Anshul Saigal on hunting for the next compounder | Economic Times

We are finding opportunity in pharma both in the large mid and small cap space, says Anshul Saigal, CIO, Kotak Portfolio Management Services. What is the outlook on L&T?Let me give you a more generalistic view. In the Indian infrastructure space, if an FPI wants to come into the country and invest, there are not too many companies which are of a size that can absorb that kind of liquidity and in that context, there are probably one or two companies of quality which can take that kind of liquidity. The second aspect is that many of these names have consolidated over five, six, seven years but they have consolidated at the same price or in the same range. Valuations have not really run ahead of themselves. Thirdly, we are coming off a period where over the last many years the outlook for order inflow in that space has been weak, particularly over last year, that outlook has weakened because of Covid and related execution. Going forward, that trend is likely to change for the better. L&T in particular, has seen a reasonably strong outlook on order inflow going forward and also revenue growth guidance. Finally, there are many assets of these infrastructure companies which are underutilised because the general private capex in this country has been weak over the last so many years. As private capex picks up, these capacities are likely to get better utilised, which in turn will lead to ROE expansion. All of these factors point towards this sector coming back into focus and investor interest in this sector becoming robust going forward. As I mentioned, there are only a handful of companies, if not one or two, which FPIs can invest in because of size limitations. This sector looks interesting. There is a cyclicality in the capex cycle. What is the best way to look at it -- EPCs, project companies, equipment companies as everything is different?You are right and each segment will have different business dynamics. Manufacturers of capital goods can benefit immensely because the upside on return on equity can be quite tremendous. There are many companies which are operating at 40-50% kind of capacity utilisation and if even 70-80% ROCE, changes things meaningfully for those companies. As ROCEs move up, the multiples that these companies get can also change quite meaningfully. In fact, we are already witnessing some of that. Even in EPC, there are opportunities as EPC is a very asset light business. There is one stock which we do not talk about but that has often given stellar returns ever since it went public in 2008 or 2009?One is to capture the opportunity or to have the opportunity and the other is to have the systems to capture that opportunity. There are many quick service restaurant players or even home delivery players who are in the market. I remember growing up, there were a few that started out around the same time. This company was also one of those but it has been able to sustain the momentum over an extended period of time while others fizzled out and that just talks of the systems that are required to sustain at a certain level. Intuitively even I can understand that the opportunity size is huge but the ability to understand whether a machine will keep rolling and rolling to the benefit of shareholders while offering value to the customers will eventually lead to shareholder value creation that allows you to make a significant returns over a period of time. We have seen that in this stock, Bajaj Finance. If you look at Eicher Motors, way back from 2008-2009 to today, all these names have been compounding machines. The opportunity was available for all of them but the machines that these companies created because of management strength and also ability and for a confluence of events, just compounded enormously more than many of their competitors. I cannot agree with you more to buy a quality business which compounds over a period of time and that has the right dynamics to compound in addition to the opportunity is paramount for making money. Where can one find the next compounding machines that will continue for the next five-seven years or would there be a different set of winners now?Just because of base, it will be difficult for them to do what they did over the last 10 years but there are many opportunities in the markets where over the next five-10 years, significant value will get created. One such space is the chemical space. The opportunity size is not just India centric it is global and so the opportunity is huge. China supplies 74-75% of global requirements. India’s contribution is only about 4%. A 1% shift away from China and towards India will mean a 25% increase in the opportunity of the Indian market and that is only on a steady base, not even factoring in growth. The Indian market itself is growing meaningfully. We have the know-how, we have the capability and we have some sizable companies in that space and yet you will be surprised to know that we do not have even a single large cap in the chemical space. All of them are midcaps and many are small caps. For the opportunity and for the quality of business that many of these companies have, this space can throw up quite a bit of surprises going forward and this is the space to look at. I would even add to this pharma although less so because pharma is more discovered than chemicals. But the outsourcing theme from India and the need for supply chains to readjust globally is going to play a meaningful role in creating value going forward. Should one stick with large cap pharma because if one looks at the history of Indian pharma sector, 20 years ago it was Dr Reddy, Cipla, Sun Pharma. These three names have not changed and only one has got added. It is Lupin. Bulk of the market share, profit, innovation or even distribution still lies with the large cap pharma. It is like large cap IT.I would say that the large caps have actually been underperformers with the exception of may be one or two over the last five or six years largely because of three reasons. One is that, their capacities are not being utilised because USFDA has not given approval. The second is that there has been price declines in many of their products and the third and the most important is that many of these companies have invested behind products as also distribution networks in the US in particular and in the rest of the world as well and that network is yet not fully utilised. They have recently launched the products and as those products start producing revenues. As these networks are better utilised and cost distributed over a larger base, margins will move up meaningfully. In the context of these stocks having underperformed, the costs being in the system, revenues not yet being in the system and valuations being down because versus 2014, many of these companies are trading at half the prices in absolute terms. As revenue starts building in, margins start moving up, ROEs move up and multiples can also move up. Large caps can offer very interesting value over the next one or two years and this return will be front ended in our judgement rather than back ended but that does not mean that we do not have opportunities to play upsides in the broader pharma space. There are many opportunities where assets are underutilised and because there is a process of ANDA registration, that process is underway and marketing is yet to start. As assets are better utilised, we will see expansion in multiples. We are finding opportunity in pharma both in the large mid and small cap space.