Over next 3-5 years, we are in for a decent pickup in automobile cycle: Pramod Gubbi

There will be a few winners and if you can position yourself amongst those, pharma also presents a decent set of opportunities, says the Founder and Head of Sales, Marcellus Investment.

A stock like SPARC is up about 8% and Info Edge is up 6-7% right now. Clearly momentum is very much intact. Are you closely monitoring given the kind of move the market seems to be in?
We have been looking at the market leaders in sectors where we believe that demand is quite structural, given that we are still a populous country and the demographic dividends largely play into consumer sectors.

Within that, our focus has always been on companies with strong balance sheets, strong barriers to entry and competitive advantages which can ensure that that growth opportunity flows through to the bottom line with very little competitive disadvantages.

In the financial sector, we have owned HDFC Bank, Kotak Bank and Bajaj Finance. In building materials we have owned Asian Paints and Berger Paints and Pidilite and similarly in pharma we have owned Abbott and Divi’s and Dr Lal PathLab. All have been leaders in their respective sectors and that is something that is critical to our investment philosophy.

What is the outlook on the auto sector? On a month on month basis, there has been a spike in numbers, tractors and the rural segment in particular has done well.
From a longer term perspective, the penetration levels are still fairly low. The longer term growth trajectory is intact. From a near term perspective, rural is perhaps where we will see a pick-up in demand. We are having a second consecutive good monsoon. There have been a plethora of reforms announced by the government as far as the agricultural economy is concerned. Hopefully, that should pay through and also there has been a significant amount of stimulus that has been provided by the government particularly in the rural population.

Adding all of these up, I think you might see the first signs of recovery coming from the rural areas but I would say this is perhaps early days yet. There is an element of pent-up demand which has helped to show decent numbers in the recent past for a more steady state sustainable recovery. We will have to wait and see how soon we can get around the whole Covid situation. We seem to be achieving some sort of flattening of the curve where we can expect some sort of return to normalcy as far as economic activity is concerned. If that happens, over the next three to five years, we are in for a decent pick up in the automobile cycle.

Where do you stand when it comes to the FMCG sector?
We have one FMCG name in the portfolio that is Nestle and we have been quite positive on it for a long time. Again, more than just the growth prospects, we look for competitive advantages and Nestle in product categories like baby foods has demonstrated that it is head and shoulders above competition. Therefore the economics of dominating a sector which has structural growth prospects becomes very attractive from our standpoint.

While we are bullish on the consumption story in India, we also would like to play companies which can defend themselves against competition because the flip side of the story is that growth is intact and growth is structural. There will always be new competitive entry and because India is still one of the few beacons of growth across the world and therefore both global players and new local players will come up in every product category which has long-term growth prospects. It boils down to whether the company in question will be able to defend itself against such competitive threats and in that way, we continue to remain confident about Nestle’s prospects.

Does the criteria of market leaders across sectors apply to banks as well? Are you looking at some of the second rung names?
Even in banks and NBFCs and in fact across the board in terms of financial services we just launched our financial services specific fund last week. That demonstrated our confidence in this whole sector and this is not to say that we pretty much passed the NPA cycle or anything. The lockdown will have its own ramifications in terms of NPAs for the banking and the NBFC sectors. The way we are looking at it is two-pronged for this sector first is to look at the structural story, where Indians are moving their household savings from physical assets to financial savings.

Historically, we have had a love affair with real estate and gold which seems to be waning although gold seems to be coming back, perhaps cyclically. In the long run, financial savings will underpin the long term growth trajectory for financial services in general.

Banks and NBFCs are heavily geared to the economic cycle and the next three to five years augur well for the economic cycle. A period like this involves an element of crisis which means that at the end of the crisis, there will be a few banks and NBFCs left which have managed to weather the storm in terms of either having had a strong balance sheet and also a strong competitive advantage and that means that the ones that manage to survive doubly benefit.

You do see a pickup in credit demand at the end of the crisis and at the same time, you see very little competition because the rest of the competition is recapitalising their balance sheets. If you can pick and choose the top banks and NBFCs which have very strong balance sheets and are able to survive this crisis, it presents an attractive opportunity for somebody looking to invest over the next three to five years.

What are the opportunities in the pharma names?
Pharma is a structural story. Given that healthcare in India will be a focus. With its 1.4 billion people, healthcare is almost like an essential product or service. But I do not think anything has changed because of Covid. Perhaps hygiene levels of people have improved and therefore the typical rate of infections would come down. How much of that is structural we will have to wait and see but from a growth opportunity perspective, it has always presented a long growth runway.

Within that, the real focus again has to be the ones that can protect their competitive position by building moats and competitive advantages around them and like I said, India is still very underpenetrated in terms of healthcare. The world’s largest pharma companies will be out there to compete in this marketplace.

But even otherwise, the pharma sector in India is largely outward facing. One has to play it case by case. I do not think you can paint all pharma companies with the same brush because the external dynamics have changed whether it is the regulatory enforcement or the distribution of pharmaceuticals in the world’s largest market, that is the US, being consolidated. That will have its own pressure on margins and returns on capital means that not all of them will succeed equally.

There will be a few winners and if you can position yourself amongst those, pharma also presents a decent set of opportunities.