An Update on the Recent Performance of. India Entrepreneur Fund (IEF)

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Kristopher Heath
5 years ago
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1 An Update on the Recent Performance of India Entrepreneur Fund (IEF) 23 rd Mar 2017

2 An Update on recent performance of India Entrepreneur Fund (IEF) Given below is the absolute performance of IEF bi-furcated in three time-frames: Apr 2016 till Sep 2016, Oct 2016 till Feb 2017 and FYTD i.e. Apr 2016 till Feb 2017 (in INR terms): Absolute Performance Apr 16 till Sep 16 Oct 16 till Feb 17 FTYD (Feb 17) IEF 21.2% -2.0% 18.7% Nifty 11.3% 3.1% 14.7% Outperformance / Underperformance visà-vis Nifty 9.9% -5.1% 4.0% Note: Performance figures are in INR net of all fees and expenses. The above returns are composite returns of all Integrated Clients as on 28 Feb Returns for individual client may differ depending on time of entry in the Strategy. Past performance may or may not be sustained in future and should not be used as basis for comparison with other investments. Returns for 1 year or less time period are absolute returns, while more than 1 year are CAGR As evident from the above performance table, the portfolio was fairly on-track in the first six months of the Financial Year It s only post Oct 2016, the performance has seen some slippage and hence let us focus on the performance over this period. Performance Attribution Analysis between Oct 2016 & Feb 2017 (source: Bloomberg in INR terms): 1

3 Key Takeaways of Attribution Analysis (Oct 2016 Feb 2017): Overall performance is a sum total of What we had and worked well: Stock calls within the Auto & Auto Ancillary sector (Eicher Motors, Motherson Sumi), & Financial Services sector (Bajaj Finserv, Bajaj Finance, HDFC Bank, Indusind Bank) worked well for the portfolio. What we did not have and worked well (this would have pulled down relative performance): Staying away from energy (Reliance, NTPC, GAIL, Power Grid, BPCL, ONGC), metals (Hindalco, Tata Steel) and telecom (Bharti and Idea) also hurt the performance. What we had and did not do well: Stocks within the Consumer Goods sector (Asian Paints, Britannia, Havells, Dabur), Healthcare (Ajanta Pharma, Sun Pharma), Services (Interglobe Aviation), Textiles (Page Industries) have dragged the performance during the time frame. What we did not have and did not do well (this would have helped relative performance): Not having IT and construction stocks overall helped. Where were we positioned and why? We seek to provide preservation of capital and growth of capital and hence focus on a part of the market which we believe can deliver long period EPS growth in a predictable manner. Since the growth is more predictable and consistent, with lower volatility we hope to see our businesses expand their valuations and expect the market to recognize it over a period of time. We were more positioned in the consumption part of the economy because other parts of the economy like Capex and Exports were not witnessing growth. Our exposure to capex was hence very limited. We did have some of the best performing businesses amongst the exporters. Consumption was the only part which was delivering the kind of growth that we sought from our businesses. The outlook was supportive as well. The pay commission monies were in the hands of central Government employees (state government and PSU employees are expected to get an increase in a staggered manner as well), agriculture production was good as a result of bountiful monsoons and interest rates were coming down. The other part where we were positioned was the private sector banking and NBFC sector. We had excluded PSUs because of the stress they are witnessing on their balance sheet. This selection continued to do well for us on an overall basis. Our portfolio got impacted by demonetization significantly. Demonetization, in effect transferred some monies from the people to the government and while this was taking place, consumption has got disrupted. This has resulted in a sharp fall in the stock prices of consumption categories during the period of November and December. As the economic impact of the event has reduced, the stocks have come back to their earlier levels. The IEP portfolio is today higher than its level on 7th Nov. However, the market levels are higher still and the market has outperformed. This has mainly been on account of: 2

1. strong up-moves in the oil, metal pack and PSU banking.

Given the volatility in this space, this is not a natural selection space for us.

The three charts below show how HRC and aluminum prices reversed trend in the period and the coincidental impact on PSU banks.

4 1. strong up-moves in the oil, metal pack and PSU banking. Outlook on metal prices being uncertain, this part of the market has traditionally been very volatile and over long periods of time has at best managed to move side-ways with only a few exceptions. Given the volatility in this space, this is not a natural selection space for us. Stocks of PSU banks also responded strongly to the up-move in metal prices because it seemed to reduce stress on the balance sheet of PSU banks. The three charts below show how HRC and aluminum prices reversed trend in the period and the coincidental impact on PSU banks. While stock price momentum may sustain in this part for longer (especially supported by expansion in the US), I would like to point out that while the up-move has been strong and steel prices have been higher than current levels in the past, they have typically not sustained there for long. Similarly, PSU banks are no longer cheap. After a strong up-move from sub USD30 levels, oil prices seem to have been peaked at USD55 levels. 2. The other part that hurt us were strong up-moves in fixed return businesses which the market priced higher on account of lower interest rates. This adjustment had to happen and has occurred. HRC Prices (China) Aluminiun (LME) Source: Bloomberg Source: Bloomberg Kotak PSUBank ETF Source: Bloomberg 3

5 How has our Earnings Growth been? Quarterly PAT Growth of IEP Companies (Y-o-Y) v/s Nifty: Quarterly PAT Growth (Y-o-Y) Q1FY16 Q2FY16 Q3FY16 Q4FY16 12M FY16 Q1FY17 Q2FY17 Q3FY17 Average of IEP Companies 24.9% 30.3% 39.3% 35.0% 29.3% 39.0% 29.8% 18.0% Nifty -3.2% 3.1% -7.0% -0.5% 0.9% -1.5% 3.1% 6.5% Source: ASKIM Research, Bloomberg based on Feb 2017 portfolio companies As evident from the above table, the quarterly PAT growth of IEP companies clearly show that the portfolio comprises of quality companies which has shown consistent growth trajectory over the last 7 quarters. Even in the quarter of demonetization, where the impact was severe, the portfolio companies have managed to deliver a PAT growth of 18% y-o-y, better than Nifty of 6.5%. Outlook Given that our companies continue to deliver strong growth while broad market has delivered smaller growth. o their relative valuations our now significantly cheaper v/s the broad market There has been a strong rally in global commodities and the prices are no longer low (for oil, steel etc). The consequent rally in stock prices has made this part fairly valued. PSU banks have also seen a strong rally. On a relative basis, this part is no longer as attractive as it used to be. The drop in interest rates, while it benefited fixed return businesses in the first phase would also benefit valuations of strongly growing businesses where the growth is more predictable. This should help our portfolio selections Lastly, we have taken the advantage of the market volatility and changed our portfolio to include Cholamandalam Finance and MRF while businesses like Sun Pharma and Interglobe where profit growth was a suspect have been sold. Overall, the valuations of our portfolio have dropped further as a consequence of these changes. We hence believe that our portfolios have stabilized and are now performing in line with the market over this calendar year and gradually outperformance should return. Portfolio Actions in the last 1 year: In the last one year, we have exited from Bharat Forge, Sun Pharma and Indigo and included Cholamandalam Finance, MRF and Welspun. Below is the brief rationale for the actions taken: Cholamandalam Finance: Cholamandalam Finance is a strong NBFC franchise. Sharp fall in market price has made the entry point attractive. We expect both the segments (Vehicle Finance and LAP) to grow strongly. We believe the impact of current demonetization will be transient. We also expect 4

6 operating leverage (strong business growth along with control on operating expenditure) to play out such that ROAs improve from the current 2% level. MRF: MRF is the market leader in tyre industry in the country. Dominant in all segments as well as a leader in the replacement market, MRF is the only company commanding a premium in most of the categories. Despite stiff competition from Chinese imports, we expect it to race ahead of the industry due to its higher OE growth and its leading position in the replacement market. It has strong presence in the high margin replacement market owing to the wide distribution network it has created over the years. We believe MRF is morphing more into branded play vs commodity play. ROCE at 51% (last 10 year average at 30%) remain superior to peers. Welspun: Welspun India is amongst the largest Indian textile player focusing on home textile products (Terry Towel, bed linen products, rugs & carpets) for US and European markets. Welspun's manufacturing competitiveness, its excellent product quality and the ability to offer entire bouquet of home textile products for its clients is evident in the fact that it has steadily increased its market share in US in both its key product categories of towels and bed sheets. It has 20% market share in towels and 11% market share in the bed linen category in US. Attractive valuation coupled with strong growth profile, business model and strong position in the US home textile market, offers attractive investment opportunity. Interglobe Aviation: In the process of exiting and converting to MRF. While the aviation industry is growing at 20%+, intense competition is taking toll on the profitability. Consequently, we are converting Indigo to MRF to focus on domestic plays which are morphing into brand plays. Bharat Forge: We believe the much anticipated recovery in the business is delayed further, resulting in further cut in earnings estimates. Business recovery got further delayed due to dramatic fall in commodity prices resulting in impact on customer financials. Sun Pharma: Halol resolution was taking much longer than anticipated, thereby blurring the earnings growth profile. Also generic pricing erosion started to show impact on profits. Disclaimer: This note has been prepared by ASK Investment Managers Private Limited (ASKIM) solely for the information of the clients of ASKIM. While reasonable care has been taken in it's preparation, this report does not purport to be a complete description of the securities, markets, investment philosophy or developments referred to herein and ASKIM does not warrant it's accuracy, completeness or results. The information contained herein may be changed without notice. To the extent permitted by law, ASKIM or its officers, employees or agents may have bought or sold the securities mentioned in this report or may do so in future. This report is not an offer or solicitation of an offer to buy or sell any securities mentioned herein. 5

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