Multipie Weekly #7: Curated reads for investors

Approach to generating 10x in 10 years on your portfolio (~26% CAGR):

• 10x portfolio returns tends to be led by 2-3 holdings that generate 30-40x (40-45% CAGR) and remaining 8-10 deliver market returns (12-13%), giving overall pf returns of 26% CAGR (10x)
• Three aspects matter – Sales growth, margin expansion and entry valuation
  • Even in a fast grower, sales growth ranges 17-20% CAGR ( 5x)
  • Margin expansion is key – in a typical 10x multibagger, sales grows 5x and if net margin doubles, it leads to 10x EPS expansion in 10 years
  • Valuation expansion or re-rating is beyond own analysis and is a function of entering before market fully understand the potential
• Analyze from both demand & supply lens to understand growth potential
• Demand is easier to estimate, key is to understand moat/ disruption from the supply side
• Supply side disruption case studies – Balkrishna (BKT Tyres), APL Apollo, Deepak Nitrite, Amara
• BKT Tyres
  • Manufactures off-road tyres (agri or mining equipments)
  • Moat: Lower cost supply vs global peers, and could shift from replacement tyres to go deeper in global supply chain and OEMs
  • Cost advantages gives BKT some pricing power over peers
  • BKT is able to manufacture at 50% cost vs Michelin, Goodyear, etc (employee cost for BKT is 5% of sales vs 25% of sales for global peers)
  • Low supply risk from China as off-road tyres need customized small batch manufacturing, unlike bulk volume supply that China prefers 
  • Currently, 25% sales from OEMs, as products were “good enough”
• APL Apollo
  • Structural steel pipe; industry growth has been single digits
  • Key: Direct forming technology with minimal set-up time change for manufacturing pipes (reduced wait time from 48-60 hours to 2-3 hours). Could thus disrupt the supply chain, unlike peers.
• Amara Raja vs Exide
  • In 2012-13, Exide was clear leader and deeply entrenched with OEMs who do not switch vendors easily
  • Amaron targeted the replacement battery market as this was more unorganized and captured it given 15-20% cheaper than Exide
  • Could gradually build inroads into OEM business
  • 2012-2017: Exide growth flat, but Amara grew 20-25% annually
• Deepak Nitrite
  • DN was into performance and fine specialty chemicals for long
  • Launch of phenol plant was a trigger; on ground supplier feedback showed distributors were buying directly from them
  • Why? Importing involved bulk buying, storage is risky and logistics/ WC costs involved 15% and needed a month of planning
  • DN could supply in 3-4 days, without any of this hassle
• Being able to destroy supply is sustainable competitive advantage versus dependence on demand which is more cyclical
• “When you destroy competition (on supply edge), it gives you pricing power and gives you that margin expansion. But if you are just another part of an industry, you will grow with the industry and cannot grow at a rate higher. This is the key to big win opportunities.”
• Preferred investments: Small and midcaps that can grow 10x on a 3000 cr starting base (more probable vs a 10x on 30,000 cr starting base)
• Think in batches of 2-3 years – one can’t look 10 years in the future
• Important to stick to businesses where one can have an outlook on the“business” and not get carried away by bull market euphoria
• Listen to the full talk (recommended)

3. Why are FIIs bullish on NBFC?

CLSA released a report titled ‘Flow Meter’ last week, where it presented data on FII flows across emerging markets as well as sector wise flows in India.  India and Brazil have seen highest 12m FII inflows at $33.8 BN and $17.6 BN respectively, while all other EMs have seen net outflows.

Interestingly, the sector that has seen highest 12m inflows is NBFC, the forgotten and forsaken blue eyed boy amidst the chemical and IT rush. The top drivers are prominent NBFCs such as Bajaj Finance and Cholamandalam.

While we plan to publish a more detailed note on NBFCs next week, here are 10 pointers that explain the current situation:

1. NBFCs are specialised lenders; have pioneered many segments; and account for ~INR 30 TN of outstanding loans (25% of system credit). Segments with high NBFC share – LAP, Auto loans, Home Loans, MFI, etc
2. Access to and cost of funding are the key drivers that determine risk profile of an NBFC. To sustain ROE, NBFCs venture into under-serviced loan and customer segments which have a higher risk profile.
3. NBFCs saw rapid growth between 2014 and 2018, due to cheap capital from Debt mutual funds via debt instruments such as Bonds & CPs
4. Loan book of NBFC + HFCs doubled in this period and has only grown marginally since then due to risk averseness (post IL&FS and DHFL issue)
5. While debt availability has stagnated for the industry, Banking system has been supporting the industry via Term Loans & Securitisation
6. Industry consolidation is visible:
   • Gainers: Lenders with strong parentage, high rated NBFC
   • Share of low vintage NBFCs has is declining in the last two years
7. NBFCs facing the most risk aversion are trying to take corrective action via focusing on asset rundown and by undertaking asset sales
8. FY21 results indicate that NBFC / HFC group has seen a major  change and balance sheets for many NBFCs are stronger than pre-COVID times
9. While Stage 2 + 3 risk loans have risen post Covid, the strength comes from decade high Provision Coverage and lower leverage on Balance Sheet post equity fund raise. This has increased the loss absorption capacity.
10. Change in NBFC business model entails:
    • Lower leverage on balance sheet
    • Co-lending with Banks and asset sell-down
    • Shift toward smaller-ticket, fast-amortizing loans

• On the tenth anniversary of Safal Niveshak, we hosted Vishal Khandelwal for a discussion on investing and life philosophy
• Listen to the audio here or watch here