:21 And when I say you've got to give these companies time,
18:23 I don't mean stock prices time,
18:25 but you give these companies time
18:26 to recalibrate their business.
18:28 Look at the business opportunity with a new lens,
18:31 go out and get market share.
18:33 And once you get their market share,
18:34 I think you get back to category dominance.
18:38 And as an investor, you necessarily have to look
18:41 for companies with category dominance.
18:43 And it'll all come through,
18:45 probably in the next two or three years.
18:47 - Does the same thing,
18:49 so just extending that just for clarity, Kenneth,
18:51 does the same thing hold true
18:53 for some aspects of pharmaceuticals?
18:57 I mean, in some sense, the US generic companies
18:59 have made a first move in effort in calendar year '23,
19:02 but CDMO, API, and the likes,
19:05 or all those have kind of stagnated now for a while.
19:08 Do they kind of make a comeback too?
19:10 - You are seeing profits out there
19:13 and they've been at a historical high since 2015.
19:16 I think 2024, you will have all pharma companies,
19:21 I don't say all pharma companies,
19:24 most pharma companies facing the US
19:25 come through with extremely high profitability.
19:30 And I don't see the slowing down
19:32 at least for the next couple of years,
19:34 because there's a lot of capital
19:35 that is already there on the ground.
19:37 A lot of registrations that have been done.
19:40 And the best part of all of this is
19:43 the Indian companies are gaining market share
19:45 against their counterparts in the West.
19:48 So it's a kind of an IT cycle playing out
19:51 wherein Indian pharma companies are going to dominate.
19:54 I wouldn't say dominate,
19:56 but they are going to take their fair amount of market share
19:59 in the international arena,
20:02 whereas the rest of the world market are in the US.
20:05 So I'd watch that space.
20:07 We are very optimistic about that part of the part.
20:12 - Are you going out on a limb
20:16 and trying to take an early position
20:18 into information technology, Kenneth,
20:19 or are you avoiding it?
20:20 The commentary, even from Accenture recently,
20:24 had no ray of hope, if you will.
20:26 - So they are fairly mature companies.
20:32 So let's divide that into large companies
20:34 and small companies.
20:35 The large companies are fairly mature businesses.
20:37 Now to trade them at extremely high multiples
20:40 may not be the right case.
20:41 To see them dip in terms of margins
20:43 and retrace them back immediately
20:45 over the course of the next one or two years
20:47 is extremely difficult.
20:48 So you have to grade yourself.
20:49 They're not going to be businesses that--
20:54 they're going to be very stable businesses,
20:56 a very stable part of your portfolio.
20:58 If you expect them to--
21:00 if you expect some of the large IT companies
21:02 to have a blue sky scenario, it may not be the case out there.
21:06 So they're stable businesses, great for a part
21:08 of the portfolio.
21:09 Look for kitchen sinkings in some of these companies
21:13 as new benefits come in place.
21:15 Take the opportunity of that and utilize it.
21:20 So it comes down to very stock specific and stock picking
21:24 in this industry.
21:25 And I wouldn't categorize the entire industry as a buy.
21:31 - OK, OK, specific pockets within there.
21:34 May I ask you, what is it that you are most constructive on?
21:40 And I'm not talking about a specific timeline of 12
21:43 to 18 months.
21:43 You could well be investing, because you
21:45 invest at times for a very long period of time as well.
21:47 Where is it that if you had a chance to put in money
21:50 currently without bothering about when the return will
21:54 come, as long as the return is magnified,
21:56 what would that bucket be?
21:59 - OK, let me break this down.
22:02 So we are at 3% or 3.5% of world GDP.
22:07 And we are at 20% to 23% of population.
22:11 And as we continue to grow, we have
22:14 to take market share from the rest of the world.
22:17 Now, you have to go and figure out
22:19 companies that will build their franchise in the rest of the
22:22 world.
22:22 That's one element of all of it.
22:24 We've seen how much wealth ideas got created.
22:27 We've seen the dominance of Indian pharmaceutical
22:30 businesses in the West.
22:31 We've seen how Indian chemical companies have gone out
22:34 and made their mark.
22:35 And from there, you will see multiple number
22:37 of more businesses.
22:38 I mean, we have the second largest steel manufacturers
22:40 in the world right now.
22:42 And we're growing capacity out there.
22:43 So all of this is coming together quite nicely.
22:46 Now, take your franchise out there.
22:48 This is the last trend that's been out.
22:50 Domestic, in-firm businesses and utilities,
22:53 I mean, they're expanding at a--
22:56 or at least the numbers that if you put together--
22:58 if you put the numbers together, it's
23:00 going to be a scale business that is out there.
23:02 Now, in that scale business, you've
23:05 got to allocate your capital to parts of the value chain
23:08 where you feel comfortable with and where you think
23:12 the returns will be--
23:16 I won't say it's a back-ended, but it will be--
23:18 it will be-- which will be out--
23:22 to have a large extent an outlier return out there.
23:26 So these are two pockets that are there.
23:28 The third pocket, which is the consumer economy,
23:30 I think that will come back.
23:33 It might have a shorter cycle than I think,
23:36 than the last time.
23:37 But whenever it does come back, you've
23:39 got to be a little ready for some of those businesses.
23:44 Now, case in point is if you look at all the USR businesses,
23:47 they're going through a massive expansion in number of stores
23:53 or in capacity--
23:54 not numbers, so in capacity.
23:56 But the market cap has gone just one way, which is down.
24:00 So look for these trends.
24:01 Look for a bottoming out of the entire cycle.
24:03 And just work your way around it.
24:06 So first two are my priorities.
24:07 The second one is essentially-- the third one
24:10 is essentially something that we're waiting and watching for.
24:16 Kenneth Andrade, such a pleasure talking to you in advance.
24:19 Easter greetings.
24:19 Have a great weekend.
24:21 Thank you, Nives.
24:22 Wish you the same.
24:23 Thank you, and look forward to talking to you more often,
24:26 most importantly.
24:27 Well, viewers, that's all that the time
24:29 that we have on this edition of Talking Point.
24:31 Thanks so much for tuning in.
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