Saurabh Mukherjea: Election outcomes won’t disrupt India’s economic stability: Saurabh Mukherjea

“We have been through a variety of political dispensations in the last three decades and growth has been in the 6-7% area. India rarely grows much faster than 7% and rarely grows much slower than 6%,” says Saurabh Mukherjea, Marcellus Investment Managers.

Tell us what exactly were the conversations like when you were sitting far away from India, but looking at India from the foreign lens, in conversation with some of your prospective clients? What were they asking you or probing you, what were they most curious about?
Let me break it into three parts. Obviously, the first discussion tends to be, what will happen in the elections, what do you think? And my response is, I really do not know. You can read the newspapers as well as anybody else can, I tell my clients. And the simple point of view on that is, regardless of what happens in the election, it looks like there will be policy continuity. There will probably be governance continuity as well, but almost certainly there will be policy continuity and hence, my point of view to the foreign investors is, beyond a point, you should not overemphasise the elections.

We have been through a variety of political dispensations in the last three decades and growth has been in the 6-7% area. India rarely grows much faster than 7% and rarely grows much slower than 6%. So, I try to persuade people not to overemphasise the politics. But I have to admit, it is hard. Most foreign investors, pension funds, endowments, tend to agonise endlessly about what will happen on 4th June. The second discussion tends to be around valuations. And the point of view generally in the Western world is, India is mehenga, India mein valuation jaida hai. And our point of view is, compared to America, the Indian, especially high-quality Indian stocks of the sort we like, high-quality Indian stocks, the valuation multiples relative to the growth they can generate are significantly lower than the S&P 500 and that max is easy to provide and I think most American investors I met understood that point, that if you look at the S&P 500, relative to where it stands on valuation, relative to the growth that they simply deliver in earnings, the quality Indian names that we like, the HDFC Banks, the Asian Paints, the Bajaj Finances, this is actually one of the most delicious valuation junctures that you will find and therefore, I think that was a more or less constructive discussion, that if you want to buy Indian quality, this is the juncture to do it, when we have had two years of run-up in low-quality names. And the third discussion tends to be, what is happening to consumption? Why do you have such a pronounced weakness in consumption? 2% consumption growth for a relatively poor country is quite unprecedented and therefore there tends to be a degree of concern as to how prolonged, how extended will be the consumption slowdown in India. And there, my submission to our foreign investors is, whichever government comes in after the elections, the first budget, the union budget in July, I am sure will contain steps to both boost employment and drive consumption up.

So, you made a very valid point about the growth, the range, irrespective of political leadership, we have managed that growth, but what was your answer to your friends and prospective clients regarding the valuation argument because that is something which is being hectically discussed here back home in India as well?
If you take trailing PE and let me just use trailing PE because it is easier to explain. If you look on trailing PE, the sorts of stocks we buy, so we will take the consistent compounders, for example, that is the largecap portfolio that we offer to our clients.

Consistent compounders was at around 35 times trailing five years ago. And when we started the firm in 2018, six years ago, consistent compounders was around on 35 times. By the time we got to Jan-Feb 2022, that had run up to 50 times.

So, over the course of those two waves of COVID and the Federal Reserve’s $10 trillion stimulus, consistent compounder has this rocket fuel re-rating from 35 times to 50 times and then it de-rated.

It de-rated steadily, earnings compounding continued, but the share prices came off, and CCP therefore is back to 35 times earnings.

So, over a six-year timeframe, we have done a proper round trip on CCP trailing PE from 35 up to 50 and back to 35. Now what are you getting? Just to keep it simple, if you pay 35 times, what are you getting? What is the growth that you are able to buy? These companies, EPS has compounded over the last three years, five years, ten years at roughly 20-25%. So, if you are paying 35 times earnings for 20-25% growth, that is a very attractive PEG as the Americans like to call it.

The PEG here is coming to 1.3, 1.4. In contrast, if you look at the S&P 500 today, S&P 500 on trailing is pushing 24-25 and S&P 500 EPS growth is around 15%. So, S&P 500 is actually closer to two times on PEG, whereas high quality Indian compounders of the sort we like are closer to 1.4, 1.5.

The sorts of names we like are available at better valuations than the S&P 500 and that is something that I think resonates with a fair few foreigners and hopefully post 4th of June that will translate into inflows into the Indian market.

Tell us what kind of changes have the team been making in your portfolios lately? If you can just share for indicative purposes, only for education purposes, some additions and deletions you have done and why?
In consistent compounders over the last six months, we have increased the Trent allocation, Trent did well for us, we increased it. It has ripped through so aggressively that we are thinking of pairing back on Trent a fair bit.
We started on Trent in July last year, which I think trebled on since July last year. We have also added Tube Investments over the last six months.

The reason we like Tube is not just the CG Power story and remarkable turnaround there by the Murugappa Group, but we also like CG for the fact that the EV initiatives that they are pursuing, the clean mobility subsidiary that they have built, TI Clean Mobility.

We think there is plenty of potential there in their EV two wheelers, their EV trucks and the EV three-wheeler business that they have put together.

In addition, the Shanthi Gears business, a small part of the Tube franchise, but I think Shanthi Gears in gears is on its way to building the preeminent gears business in the country.

We have also added Eicher Motors to consistent compounders, Eicher Motors was in our midcap portfolio for a couple of years, but as having seen how Siddhartha Lal has systematically built this franchise over the last 15 years and specifically in the last five years, strengthened the export potential of the Eicher franchise, bought in more bikes, bought in premium bikes at the 600cc level and bought in a 250cc bike with better price points than Eicher used to historically give, we think he has built plenty of optionality here. The VECV business, the Volvo Eicher business is also doing very well for Eicher Motors.

There are a couple of other additions that are underway in CCP, I am not in liberty to talk about them, but CCP has basically seen one-third of the portfolio has been overhauled over the last 12 months as we try to lock into the new growth engines that the country has in the form of industrial, manufacturing, and in the form of potential revival of the retail space.

As I said, the consumption piece has been weak in India now for the last two years and I strongly believe that whatever happens on 4th June, we will see a very pro-consumption budget in July. It will be very difficult for whoever is in charge of the country not to push through a pro-consumption budget in July.

The consumption weakness is so evident in the GDP numbers that I reckon there will be a consumption revival. Therefore, we are looking for some retail names that can help us juice up the consumption piece over and above what Trent has already done for us.

In small and midcap, in the last six months, we have added names such as Eureka Forbes. We have added RHI Magnesita around eight-nine months ago. We continue to believe that there will be a private sector capex revival.
The government capex revival obviously is well understood, but I think there is also a private sector capex revival underway and names like SKF should help us benefit from that.

SKF has had a rocket rally since we loaded up on it a few months ago and courtesy of the run-up in valuations we had to step back a bit.

One disclaimer to everybody who is listening, I am an investor in Marcellus’s products. Naturally, I have a beneficial interest in this, so are my parents, and obviously so are our 8,000 clients.