Domestic economy in great shape, global risk appetite still soft: Saurabh Mukherjea

"We are getting incremental clarity with the inflation pictures coming off but until decisive clarity emerges on that I think we will see a degree of trepidation across the world on equities, whether it is Indian equities, American equities or indeed European equities," says Saurabh Mukherjea, Founder, Marcellus Investment Managers.

What to your mind is the big moot point for 2023? A variety of trends are now visible; tech is under pressure, banks are flying, high PE stocks are getting crushed. How would you summarise the first initial overs of 2023?
I think it is a mixture of two things; one is from a domestic perspective, the economy clearly is in fine fettle. I think we cannot but look at the results season and conclude that the result season so far suggests that the economy is in fine fettle whether you look at the banks as a result, even Havells result, even Asian Paints the top line print is flat. The fact that operating margins are up 400 bps suggests that as a country by and large across sector, financial services, IT exports, domestic manufacturing are in reasonably good shape.

The challenge for us in India is that the rest of the world is not in good shape and specifically, the rest of the world still has not made up its mind as to when to start pulling back interest rates. Whilst both Europe and America have had a couple of CPI prints which are moving south, it is not yet decisive enough for their central banks to start signalling that the rate hike cycle is done.

I think until such time, global investors' mood will remain a little jittery. Remember, most global investors have not seen rate hike cycles this powerful ever in their career. In fact, even in my career, I have never seen a one-year period where the US rates go up 400 bps. So domestic economy is in great shape, global risk appetite still soft.

We are getting incremental clarity with the inflation pictures coming off but until decisive clarity emerges on that I think we will see a degree of trepidation across the world on equities, whether it is Indian equities, American equities or indeed European equities.

Lot of folks are saying a State Bank of India fixed deposit is giving 9% return. Interest rates sooner than later will peak out which means bond would be attractive. So if you are buying into equities now, you are buying the market at a reasonable level and if the possibility of a 10% return, which is a probability versus a 9% assured return in State Bank of India fixed deposit or a double digit return in debt, one should go for the latter not for equities.
I think if you lived in a developed country and you got 9% on an FD I would say take it every time. If I lived in a developed country and I got 9% on an FD, I would take it. But living in India and taking 9% on an FD, even 9% and on FD, I am not so sure, is a great long-term idea primarily because inflation for people like us, typically is around 6%-7%. Our cost of living tends to go up little higher than most other people because there is a huge imported component in our cost of living and 6-7% inflation means that if your FD is giving you after tax say 7% you are not really creating wealth.

Now some people might be happy not to create wealth but most people in my generation, most of my client base want to create a degree of wealth for themselves and I am afraid that is not going to come from investing in fixed deposits in a country like India, that is only going to come from investing in high quality equities. And hence the premise that I put forward in my books over the last four or five years that buy high quality companies, sit on them for long periods of time and see your wealth expand at anywhere between 15 to 20% depending on your portfolio and your patience. But this era of investing in FDs and creating wealth, I think that sort of ended roughly 20 years ago.

Let us look at your portfolio companies which have come out with numbers so far. Asian Paints yesterday, ICICI Lombard I think earlier this week, HDFC Bank over the weekend and TCS was the first one to come out with numbers. What has been the standout miss for you? What has been the standout hit for you?
I think the most positive development I can see is that right through last year people kept telling us, that there is a global slowdown, IT services would be hit and people like us kept saying that I do not understand how you can be bearish on IT services. It is like being bearish on steam engines at the heart of the industrial revolution. So I think this time around, finally convincingly not just TCS but also Infosys even HCL Tech results show that regardless of what happens to GDP growth in the Western world the migration to cloud outsourcing to India are incredibly powerful things that will power through an economic slowdown and that reinforces our faith, which is why at one level, actually in our mid-cap portfolio in Rising Giants, we have gone ahead and added a Tata Elxsi.

So over and above L&T Technology Services which was already our existing engineering R&D play, we have added another engineering R&D play Tata Elxsi.

The West needs more Indian help for engineering, for research and development, they do not have that many STEM graduates, we have more STEM graduates, we have high quality companies with great pedigree.

So I think this area is something we will keep looking to build on a decade or 10 years surge in Western intellect related work, migrating to India. The area where we are a little circumspect and you could see that say both on Asian Paints results and also even Havells results, we do not hold Havells but I think electrical is a good benchmark to observe.

There is a degree of top-line softness in Asian Paint’s case after I think three years of blistering top-line growth. I think the CAGR at 17% had a soft quarter on the top-line. But thankfully, it is made up by the fact that you have seen EBITDA margins recovering as the global commodity wave ebbs. Asian Paints I think, saw 400 bps jump in EBITDA margins. So we look forward to see when the top-line growth picks up a little bit, I suspect that might take a couple of quarters but it is good to see EBITDA margins recover and I think we will see this across the market.
The commodity price inflation surge is broadly done and operating margins will recover.

I will ask you a question which perhaps is more like an association with Saurabh Mukherjea. He is married to some of his favourite stocks forever Kotak, HDFC Bank, Asian Paints is that true or these are purely based on your conviction not about sentiment. I mean, if these companies do not grow, Marcellus will be happy to sell them or get rid of them.
As a country we raise our children with huge amount of care, love and affection and we nurture our children, we give them the best education we can, we hope that they go to university, do well in life and so on. And yet, we have a very mercenary attitude towards stocks, right?

Some people buy on PE multiples, they sell on a beat, the sell when results are little weak or they buy when results are a little strong and I have never quite understood the dichotomy. It is not as if you and I are living in a country where there are plenty of high-quality companies that is not the case. We are living in a country where high integrity promoters with high competence, the combination of integrity and competence is super scarce in India and we are only at 25 year old free market economy. We are not a hundred year old free market economy. We do not have a very large pool of high integrity, high competence promoters that pool is very small. Within that small pool, what we have done is across our portfolios, identified roughly 30 promoters/management teams and to us they are almost like relationships to be built, businesses to be nurtured rather than to be dealt with in a mercenary basis saying PE multiple has gone up or EBITDA margin is weak and can get out.

Where we sell is when we see a promoter either lose integrity or show incompetence. Integrity and incompetence are a big deal for us. When we see demonstrations of that we head for the door, we do not sell companies just because a quarter has done weak or the Indian classic PE multiple looks very high.


You have always maintained your stance that you have historically avoided PSUs and that is going to be a strategy that you will continue to adopt. But given the fact that now we are seeing overseas investors returning to some of these stocks the likes of NMDC, IRCTC, BHEL, etc, is there going to be no change in your thesis.
Whether overseas investors buy or do not buy PSUs in a way it is not our concern. Whereas I have said historically our concern on PSUs has been the PSUs are serving two masters. It is serving its owner, Government of India, quite rightly. The government owns the PSUs to propagate a bunch of goals around national development.

So, for example, the government owns Power Grid or NTPC or Coal India to make sure that you and I get affordable electricity and the same has rolled out across the length and breadth of the country. And therefore, the PSUs’ primary responsibility is to serve its master, the Government of India.

A secondary responsibility is to serve shareholders and that is why our belief is it is difficult for a PSU to generate results for our clients over long periods of time. They will have these bursts of activity in the share price when say Coal India goes up 60-70% that is fine but to the extent none of us know who is going to be running Coal India or Power Grid or indeed say Bank of India or Bank of Baroda. We do not know who will run that PSU five years hence and therefore, we do not quite know who exactly are we backing. What we do know for sure is the master of these companies, the owner, will be primarily Government of India and these companies, therefore, have to serve the national imperative, not the minority shareholders’ interest and hence the avoidance of PSUs.

You have spoken about IT and that is why you talked about adding Tata Elxsi? But the question I want to ask was and what we have read that you chose Tata Elxsi after dumping Relaxo. Why did you exit Relaxo?
We have held Relaxo for six years. We have been very happy shareholders, extremely thankful to what the remarkable Dua family have done for not just us, the other shareholders. They have built a company market cap approaching $3 billion dominance in the entry-level footwear market.

The reason we exited is, as we saw through COVID, the low-income strata of Indian society getting pulverized. We were not alone. You would have seen it in results of numerous companies. I remember through COVID HUL having a really tough time. FMCG companies had a tough time. Domestic pharma companies struggled on domestic volumes in the wake of this. So COVID pulverized the weakest economic strata of our country. And unfortunately, after COVID subsided, you had this brutal wave of input cost inflation after Russia attacked Ukraine. In that input cost inflation wave, Relaxo pushed up its prices, especially for entry-level footwear. I remember through last summer we were tracking this so I keep going to Amazon and checking out their entry-level footwear prices and I saw the price of that chappal jump from Rs 80 to Rs 150 and that is when we knew that this is going to be tough.

That was where I think the challenge began, they lost market share as a courtesy that price hike, the unorganised segment, which uses low-quality inputs, gained market share at the expense of Relaxo. And also some of the organised players from south India invaded the north. So, we thought about it long and hard through the last six months of 2022 but ultimately we made the call that given the changing economic realities of the country, especially for low-income people, it is going to be difficult for us to compound here at 20% for the foreseeable future and hence we exited from Relaxo.


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