The harsh portfolio!

Among the real estate picks, have you considered Sobha Ltd? Would be great if you could share the rationale behind selecting Kpatil and ashiyana. Thanks!

I took a top-down approach, I wanted exposure to real estate players in markets with relatively low inventory (Hyderabad, Pune, Bangalore) and clean corporate governance.

  • Kolte is a play on Pune real estate market. They have done reasonably well during this downturn and have decent corporate governance. They undertake new projects by doing joint ventures with financial investors, hence not taking too much debt.
  • Ashiana caters to a niche space (senior citizen housing) and is responsible for property maintenance services which provides an annuity stream of revenue. Ashiana is one of those rare non-leveraged real-estate players (d/e < 0.2) with really good corporate governance (have a look at this playlist)

Both are available at ridiculous valuations and can give decent returns when sector turns and if they are able to execute their strategy.

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I have been reshuffling my portfolio substantially during this market fall. The broad idea is to replace existing portfolio companies with other companies which in my assessment can generate higher returns in the future.

Today, I replaced Reliance Industries (4% position) with Balkrishna Industries (2% position) from the portfolio. This generates 2% cash which I am looking to deploy quickly. The model portfolio is shown below:

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I have added AIA Engineering in the model portfolio (position size: 2%). AIA makes grinding media which finds its application in cement and mining industry. It is a market leader along with Magotteaux (Belgium based). AIA is exposed to the mining and cement sectors, although the cyclicality of AIA is lower as it manufactures indutrial consumables. They are trying to move up the supply chain by offering integrated services to mines. They dont have much debt on their balance sheet (d/e < 0.1), have high ROCEs (>20%), and don’t have any obvious corporate governance issues. Its fairly priced at current prices, and I might increase the position size if prices or growth becomes more attractive.

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As of today, I have done a switch from AIA Engineering to Wonderla Holidays in the model portfolio, maintaining a position size of 2%. The reason for this switch is below:

  • I was earlier valuing AIA on their accrual profits without realizing that AIA only converts 70-75% of their accrual profits to cash profits. This required me to revalue the business and I realized that AIA was trading at slightly higher than fair valuations
  • Wonderla on the other hand is definitely undervalued in my assessment (detailed post here).

I understand that this switch may not work out in the near term as Wonderla parks are currently closed. However, over the next 5 years, with a 12% growth rate (with stabilization of Hyderabad park and start of Chennai park), I expect share price returns to be in excess of 25%. This attractive risk reward is why I have made this switch. The model portfolio is shown below

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In-line with past updates of increasing allocation to cyclical sectors, I have sold my position in Mahindra Logistics (2%) and added NALCO (1% position). This builds up 1% cash which I am looking to deploy very soon.

The reason for this switch is below:

  • NALCO has a normalized PBT margin ~ 18%. For the last 2 quarters, PBT margins have been negative due to pressure on aluminum prices. Aluminum prices like most commodities is cyclical. FY13, FY14 period was the last bear cycle, followed by a cyclical uptick in FY15, followed by cyclical downtick in FY16 & FY17 and a cyclical uptick in FY18 and FY19. Over long term, the company trades at P/sales ~ 2 and it goes below 1 during cyclical downticks. Currently, company is trading at P/sales ~ 0.6 (market cap ~ 5600 cr. with cash of ~2800 cr.) Valuations are reflecting poor future prospects. In the next five years (i.e. by FY25), a cyclical upturn in aluminum is likely. When that happens, sales will go beyond the last peak sales and is likely to cross 12’000 cr. I will consider selling at P/sales > 2 i.e. 24’000 cr. (~128 share price). Current stock price is ~30. This gives me a favorable risk reward. Plus, its a debt free balance sheet with 51.5% GOI stake (i.e. not too much scope for further equity dilution)
  • Mahindra Logistics: The growth is supposed to recover after corona stabilization. As company is rapidly expanding into new business (i.e. cold storage, warehousing), I am comfortable giving it a growth rate of ~15% for the next 5 years and a normalized PBT margin ~ 4% (Global leader C.H. Robinson has long term EBIT margins ~ 5.5%). Looking five years ahead (FY25), with 15% topline growth, revenues will go from ~3200 cr. (taking into account corona impact) to ~6500 cr. At 4% PBT margins, PAT ~ 195 cr. PE ~ 20 will give Mcap ~ 3900 cr. Current Mcap ~ 1800 cr.

In essence, I have a better risk reward in NALCO compared to Mahindra Logistics. Also, I have certain doubts about accounting in Mahindra Logistics (details here)

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Harsh
I must say there are few conflicts which I observe in your portfolio. First I would like to compliment the way you analyze in depth the value of a given company/business. Mostly you are trying to buy mispriced bets which might be of higher value in the future. But I fail to understand why do you have more than 25 stocks in your portfolio, what is stopping you from keeping it focused to say around 10-15 stocks and you can further classify them as core/opportunistic/cyclical/value… This might help you in two ways …1. you will have less moving parts to worry about and also you will have more time to read and observe the current names. With your thesis playing out on a story you can evolve from their and replicate it elsewhere with high conviction.
Also do read about how a portfolio starts replicating a indexs performance once the constituents go north of 10-15 … I did read a long article on the same with decent size data …will share if I find it.
Regards
Divyansh

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It will be very useful for me if you can tell me the conflicts that you see. I maintain a very detailed account of the kind of bet I am making (shown below). My corpus size allow me to be flexible with my investing decisions i.e. I don’t need to own only high quality businesses. I am happy with lower quality if risk-reward is in my favor.

I haven’t come across any research that shows owning a large basket of stocks leads to market performance. What you are probably referring to is the number of stocks an investor needs to have adequate diversification, which is very different from tracking error. You can have a 1000 stock portfolio and have a large tracking error from the underlying index. Past academic research have identified a few factors such as quality, company size, valuation, etc. that can help explain excess returns. In order to harness one factor, we need a large basket of stocks (atleast 100), that’s the fundamental attribute of long-short strategies that try to harness a given factor.

Coming back to reality, my thumb rule is to keep 20-30 stocks with largely diversified cashflow (geographic, industry, etc.). This provides adequate diverification and I can track them reasonably well. Plus, I will be glad if you can help me identify unidentified risks :slight_smile:

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Hi Harsh,

Keen to know what updates you’ve made in the last one month to your portfolio since the last update.

Also are you looking at any other cyclical opportunities apart from Nalco like Paper which could have a quicker turnaround?

I have made no updates to the model portfolio since the last update. There are two of my portfolio companies which are more than fairly valued (PI Industries & Divis Lab). I might bring down their weightage and increase weightage in certain other companies (details below). I will update the page once I initiate a transaction.

About the paper sector, I haven’t studied it. I have been studying metals (both ferrous and non-ferrous). At appropriate valuations, I might consider adding Sandur Manganese and/or Vedanta. Other companies which I have been studying are Syngene (which can be a replacement for PI Industries), Cochin Shipyard, INOX Leisure and Vedanta.

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This is somewhat surprising. You already have 14% exposure to pharma. You already have Divi’s which is somewhat similar to Syngene (I may be wrong). PI is into Agri/speciality chemical space. Especially, agriculture/farmer/rural is the focus of the government now. Monsoon forecast seems to be good. Why are you thinking of replacing PI with Syngene?

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I haven’t done it, so lets not jump guns. Syngene is a contract research organization and is not exposed to the usual vagaries of pharma. However, it is in a more regulated place compared to PI. If I had to choose between Syngene and PI as a business, I will go for PI because there is no FDA, plus the fixed asset turnover is higher for PI making it more capital efficient. However, this is also reflected in valuations, with PI trading at a large premium to syngene. Also, I may start trimming down my position in Divis (at a given price) and Syngene can be a replacement. However, given the limited listing history of Syngene, I am unable to convince myself to pay a fair price for this business. I generally like to buy a business once it has seen atleast one full market cycle to know how the manager behaves in tough times. Given that we have a long history of Biocon, I am somewhat comfortable with the management.

I cannot care less about this. I bought PI a few years back not because I had a view on monsoon or the government focus. For me, PI is a decently run business with a large tailwind of outsourcing of drug/chemical manufacturing by innovator companies to places with labor cost arbitrage. However, I also respect valuations. My general rule for a decently growing company is to start cutting positions if I cannot envisage decent returns over a 5-year period, assuming my growth assumption fructify. That’s why I might cut some positions in PI.

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Thank You Harsh. I am new to investing. I asked because I am tracking Biocon, Divi’s, PI and some other pharma stocks. Booking profits and investing it in other companies which may give better return in future is an important part of investment - which comes only with experience - I guess.

As of today, I have added 1% position in INOX Leisure which brings the cash back to zero.

Rationale:
My long term growth projections for INOX is about 15-18% over the next 5 to 7 years based on data below:

  • Plan to add 830 screens to the current screen count of 574 in next 5-7 years (increase in screens: 13.6%)
  • Long term ticket price increase: 4%
  • Premiumization: 1-2% (based on increased contribution of F&B sales and advertising revenue)

The normalized OPM are ~14% which gives me an fair enterprise value of ~2.2 times based sales. Lets do some crystal gazing!
FY19 revenues were 1664 cr, FY20 revenues will be close to 1600 cr. (taking COVID into account), FY25 revenues at 15% CAGR ~ 3200 cr., Enterprise value ~ 7040 cr. (P/sales: 2.2, share price: 685). The current share price of 190 gives an attractive risk reward. As company is unleveraged, there is a low likelihood of bankruptcy.

Key risks:

  • Rapid expansion will lead to repeated equity dilution (in my estimate the SSG ~ 12-15%, anything more than that requires dilution).
  • A shift to OTT

The updated portfolio is below:

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What’s your opinion of files getting directly to homes through digital or the cinema halls not being used? Hope you aware of a dispute between producers and exihibitors going on currently.

No firm opinions. The digital threat has been looming for a while, but it doesn’t seem there are too many entertainment avenues for urban people. Anyway, company reports footfalls and I will much rather look at that in a normalized scenario before coming to any conclusion.

Hi Harsh,

Is there any reason you are not looking into HDFC AMC rather than Nippon as an investment option

While Nippon group does bring some credibility, Anil Ambani run companies have fared poorly in the market wrt corp. governence .

Hdfc AMC is run by Prashant Jain , who has a great track record and name in the market

Thanks for this very useful comment, I used to own HDFC AMC a while back and sold it when its dividend yield fell below 1%. I completely agree that HDFC AMC has a stronger distribution network in terms of banking parentage, but Nippon has a stronger network in B-30 cities. Nippon has the highest retail AUM coming from B-30 cities, which is advantageous as this allows them to charge additional expense ratio. Also, this makes their book less chunkier.

Overall, AMC businesses are superior in terms of being asset light along with strong operating leverage. This comes at the cost of more cyclicality in profits. Nippon management has clearly stated that they will focus on profitable growth and gain market share in debt which is already bearing results (see slide below). Plus, they return most of the profits in terms of dividends giving a nice dividend yield (current trailing dividend yield ~ 2%). I will add back HDFC AMC to my portfolio at a given price (~1800 probably).

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Thanks for pointing this out. Definitely with the recent drubbing , Nippon has entered the buy range.

But what about the management quality?

Management has changed, its Nippon not Reliance now. They are returning most of the profits as dividends, no intercorporate deposits, etc. Plus they are trying to leverage the Nippon network to provide advisory services to their international clients. Do you know something about the nippon management in terms of bad capital allocation?

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