Rakshit Ranjan on why Marcellus won't go for AC companies this summer

Rakshit Ranjan, Investment Management, Marcellus Investment Managers, says “there has been more rebalancing of allocations wherever the share price corrections were far greater than otherwise elsewhere in the portfolio. But in terms of recent additions for instance, one of the pharma companies – Divi’s Labs – was part of only one of Marcellus’ portfolios and we have added it to another of Marcellus' portfolios, so we are quite positive, optimistic on that one. Largely speaking in the last 12 months, we have tried to capitalize on more opportunities to benefit from rebalancing activity rather than massive entries and exits in the portfolio.”

In times of exuberance, you behave in a much more calm manner. When the markets fall badly, that is what excites you. So are you excited right now or are you calmly observing?
There are pockets in the market, particularly quality growth stocks, where whilst the market has not fallen. There is a massive disconnect between the fundamentals and the share prices of some of these quality growth stocks. So that is the biggest area of excitement as that is pretty much the biggest area of exposure for our funds.

If you look at the recently reported results, there is a marked difference between say quality banks versus not so high quality banks, quality IT companies versus the others. Over the next one-one and a half months as the results keep getting reported, we would see results reflecting lack of noise of Covid, lack of noise of commodity price going up and down, and this will particularly amplify from the June quarter onwards because there is a little bit of noise in the fourth quarter FY22 as a base for the fourth quarter FY23 results being reported this time.

But as the noise goes away, commodity prices, the Covid-related, Omicron-related or many of the outcomes of capital allocation decisions done by quality growth companies, the job opening in terms of fundamentals should drive the share prices and that is where we are most excited.

What exactly is looking appealing to you at the current juncture when it comes to the broader markets? Have there been any recent additions in the portfolio? Could you revisit some of the names that you all own?
Yes, there has been more rebalancing of allocations wherever the share price corrections were far greater than otherwise elsewhere in the portfolio. But in terms of recent additions for instance, one of the pharma companies – Divi’s Labs – was part of only one of Marcellus’ portfolios and we have added it to another of Marcellus' portfolios, so we are quite positive, optimistic on that one.

That was about a month-month and a half ago but largely speaking in the last 12 months, we have tried to capitalize on more opportunities to benefit from rebalancing activity rather than massive entries and exits in the portfolio.

But look at how the last six months have been for Divi’s. After making a bottom of around Rs 2,800, it is at around Rs 3,265 right now. It has been rising steadily. Yesterday Laurus came out with their numbers. Though numbers are overall nothing great, but the API part of the number did very well. So did Glenmark Life. Do you think the worst of the corrections in the API business is getting over?
Our conviction on Divi’s is more from a stock-specific perspective rather than from a category oriented perspective. So from a stock-specific perspective, Divi’s is a firm where half of its business is not API related. It is a contract manufacturing of patented molecules largely etc. And as a result of this part of the business, there tends to be a lot of volatility from quarter to quarter in reported results because certain contracts expire, others get added and the timing differential between the two types of contracts, expiries and additions, causes volatility.

Typically, we have historically seen that with this volatility, the share price also tends to be very volatile. Till about a year-year and a half ago, when Divi's share price had reached very high levels, we have been reducing our allocation to Divi’s in the portfolios. Once the share price corrected about six months ago, we did a lot of checks at the ground level to understand the global dynamics of the big pharma and their sort of relationship with Divi’s, how it has been evolving etc. That is where the company specific aspects kicked in to our conviction and hence we decided to add.

So it is more company specific here, although having said that, in general quality oriented businesses which have done significant investments in the last two to three years to benefit from the Covid event as a crisis or Russia-Ukraine event as a crisis, they will all see the benefits of accelerated investments in the next 12 to 24 months. So whilst we do not know and cover some of the stocks that you mentioned, Divi’s is a stock specific call.

Do you research the area of consumer durables, particularly air conditioners? Voltas has been a massive underperformer. This time around, despite the worst heat wave, the stock did not do very well, perhaps got to do with the numbers also on the weaker side. But so much is competition coming in. Earlier, there were just two top companies, Voltas and Blue Star. Now there is Daikin, Havells which has acquired Lloyds. Panasonic. Have you looked at that point?
Yes, I mean, we have looked and rejected that space for precisely the reasons you mentioned. In this space, there are companies which do not have a significant product edge, because it is not that the R&D of one AC manufacturer or one electrical appliance manufacturer is significantly better than the R&D or the product development of another. Most of them are actually third party contract manufacturing companies. And when it comes to distribution, when it comes to marketing supply chain, there are not significant competitive advantages that we have identified which have allowed companies to maintain dominance along with profitability.

There are some companies which have actually sustained dominance. dominance by itself is not reflective of pricing power, because if you do not have pricing power, then you can have dominance without profitability. Hence, it is a space where you will have one or two companies doing well for two, three, four years, but you cannot have a buy and hold and expect to say 20, 25% free cash flow compounding over a very long horizon barring maybe one or two companies which are part of our coverage, but not in the holding portfolio. So largely, we have avoided this space in the past.