Rashmi Kwatra of Sixteenth Street Capital on resilience of Indian market and where to find value

“We really think of ourselves as partners for the entrepreneurs and the management teams and the founders that we are investing in where fiduciary is the capital, our clients and partners trust us to really do our work and partner with the right and ethical people,” says Rashmi Kwatra, Founder & CIO of Singapore-based hedge fund, Sixteenth Street Capital

On the Indian market
I think India is in a league of its own. The only region that comes close as a block is Southeast Asia and there are many structural thematic trends why this is the case. In India and Southeast Asia, structurally, people are still entering the workforce. In most of the developed markets, the demographic dividend is no longer so positive and the young population is supporting an elderly population.

So, India is at the right stage where people are entering the workforce and therefore household incomes are growing leading to higher propensity to spend. In terms of how it compares to other emerging markets, there are a few markets in Southeast Asia like Indonesia, Philippines where I see similar structural trends. But India is relatively better off than most emerging markets also in terms of where it is from a domestic capital base.

As the country goes through stages of development, the wealth of the population also increases as does the institutionalisation of domestic capital and India is now at a cusp where we have enough savings channelled into financial services and the capital markets where we are not as reliant on foreign inflows or foreign capital of more developed markets as we have been in the past.

That is what is setting India up, differentiating it from some emerging markets today. There are many structural trends we can talk about, as to why it is such an interesting investment horizon for many years to come for India.

Let us deep dive into the portfolio. Bajaj Finserv is one of the top holdings. I just want to understand what made the company appealing. Is it the holding of Bajaj Finance or is it the entire insurance play that we are betting on that made Bajaj Finserv look appealing?
In general, financial services is a sector that is very appealing in the Indian context. When I launched this one five years ago, people were asking me why now? Why India? Why Southeast Asia now? I was talking about what is happening in digital and financial inclusion and that it is really remarkable that maybe just five years ago, somebody could not tell the difference between Avanne or Rashmi but today with Aadhar, everybody has a national identity.

India has the largest biometric database in the world of its citizens and it is phenomenal that over the last five years, almost everybody can get a bank account. However, household credit as a percentage of GDP in India is still sub 20% in markets like the United States. In the United Kingdom, it is over 80%. So, we are still at a very early stage of credit penetration and there is a long way to go in the credit business of something like Bajaj Finance. But it is not just about credit growth. When you layer on services like insurance, we are at such an early stage that most Indians still do not have health insurance. If you speak to your peers in the US or the UK, they do have health insurance.

We are at a very early stage of financial products and so we are just as excited about their insurance business and the asset management business. Bajaj Finserv allows us access to partner with a phenomenal management team which has demonstrated their ethics and aligned with their shareholders. They have done the right things in the past to take market share or build up a resilient business and they are in industries with very long runways for growth, where incremental return on capital can be very high. So it is all of the above.

Since you are so excited about the insurance business and asset management, I am curious to understand why there is not just a pure play insurance stock in the entire portfolio?
It is not that we do not believe in the pure play insurance player. Some of them are doing a fantastic job executing. I still think it is a very long large market. We will see new players also grab market share and the entire space, be it the platform players or the direct players, are going to have very interesting and long runways. We really take a very selective approach to whom we partnered with.

Let us just understand a little bit more about that space as a whole from your perspective. Would it be the value retail proposition that is looking appealing or is it purely betting on how well Zara is performing or the Tata Group, which is known for strong businesses?
You hit the nail in terms of it is all of the above for us. We really think of ourselves as partners for the entrepreneurs and the management teams and the founders that we are investing in where fiduciary is the capital, our clients and partners trust us to really do our work and partner with the right and ethical people.

The fact that Trent is run by the Tata Group and has historically demonstrated that they are ethical in terms of decision making and partnership mentality and that is important to us. Secondly, historically, they have demonstrated that they make wise capital allocation decisions, They think very long term, very focussed. If you have ever spoken to the Trent management, you will hear that they are so laser focussed on what they are doing. There it is execution first, execution second and execution third.

So it started with this JV with Zara which is fantastic. It shows that even Inditex is a great partner and an ethical partner for them to grow in India. But the average selling price of a garment in Zara is almost $50 or Rs 4,000. It is still very high for the Indian consumers. So Zara today has 50 stores in India and Trent can open two or three on behalf of Inditex but what the management team was able to do with that was in terms of learn the supply chain, learn how to effectively manage asset churn, learn how to think about customer preferences and really focus on customer first and create a format that is more adaptable and a much better fit for the Indian consumer. That is really when I got excited.

When they started to pilot the Zudio store format, which is a much smaller store format. Value retail, as we say, the average selling price is $7 for a garment versus $50, just shy of Rs 500. It is much more affordable for the Indian consumer. The way that they have been able to do this in terms of their capex per store, for example, is half that of the next best value retail format and yet their sales per square foot is double that.

So once again their execution focus, the fact that they are doing it much better than everybody else and have now cracked a model that is much more scalable because the incremental return on capital and the runway for growth for that is very important to us.

I watched as Zudio slowly opened from one store to 32 stores. It took them almost as much time to open 32 stores as it did for them to go to 32 to 200 which is where they are today. And it will take them just that amount of time to go from 200 to 1,000. So for us, it is really a management team that has shown that they are very long term and focussed. They were slow at the start but when they cracked it, they could really have created a model and execution capabilities and prudence in capital allocation to be able to scale for a very long time to come. That is what we are excited about.

The portfolio includes APL Apollo Tubes, a steel tube manufacturer. Given that it is so closely linked to cyclicality and contingent on raw material price movement, is that a bit of a concern?
It is actually not so. While steel is a large raw material for all piping companies including APL Apollo, what is happening is that value added services are moving as a category in leaps and bounds. APL Apollo has a huge market share in value added services when it comes to piping, etc.

They are able to acquire steel at a cost advantage to all of their players. They have above 50% market share and so their cost advantage is very large and the thesis comes from the fact that there is just multi-pronged growth in terms of value added services where their products are being used in residential construction, home construction and so their margins are not as determined by over the years by fluctuations in steel prices. But more so, the mix changes to be more value added services and as they continue on that journey, they become much more comparable to a consumer goods company than a cyclical company.

I am curious because there are no pure play banks in the portfolio at all. Given the kind of weightage that we have within the banking sector in India, the fact that this leg of the bull market has primarily been led by banks – be it private names or even some of the much smaller public sector banks – how come there is no mention of that?
We are very fortunate that we are at a size and scale where I can be very selective. I believe financial services, banks have a long runway for growth but we do not have to own HDFC Bank or ICICI Bank even though they are fantastic companies and we can be a little nuanced to find the next company that we think is earlier in their stage of growth and has and an even longer runway and maybe higher rates of returns.

We are really focussed on doing the best work and I think that is what differentiates us from maybe other global larger funds and that have to put a lot of capital to work. I do not have the resources to get to know these markets inside out but we have a relatively large team on the ground in India, on the ground in south-east Asia hunting for the best companies. It is really a reflection of where we see the best growth potentials coupled by greatest management teams and that is not to say that the banks are not going to be great investments, but maybe we can do a little better.