Uday Kotak’s letter to Shareholders

Dear Friend,

As I write this note, the world is on the edge about the future of Euro zone. ”Grexit” is the new terminology. A global bank has announced a US$ 2 bn treasury loss on trading credit derivatives. Facebook is having trouble with its post IPO phase. The business of money is truly “fragile, handle with care”.

I am reminded of my early days, when I was taught the first principles of finance: if you put in ` 10 of equity and borrow ` 100, you can lend out ` 110. However, if just ` 5 of loans out of the ` 110 go bad, you lose 50% of your equity, and it takes just ` 10 of assets going bad to bankrupt you!

It is quite surprising how global finance had missed this basic principle, their vision blurred perhaps by the jargon of risk weights, tier II capital, et al. We have seen financial institutions with less than 2 to 3 % equity, i.e. effective debt equity ratio of 40 and 50 times, positioning themselves as masters of global finance. And that is what has brought the financial sector down on its knees. It is important that banks focus both on “return on equity” as well as on “return of equity”.

It is only now that the importance of an “Arjuna’s eye” kind of focus on risk and risk management is gaining centre stage, along with the importance of “Financial Stability” as the core of what the financial sector and financial institutions need to focus on and be evaluated for.

Also, over the years, I have found banks focusing more on the P&L than on the Balance Sheet. In fact, particularly for banks, the Balance Sheet is more important, and P&L is only a derivative of the Balance Sheet.

It is through this lens that we look at the Indian economy, financial sector and Kotak.

The Indian economy has valid reasons to complain about the global economy and policy. Global financial policy of easy money is leading to unintended market outcomes, that too without achieving the intended economic outcomes. In terms of market outcomes we are seeing bubbles in bond markets and commodities. Both need to burst, and my view is that they will, sooner rather than later.

But India’s macro challenges are more than just global headwinds. High oil and high gold imports, combined with a relatively high-cost and inefficient domestic sector impacting commensurate export competitiveness have caused a high current account deficit of 4% of GDP.

Second, the inability of the fisc. to pass on higher oil costs is one of the main reasons for a higher fiscal deficit of 5.9% at the centre and around 9% for India consolidated.

And third, the much debated governance deficit challenges. It is critical to get the balance right between good politics and good economics.

The outcome for India macro is 20% more depreciation of currency in less than a year, and slowdown in growth to between 6 and 7%. While, this leads to short term challenges, I feel that some of the pain is priced in and with a little wind from the policy front, India has the ability to bounce back in due course of time.

That brings me to India’s financial sector. One of the most important challenges in the banking sector is its ability to define and price risk. The sector very often takes equity type risks for debt level returns. Also, a few large companies particularly in sensitive sectors like infrastructure, have a disproportionate slice of banks’ balance sheets. Therefore, concentration risk is real for Indian banks. Further, a well intended measure of smoothening cash flows through restructuring runs the risk of becoming a tool for ‘ever greening’.

Against this backdrop, how are we at Kotak running the firm?

First of all we have ensured higher equity to absorb potential shocks. We are at about 16% core equity excluding any Tier-II etc. Further, we are doing our best to imagine potential risks and have a game plan to manage them.And we are continuing to build. The big focus is on building a stable and low cost liability base. We have embraced the policy measure on savings deregulation and are seeing a positive customer response. We intend to make progress on Government accounts which are now open for all banks to pursue.

On the advances side we grew at about 30%, and would like to continue a good growth trajectory. But if we spot red lights, we will not hesitate to step on the brakes as well.

Our non-financing businesses like securities, investment banking, asset management and life insurance are going through their structural and cyclical challenges. But, we believe that their time too will come, and we are positioning ourselves to become internally stronger in this interim period.

The other internal focus is around technology, quality, lower people churn and continuity, superior customer experience leading to excellence, and all this at reasonable costs. On the external side, we are more open to inorganic growth opportunities than we have been in earlier times.

I look forward to building a stable and long term institution, focused on customer delight. Of course, if I may paraphrase Robert Frost just a bit, we have “miles to go before we sleep”.

Best wishes,


IDFC MF’s Expectation for 2012

Domestically we believe 2012 will be a year of consolidation and slow growth with low visibility on pickup of the investment climate and demand pull waning due to a non supportive fiscal. A lot needs to be seen how political order is restored and the budget session would be a pointer to the government’s stance on fiscal deficit and growth.

Our themes for 2012 would be currency depreciation (continuation of risk off trade), growth slowdown (political and policy), NPA scare in the banking system, likely falling commodity prices, and a declining inflation and interest rate scenario. In this capital starved economy where availability and cost of capital are issue for sustaining normal operations, investment pickup is unlikely and asset / capital light businesses should do well. That would entail IT, pharmaceutical, consumer business and the services part of the economy to do well. We believe it is too early to play financial leverage or operating leverage as a large part of India Inc will struggle with a weak demand.

My view: I have observed that its not easy to forecast for the whole year. Be it any smart investor! I think its better to divide 2012 into first half and second half. I believe 2Ps (political and policy) would both be favourable for India Inc in the second half while first quarter of first half should be a consolidation period. Remain long on consumption.

We hope the year 2012 is a great one for India and all of us. Wish you all a very happy and prosperous New Year!!

Akash Prakash’s Amansa Capital Portfolio

Amansa Capital, run by Akash Prakash, having assets under management of around $300mn with a focus on midcap companies in India. In an interview with FinanceAsia, Akash Prakash mentioned that they have invested in around 25 companies with investment size of $8mn-12mn each though I can only find out 13 of them with market value of $110mn.

Cholamandalam Investment and Finance Ltd (market value of around Rs 53crs)

Max India (Management mentioned they will recover all losses of previous 3 quarters and end FY11 in the black. Major beneficiary of reforms in Insurance if and when it happens )

Whirlpool of India (MV of Rs 50crs) . I had posted about Whirlpool last year in my blog.

Greaves Cotton (Manufacturers of engines for Piaggio, Tata Motors and Mahindra & Mahindra’s three-wheeler vehicles. Also manufactures Construction equipment. I have a vested interest in this stock)

Rallis India (Stock had a dream run over the past 2 years. Still it should do well in the long term)

Entertainment Network of India Ltd (ENIL) (Owners of Radio Station “Radio Mirchi” )

Gujarat Pipavav Port (Anchor investor in IPO last year)

Blue Star (See recovery in earnings only in H2 of FY12)

Kirloskar Oil Engines Ltd (market value of around Rs 32crs)

Edelweiss Capital (I have not seen any industry as competitive as broking)

Carborundum Universal (The company targets a Return on Capital Employed of 25% from 21.5% currently over the next few years)

OnMobile Global (Beneficiary of 3G)

Tube Investments of India ( It seems like some sort of obsession with Muruguppa Group companies! )

I think (from the few companies I track) the portfolio is very well diversified across sectors with companies known for maintaining high standard of corporate governance. Since Akash Prakash appears on business channels frequently and writes a column for Business Standard with no mention of his fund’s holdings anywhere, I thought why not find out from the BSE!

Key-takeaways from Whirlpool Annual Report FY10

Theme of the Annual Report,

Taking a leap into the next growth curve

India is at an inflection point of sustained growth and so is Whirlpool. With a strong brand, well differentiated products and a healthy balance sheet, Whirlpool of India has embarked on a journey of accelerated growth. With the intention of doubling its business over the next 3-4 years, it has charted a 3-pronged business strategy.

  • Grow the core business
  • Extend the core business
  • Expand beyond the core

This business strategy will be supported both by heavy investments and channel strategy.

Channel Development:

  • Reaching out to tier 2, 3 & 4 towns

The immediate focus of Whirlpool is on 700+ towns in tier 2, 3 and 4 where it plans to expand its presence.

  • Expanding Modern Trade Footprint

Volume grew by almost 60% last year, vital for growing the premium range.

  • Enhancing Brand Experience

Increasing visibility and reach through exclusive outlets by trebling the number of brand shops from the current count of 35.

Home Appliance Industry comprising Refrigerators, Washing Machines, Microwaves and Air-conditioners grew by 15-20%. Our estimate of category growth is 15-20% for Refrigerators and Microwaves and 20-25% for Washing Machines and Air-conditioners.

Outlook and Opportunities:

Penetration of home appliance is still very low and the long term growth opportunity for this industry is very attractive. Out of every 100 consumers living in urban India, only 33 own a refrigerator and 13 a washing machine and these numbers are miniscule in rural areas. Penetration of air conditioners, microwaves and electrical water purifiers is even lower.

Within the home appliance industry, categories/segments that are expected to grow ahead of the industry average are washing machines, microwaves and air-conditioners.

My take : Whirlpool has a diversified portfolio of products leading with refrigerators. Market size should be huge but the competition is also intense. It is a debt-free company with a very good return ratios (ROE of 44% and ROCE of 49%) and at CMP of 300, it trades at 30x FY10 and 23x FY11 expected earnings which is neither cheap nor expensive. Company plans to invest Rs 4bn over next 3 years which indicates the growth prospects it foresees.

Theme: Domestic Consumption -The way forward!

All the data below has been sourced from the Investor Diaries of Arisaig Partners, $471mn India Fund focussing on Consumer stocks in Asia. The Fund holds Colgate, Nestle, GSK Consumer, Marico, Godrej Consumer, Britannia and Jubilant Foodworks.

Approach: Our approach involves two stages:

Firstly, we try to predict the long term potential size of each of the key consumer segments in which we invest (e.g. confectionery, soft drinks, detergents, noodles, fast food, beer, etc.). We do so by comparing consumption trends globally in relation to GDP per capita at various stages of economic development. We have been pleasantly surprised by how much data is available in this area. This allows us to create a scatter diagram, and then a “best fit” curve – a guide as to how demand for a product or service can be expected to develop as GDP expands, structural barriers decline and, most importantly, consumers’ propensity to spend higher proportions of their income on discretionary items rises. This “triple whammy” can lead to sector growth rates well above general levels of economic growth. We refer to this as our “scale factor”. It invariably takes the shape of an “S” when graphed.

Having established a number for the sector growth potential by country, the second stage of our model looks at company specifics. We estimate the potential for a company to increase its market share and then try to assess its likely economic value added. We do this by making assessments of long term trends in margins, tax rates and fixed and operating asset intensity. This allows us to establish a long term cash flow profile for each company based on its value adding capabilities. Then we discount the cash flows back to provide a current valuation.

Long term Strategy:  We say this strategy will outperform because over long periods dominant consumer companies always do. This is for obvious reasons: low capital intensity, high cash generation, defensible moats (brands, distribution etc), and resilience against external shocks (we all need to eat, drink, wash and brush our teeth). The equivalent companies in the US have compounded at 15% per annum over the last thirty years. Add in emerging market tail winds in the form of: (a) disposable incomes rising faster than absolute incomes; (b) the evolution of a credit culture (mortgages and credit cards); (c) favorable demographics (except in China); (d) urbanisation; (e) formalisation of consumption (i.e. more supermarkets / fewer Mom & Pops); and (f) improving distribution reach as a result of infrastructure development, then these Asian businesses should do even better over the long haul.

HUL: We met the CEO to review our seventy page research report which concludes that the company will struggle both to retain market share in soaps and detergents and to drive growth from food and cosmetics (it is really only strong in deodorants, where, admittedly, wider usage would bring immediate benefit). Whilst he impressed us with his plans to improve distribution and product time-to-market, we feel our money is better placed with the more focused Nestle and Colgate.

Colgate: We were told that they have no plans to introduce non-oral hygiene products, such as the Palmolive range, until their market share in toothpaste reaches 70% from the 50% currently. The risk is the possible entry of P&G into this sector with Crest, the largest selling toothpaste brand globally, although, for now, P&G seems more concerned with battling Unilever in detergents.

Nestle: Despite dominant market shares in baby food, instant noodles, soups, sauces, coffee, etc., annual sales have only just surpassed USD 1 billion. Of course, this is miles above the USD 8 million revenues recorded when the company first listed in India in 1978 – at Rps 12.5 per share versus today’s Rps 2400 per share. We expect revenues to be in the order of USD 12 billion twenty years hence. This does not take into account the likely launch of the Perrier, Haagen-Dazs and Gerber brands.

Britannia: Indians eat more biscuits than anybody else in the world – about 150 per annum each; yet their market remains tiny, barely USD 1.9 billion in size. The bulk of, course, are the plain glucose variety costing only USD 1.4 per kilo (versus USD 16 in Japan!). Britannia Industries, has been the only disappointment, as last year’s decline in raw material prices allowed a flood of opportunistic, cheap glucose biscuit manufacturers to take market share. The introduction, however, of a unified sales tax across the country from 2010 will see off many of the fly-by-night producers who in this sector, as in many others, depend on tax dodging to stay competitive. The tax will free up fixed and working capital as producers will no longer be obliged to operate multiple factories and warehouses to qualify for tax advantages on a state-by-state basis.

GSK Consumer: Although the Horlicks malt drink accounts for 75% of the India business, plans are well advanced to extend this brand into nutrition bars and the like, as well as to launch the Lucozade energy drink brand.

Potential: Right now market share is, in the case of India, 12% of its packaged food (Nestle), 33% of its biscuit (Britannia), 40% of its toothpaste (Colgate) and 20% of its hair care sectors (Marico). What’s more, it is worth remembering that the market share data only refers to the “organised” sector. As consumers shift from the informal market, often equal in size to the visible sector, the overall scale of the addressable opportunity will increase dramatically. Just by holding their current market shares, these companies could eventually become global leaders.

Risks: The risks to this rosy scenario are mainly geo-political – China and India could go to war over water. Six out of seven of the region’s largest rivers originate from the Tibetan plateau, which could explain why the area is so hotly contested.

Valuation: In the old days we thought it was better to own the third player on 10x versus the market leader on 20x. Well, that was misguided. The third player invariably gets marginalised, resorting to dodgy practices to stay alive, whilst the market leader consistently surprises positively, using the cash flow from its dominant position to reinforce its brands, etc. Our men may be de-rated, but they won’t be de-railed. As brand owners, they have pricing power. Indeed they tend to push up prices faster than their costs. They don’t have debt and, if rates rise, will simply earn more on their cash holdings. Meanwhile, their customers still need to eat, drink and wash. A portfolio of dominant consumer companies is the best inflation hedge of all.

Rakesh Jhunjhunwala’s holdings as on 31st December’09

This is just a small brief of Big Bull’s holdings (bought/sold) during the last quarter.


Lupin – 79,500 shares

Titan – 1,57,000 shares

Nagarjuna Constructions – 12,50,000 shares

Rallis India – 35,000 shares

McNally Bharat Engineering – 4,80,078 shares


Punj Lloyd – 12,50,000 shares

Praj Industries – 12,50,000 shares

Karur Vysya Bank – 5,27,503 shares

HOEC – 5,50,500 shares

No change in holdings in Crisil, Pantaloon-DVR, Bilcare, Geojit BNP Paribas, Geometric and Zen Technologies.

Big Bull is selling stocks whose earnings disappoint or are likely to disappoint in the future. Punj Lloyd since its IPO has gone nowhere.

VC/PE: Small Cap Stock Ideas!

Venture Capital/Private Equity investors are usually the one who spots the emerging companies and exit with a phenomenal returns.  VC/PE, typically invest in the unlisted companies but there are investments in the listed space as well. I found 4 interesting small cap (<2000crs market cap) companies with Interesting business model and Scalability. What’s more is that these are the only listed companies in their respective segments. They have no listed peers.

Manappuram General Finance & Leasing Ltd (CMP- 651) : Provides loans on gold which is at large an unorganised segment currently. Market cap of Rs 1125crs (it will increase after the merger with its subsidiary), ROE of 30-35%, NIM of 13% and the Highest Credit rated  NBFC. Venture Capital investors hold an aggregate 32% stake in the company.

Shriram City Union Finance (CMP – 394) : It is sort of a micro-finance organization. Small ticket retail loans with shorter tenors operating in the semi-urban and rural areas. Market cap of Rs 1816crs, ROE of 20%, NIM of around 11-12% and a Strong management. Shriram Group is very popular among the VC/PE  investors.

e-Clerx (CMP – 426) : Only listed play on the KPO space. The company derives major portion of its revenues from the financial vertical. It has a market cap of 789crs, ROE and ROCE in excess of 35% and growth will be directly related to the US economy.

Himadri Chemicals (CMP -432) : Manufactures Coal Tar and plans to triple capacity and be counted amongst the top three players globally in 3 years. It has a market cap of Rs 1426crs, ROE of around 20% with a high entry barriers which leads to a certain competitive advantage.