Covid will flick on the switch for massive consolidation in banks & NBFCs: Saurabh Mukherjea

You are far better off buying a well run market leader who will also benefit from the recovery, says the Founder, Marcellus Investment Managers.

At a time, when some of the large cap stocks are expensive and the temptation to buy good quality small and midcap stocks is there, how does one go about choosing one’s spots?
The point we have made in our Little Champs portfolio, which I have to say upfront, is shut to inflows. We are not taking any more money in Little Champs. But the points we made when we were raising money through the last 12 months was that just like Nestle dominates baby milk powder and Asian Paints dominate paints, similarly Garware Technical Fibres dominates the global market for commercial fishing nets. They have more than 50% market share globally in commercial fishing nets.

Commercial fishing nets are an essential commodity for Norwegian and Japanese and Australian fishermen and Garware Technical Fibres is their chosen vendor. So if you buy the dominance of Garware Technical Fibres, there are a whole bunch of reasons why over the last 20 years Garware from his Pune operation has been able to build this fabulous franchise. But if you buy the underlying barriers to entry that Vayu Garware has built, then obviously as the world and our country recover from the pandemic, you will see a nice story playing out. Here the niche market leader continues to chug out 20-25% earnings growth with return on capital significantly above cost of capital that throws off cash flow which it puts back into the business and carries on growing.

We have discussed GMM Pfaudler several times. I do not want to repeat that again because it is a story that your viewers understood very well. But Garware Technical Fibres or an Alkyl Amines are all dominant companies. By dominant I mean 50-60-70-80% market share in the niche industries and hence they behave very similar to an Asian Paints or a Nestle. They give you steady compounding over long periods of time and that will be especially relevant as the world and India comes out of Covid and the economic recovery proceeds.

In the medium and short term, is one better off tilting towards names which will benefit from economic recovery -- steel, cement, metals -- because that is where the price action now seems to be moving?
It feels very seductive to say let us buy these companies with operating leverage. But one runs into two problems. Firstly, many of these companies with the operating leverage have broken balance sheets. So they will use your desire to purchase the stock and the near term share price recovery to raise capital and that will take away much of your upside. The second is, suppose you get in today and as the recovery is in an early stage, let me buy steel and cement and benefit from the early upswing in the economy. How do you know when to get out? You are not going to get a text message from the big bang in the sky that this is the time to get out. So the exit decision is very difficult and it is not apparent to me that too many people out there, including myself, have a great handle on it.

You are far better off buying a well run market leader who will also benefit from the recovery. So I will use my book to make this point. My publisher is the largest publisher in the country and what they told me back in February or March when they saw Covid hitting us is that they would hold my book back by five months. Obviously I was not very happy about it and they explained to me that if they published in March or April, with the lockdown underway, sales will be muted. Amazon was not delivering books through March, April. Book shops are shut. You will suffer. So they explained to me the merits of holding it back. They held the book back till 16th August and we are seeing the benefits of that. Book sales in India through June, July and half way through August have recovered very sharply, much like everything else -- motor bikes, tractors, undergarments.

The fact that I am working with the market leading publisher who has the wisdom to hold back firepower and then load up its guns and fire when the recovery is proceeding, I benefit from that as a supplier and whoever is the shareholder of my publisher -- mostly in Europe and America -- also benefit from their action.

Garware Technical Fibres or Alkyl Amines also behave like this and you and I as shareholders or investors in high class companies can benefit from the recovery and it is a much more smoother ride. I do not have to figure out, I do not have to second guess Vayu Garware and sell the stock a year out because I have seen that over 20 years this man has built a great franchise.

Do you think the time to buy into the top five names in the financial sector is now when they are beaten down and are underperforming the rest of the market?
We have emphatically made a case that it is the time to buy the best franchises not just on the lending side but also on the asset management and insurance side. And here is our logic. The only large sector in the Indian economy which is not consolidated, which does not have one or two players taking away 80-85% of the profits, the only large share in the Indian economy which is not consolidated in this manner is financial services. We got a plethora of banks, 10,000 NBFCs, 30-40 asset management companies and so on.

For several years, we have been trying to figure out when will this sector consolidate? If baby milk powder is consolidated and undergarments is consolidated and paints is consolidated, we believe it was a matter of time before the financial services industry consolidated and as soon as Covid hit, we did the maths. We figured out there will be balance sheet write offs and we said this is the trigger, Covid will drive massive consolidation both in banks and in NBFCs. The weaker lenders will not be able to raise capital. I do not think the PSU banks will be recapitalised by Government of India, given the fiscal constraints that the government faces.

The PSU banks account for 65% share. As the PSU banks shed market share, the top private sector banks consolidate market share, big holdings of HDFC Bank, Kotak Bank and in the NBFC context, Bajaj Finance comes through. So Covid in a way becomes the trigger which drives consolidation in the largest sector in the stock market. It is too delicious an opportunity to miss and that is why a month back, we opened a product called Things of Capital whch just focusses on this consolidation play. It is an epic play, it has been a long time coming and Covid will basically flick on the switch for consolidation in this big sector.