Ajay's portfolio - Feedback solicited

(Ajay) #1

I am posting details of my equity portfolio for obtaining feedback from senior members and fellow investors. Really keen to obtain your viewpoints on the rationale for individual investments. Thanks in advance!

I started investing in 2011, but have invested meaningfully only in the last 2-3 years. It would be apparent from my porfolio that I have a strong (likely unhealthy) bias (~80% of direct equity portfolio) towards the financial services space - due to my experience of working with banks and insurance companies in different capacities. However I believe that concentration risk is balanced out by my MF portfolio which is composed of large cap and multi-cap funds.


Investment rationale

Reliance Capital
The best run ADAG company. Almost all operating businesses are in sectors which are well regulated and with bright industry growth prospects. The company has executed on promises for value unlocking (RNAM, HFC and forthcoming general insurance IPO). Presence of Nippon Life as a JV partner for MF and life insurance business is a comforting factor.
Value unlocking triggers: Deleveraging at holdco level through sale of non-core investments Risks: Part of ADAG group

Piramal Enterprises
Ajay Piramal is a terrific capital allocator and somehow has the magic of identifying and executing on his vision. Have been invested in Piramal since 2012.
Value unlocking triggers: Demerger of FS and pharma business Risks: Information management business is stagnant since acquisition, unseasoned lending book

L&T Finance Holdings
Exit of previous management and entry of Bain Capital along with the new CEO have transformed the business. Financial performance has been fantastic over the last 4-6 quarters leading to sharp price rally. Expect pace of growth to slow once portfolio realignment is complete.
Value unlocking triggers: Asset and wealth management business performs better than industry Risks: NPAs increase from hereon

Dewan Housing Finance Limited
Invested in DHFL since 2013 - performance till date has been quite good. Cheapest HFC on a valuation basis.
Value unlocking triggers: Perception change and value unlocking from subsidiaries/ associates Risks: Increased competition and increasing proportion of non-retail loans

Defensive play with steady growth and almost guranteed income streams. Switched to Powergrid from Adani Transmission after Adani prices increased sharply
Value unlocking triggers: Unlikely - to see steady growth Risks: Nothing material

Petronet LNG
Defensive play with steady growth and limited competition
Value unlocking triggers: Kochi terminal utilisation Risks: Capacity commissioning by competition

Zee Media Corp
Acquisiton of BigFM from ADAG group encouraged me to look at this company. Negligible institutional holding at present. If the company is able to execute on vision, then opportunity to make good money
Value unlocking triggers: Successful integration of radio business Risks: Risk of new channels, especially WION, not doing well

Lumax Industries
Leader in automotive lighting space with strong relationships with OEMs and technology & equity partnership with Stanley of Japan. Shift to LED lighting expected to increase per vehicle lighting content value
Value unlocking triggers: Accelerated shift to LED from traditional lighting Risks: Margins on LED lights might get compressed due to pressure from OEMs

Insurance companies
I believe that insurance companies are in a sweet spot and will continues to grow for years. However given the relatively few listed companies, I found it difficult to identify which ones would do well. Hence invested in a bunch of them.

IDFC Limited
Invested before the merger announcement with Shriram. I do feel that management is under immense pressure to simplfy the holding structure to unlock value. However given the size of the company, the poor performance of IDFC Bank and management which I do not fully trust, I am unsure if I should hold or exit.

SEBI’s recent order permitting universal exchanges is a threat. While it is certain that BSE and NSE would enter the commodities space, I am not sure if MCX will be able to retain its leadership position. In any case, margins will be under pressure once new entrants commence operations. I probably made a mistake of not researching the sector enough and will exit in the coming days at a loss.

I have initiated tracking positions in Pokarna, Shriram City Union and GIC Housing and will form a firm opinion as time goes.

(James Sebastian) #2

Good to hear from you Ajay.

Would you explain the rationale of allocating 32% (almost 1/3rd) of core portfolio or 25+% of overall PF to Reliance capital making it a very big bet. What’s the past performance of this after you entered in to this script ?

(8sarveshg) #3


So this is a BFSI focused portfolio with BFSI being 80% of the portfolio. While I wouldn’t comment on the specific stocks. I think three fundamental questions you should think about. I neither agree or disagree with your portfolio but just wanted to give you some thoughts to ponder upon.

  1. Are you having such a great edge in understanding the BFSI business because of certain specific reasons that you have decided to put your entire money into just one sector even when you have stayed away from the best quality companies in the sector i.e. HDFC, HDFC Bank & Kotak as well as have stayed from such of the larger names like SBI, ICICI bank as well as Axis which atleast look cheap on paper.

  2. If value is your style and hence Reliance Capital is your largest holding, what is something like Piramal which is almost fully valued doing as the second largest holding. Top stock valued at 1x P/B and Second top stock valued at 5-7x P/B.

  3. I hope you know that BFSI share of NIFTY is at all time high of almost 40% - never in the history has BFSI stocks rallied so much that they have gained almost double the share of NIFTY within few years (from early 20s at the beginning of this century to almost 40% now). Since BFSI has outperformed the general market and other sectors so much inspite of most of the companies in BFSI not offering a differentiated product and hence not having much of pricing power like consumer and other sectors. Do you really think that this outperformance of BFSI over all other sectors is going to continue - the reason I am asking you this is because your portfolio seem to have taken that stance.

All the best,
Sarvesh Gupta

(Ajay) #4

Thanks James.

My average cost in RelCap is ~460. I held the stock earlier and sold at ~740. Then entered again as it kept falling during the RCom collapse.

I did not mean to end up allocating such a large portion to the overall portfolio and will probably bring it down to 15% of overall PF. I am not a fan of undifferentiated corporate lending businesses and all the good banks (HDFC Bk, Kotak, IndusInd) are ridiculously valued. So given RCap’s strong MF business and presence in other promising areas like general insurance, life insurance, HFC plus recent management change in the laggard lending business, allied with relatively cheap valuations, I made RCap my top bet.

While the past track record does not encourage much confidence, I think the management in the past 1-2 years has largely kept to their promises and with separate listing of subsidiaries, we should have greater transparency and increased institutional investor scrutiny.

(Ajay) #5

Hi Sarvesh…thanks for the great and insightful feedback. Really appreciate the detailed feedback.

I don’t have answers to some of your questions (I will have to go back and think about many of the points you mention :slight_smile: ) but will try to answer the first one:

Staying away from top quality cos like HDFC, Kotak: No doubt, these names have performed consistently for a long period of time, but valuations are very expensive with P/B of 4 or greater. All of them are primarily in the lending space where corporate lending isnt doing well and there is increased competition in retail lending. Hence decided to stay away from these names,

Staying away from larger names like ICICI and Axis: Maybe I am biased (I used to work for one of them), but I do think their corporate lending books are nowhere as solid as they would have us believe. While prices are relatively cheap, these banks are unlikely to grow at more than 15% yearly.

(Yogesh Sane) #6

If you are comfortable putting 26% of your portfolio in a single company, you may consider consolidating your < 5% positions into fewer positions. e.g. you can consolidate 4 insurance companies into 1. My experience is when you force yourself to choose one out of several companies, you end up doing a deep analysis of all them and that actually helps in building conviction. May be that will work for you as well.

(Ajay) #7

That seems like a good suggestion. I only recently invested in insurance companies and am still tracking the performance of the different companies. I will take your suggestion and undertake further analysis. Thank you.

Best regards

(Dhiraj Dave) #8

I would suggest you calculate Debt//equity ratio as value wieght and RoNW (again) current value weight. Does it worth to put almost all 80% of investment and having wieghted average debt equity more than 4 (my indicative number, given insurance/stock exchnage has near zero leverage and other NBFC/lending firm haveing 5-6 times leverage) and RoNW less than 20%, does is make sense of having such lopsided risky portfolio? If you are expert and convince about then it is fine.

Also, in your reply about not investing Axis/ICICI Bank, I find very intelligent view of an insider and appreciate same. However, could not understand contrdiction when it come to the largest holding. How sure you are about qualty of book of your largest holding?

Further, have you consider impact on protfolio due to likely revision in interest rate and firm interest enviroment for next 12 months at least?

Wish you all the best and please take your final investment call after going through all points. You are the best person to take call on your investment. My apology in case I have hurt you anyway with my words.

(Ajay) #9

Thank you Dhiraj for your feedback.

Would be great if you could clarify your comment on portfolio level D/E ratio and RoNW. While it appears to be a sound metric in general, can you please comment if it is equally applicable in case of financial services firms too - any institution undertaking lending would have a D/E of atleast 5-6 times as you have rightly pointed out. Is that not an intrinsic part of the business vs. a non-financial firm where lower D/E ratio with higher RoNW is generally better.

On the quality of RCap’s lending portfolio - I do not have any special insight other than what is publicly available. However a few points which give comfort:

  • The lending business (HFC and Commercial Finance) would contribute less than 35-40% of RCap’s valuation as most of the value comes from the MF and insurance businesses
  • Even HFC is generally better than corp lending in terms of granular lending. Plus RCap has appointed a new CEO (ex-Bajaj Fin.) for the laggard commercial finance business and also rebranded it as Reliance Money. So hopefully that portfolio should also see greater retailisation over time

However agree with you and with other members that my portfolio is quite lopsided with excessive exposure to BFSI space. I will hopefully get some ideas and rebalance my portfolio :slight_smile:

(Dhiraj Dave) #10

In my opinion, I am still not be able to get an idea about how to value financial sector. Inherintly business does not have any free cashflow, if it is growing. The profit generated shall be redepoyed in the business as part of capital adequacy. So if I use traditional valuation of dividend /Free cashflow discounting, I have to assume whole loan would be paid back without any haircut which is big leap of faith.

The current valuation approach of pricing based on Price/BV is in my limited understanding, greater fool concept valuation concept. Higher price/book value offer opporutnity dilute equity at higher value (to fund future growth capital for capital adequncy) and hence indirectly increasing book value for existing holder (since dilution is generally limited to 10% existing equity, if happen at say 3 times of book value, existing 90% euityholder would get benefit of 0.27 growth in networt. HDFC and other banks have done this successfully over decades and generated very high networth over the period. Hence, I might be completely wrong, but I find it as bigger bubble argument which has to be bust. What happen in adverse market if equity dilution happen at lower price/BV (as happening currently in PSU Banks)?

So lending business, generally end with gearing more than 5-8 times of equity. Now gearing is risk, i.e. higher the gearing higher the risk for equity risk holder. Also, in general, gearing is used to increase return for equity shareholders (which compensate incresing risk due to higher fixed interest service by equity shareholder). However, what I find that in financial sector, despite gearing increasing almost 5-8 times of equity, Return of equity is not even exceed 20% except in few extremely good years. Now compare this with business in Autombile/Chemical/Pharmaceutical/IT. Most of these business has gearing less than <0.5 (many time they have excess cash which is returned to shareholder). So in my framework, I try to see incremental Return on networth by increasing gearing. Assuming, 14%-15% being expected RONW with 0.5-1 gearing, I find financial sector as miserable in delivering high ROE discount multiple gearing. Just 4-5% growth in ROE with alomost 500-800% jump in gearing.

This is my understanding and it may be completely wrong. I do look forward to conterview and update my understanding.

On the second point of valuation of Reliance Capital being holding company and nearly 40-50% being accounted for non-lending business; I believe it is one way to look at valuation assuming interest is serviced fully. In case, due to non-performing loan/adverse liquidity situation, the company has being not able to service interest, it would drastically result lower value and then market would value more as left over equity rather then holding company discount structure.

In nutshell, higher the leverage, higher the risk. If you feel you are getting compensated for higher risk, you should be investing. I am personally not find that risk worth taking considering the reward, which has more to do with my conservative profile and shall not be applicable to any other person.

Hope this explain my position. Wish you all the best for fiuture. It has been wonderful learning for me when you counter question me. While writing down my thought, I got more clarity. Thanks and do look forward to your reward.

(Ajay) #11

Hi Dhiraj,

I would recommend you to read Aswath Damodaran’s popular paper on valuing financial services firms, if you haven’t done so already. He explains it far more elegantly than I would ever be able to.
.finfirm09.pdf (638.9 KB)

On the topic of appropriateness of P/BV as the valuation metric for banks and NBFCs, there is a sound basis. As financial firms’ cashflow cannot be measured with certainty, we are left with only dividend discount model and EVA/ excess returns model to value them. In India, given the high growth rates and low dividend payout, I think the most suitable method is to value them based on the excess returns model. A very simplified definition would be as below:
Current book value + Present value of excess RoE over cost of equity

On valuations of RCap, I guess all of us will have our own views on the risks and pitfalls of the business. Only time will tell how the story unfolds.

Would be great if any senior members with expertise in banking/ FS sectors can add in their views