Wizard of Dalal St: What makes Kenneth Andrade tick
"The first thing that comes to my mind when I think about Kenneth and his tremendous achievements in investing is that he is certainly India's most thoughtful and consistently successful thematic investor. I think there are a few who have the ability to think about the big theme, logically build an investment hypothesis around it and then convert it into a winning investment." This is how Sanjoy Bhattacharya, Managing Partner of Fortuna Capital chooses to describe private investor Kenneth Andrade.
Andrade's big bets Kaveri Seed and Page Industries prove how well he approaches thematic investing, says Bhattacharya.
Andrade advises investors to look for nice companies to invest in irrespective of the environment — it doesn't matter whether it is a bull market or a bear market. He claims his best performance came in when the Sensex was between 15000 and 20000.
Andrade lives by the mantra: "In an industry where margins are under pressure and in that scenario if a company is dropping balance sheet to increase sales and profitability is not there, you have got that company right."
Below is the verbatim transcript of Kenneth Andrade's interview with Ramesh Damani on CNBC-TV18.
Q: Buffett famously said once that he started investing when he was seven. Before that he had wasted his life. How come and when did you start investing?
A: The journey essentially started when I joined college and that was just out of school.
Q: Which year?
A: This was about 1985. I just about moved into college, got introduced to a couple of publications and at that point of time that was the only source of information that was available on capital market. Took the publication and correlated to my dad’s portfolio and found a lot interest between the two and how stocks moved and what information was available about those companies. That is where the journey started off.
The qualitative aspect gave you the longevity of the business, taught you how managements think, how businesses evolve over a period of time. And that is how the two things came together towards the turn of the 1990s.
Q: And did you find that what you wrote about had an impact on the number of times it was oversubscribed or price on listing, do you find a correlation there?
A: There was significantly, because at that point in time, publications had a huge mass following especially for the initial public offering (IPO) market and if you back to the 1990s or even in the mid-1980s, the IPO market was a very vibrant market. We used to have the Controller of Capital Issues (CCI) and there used to be a big mark-up on listings. So, it was a fairly profitable exercise to anyone who could monetise that entire system. And yes, the impact on price discovery by publications was huge.
Q: But, how did you make that journey from a scribe at Capital Markets to a stock picker?
A: In the 1990s, as we evolved through the 1990s, I do not remember seeing a single bull market which was sustainable over a extremely long period of time.
Q: That is the great truth, no bull market is forever.
A: But the 1990s was really an exception because you had the Asian Crisis which virtually took up a significant part of that decade. So, through the decade, you established yourself or rather, I established myself in building the breadth of a market.
Q: What was that foundation of that stock picking career? In which firm?
A: The inflection point was in Sharekhan where you had all the data and then you actually went out through recommendations and advise clients.
Q: And you had an audience.
A: And you had an audience. And well, the impact, I must say in Sharekhan was much more than I had ever seen in the decade that went by. And that got the momentum rolling.
Q: You are still young in your career in Sharekhan, at what time does Ken decide that this is a great business but I need a philosophy to guide me, when did you come up on those learning’s?
A: Money management came to me in Kotak and I think the big change in Kotak and the great, big learning curve in Kotak was when I overlooked a fund called the Kotak MNC Fund. The universe out there was just about 51 companies.
Q: Small universe.
A: Very small universe and if I could put it differently you are put into a box and you had to optimize the box and you got compared to everyone on the state and that is where the philosophy essentially came together.
Q: In the early years which companies did you spot on that?
A: I think managing an MNC portfolio for three years and looking at each of these companies fairly minutely, established the competitive trends of why MNCs over a longer term period sustain themselves compared to most of the Indian counterparts.
Q: Why is that, what is the secret sauce?
A: One, they have the management bandwidth. Two, they develop products which are much ahead so R&D and they invest a significant amount of money in people in terms of building their distribution capabilities, in terms of building their capabilities in-house and attract the best talents in the business.
Q: These companies are never cheap historically on a earnings basis, on a cash flow basis. They are always expensive. So now how do you meld valuation with your picks?
A: They are always expensive may not be the right conjecture because if I just step back a bit and look at my career in IDFC, one of my unknown picks have been GlaxoSmithKline.
Q: The pharmaceutical or the consumer?
A: The consumer company. When you purchase that company, it was at 12 times earnings. If I look at another space out there which was Bata India that was a company which was at 15 times earnings.
Q: But probably deservedly so, it had done nothing for 30 years.
A: I used to track Bata in the 90s from a bit of the sell side matrix. When you open the balance sheet in 2005, when you saw the complete inversion of the structure, you moved from debt equity of 3:1 to having cash on book and generating significant amount of cash flows. The business matrix completely changed from being a wholesale business to a retail business.
Managing an MNC portfolio, if you eliminate the top three-five companies which are obviously the most followed at that point in time, within the box if you have to optimize, the bottom end of the market was actually quite open for you. There was no ownership, the potential of the businesses were large, and they were scalable businesses and probably some of the best products that were available for the Indian market.
Q: You talked about Michael Milken, Junk Bond - 1980s but he said democratisation of capital was happening, do you see that happening in India?
A: The first phase has happened and that is just expanding itself to the smaller companies right now but I think the big changes that will happen is when leveraging the personal balance sheet actually takes place. If you look at RBI data on banking loans, 67 percent of all loans go to corporate. Close to about 14-20 percent go to mortgages. What is going into personal leverage is just about 4 or 5 percent. So, the potential for that to increase significantly on a lower base not only has it de-risked the banking balance sheets but essentially takes capital down to the least common denominator of our society because there are lot of smaller businesses down there and it is established as a fact that microfinance companies are growing at this pace.
Q: Let me get you back to 2000 which was very organised, you are in IDFC, did you feel the pressure?
A: I like what I did. There was a little bit of pressure on performance on relative comparison etc but I think the main joy of it all was getting things right, was being first in the business, was holding on it for a decade and seeing the company transform in terms of its P&L and in terms of balance sheet.. I think there was more joy than there was pressure in the entire experience.
Q: More joy than pressure?
A: Yes more joy than pressure.
Q: You are the first fund manager to tell me that. However the joy was in the markets, 2003 a great bull market had started in India, in retrospect we know that. How were you placed at that time? What made you convince that a bull market was beginning or were you convinced?
A: I wasn’t looking at it from a bull market or a bear market. Essentially I was looking for nice companies. Irrespective of what the environment is they continued to do well. So, if I can fast forward it a little, my best performance in all my funds came in when the markets were between 15000 and 20000 and that is the time the NAVs actually went up 3X. We just got the companies right.
Q: You have often said that you like investing in monopolistic businesses, how does that help you?
A: The paint segment is one industry where it has shown how a monopoly can be created virtually out of cash flows. One company in the industry accounts for close to about 70-80 percent of all the cash flows in the business and that hasn’t changed for extremely long period of time. You had it in tobacco but that was for a different reason altogether. In the initial stages you also had it in some of the pharma companies in India till fragmentation came through.
When I talk about monopolies, monopolies essentially come out from businesses which are consolidating. So, it is nice to look for an industry which is making losses and one company making a profit.
Q: The other thing that you have always emphasised is efficiency of capital. What is that and how do you gauge it?
A: One of my favourite ratios out here in terms of picking companies is market cap to sales or EV to sales. In an industry where margins are under pressure and if the company is actually dropping balance sheet to increase sales and profitability is not there, I think you have got the company right.
If a company has got no profitability but is dropping balance sheet and increasing the sales turnover you got your company right.
Q: Give me an example of a company that you found that was taking a fragmented industry, consolidating it and the balance sheet power was going through?
A: I think one of my longest holdings in my career has been a company called MRF. Interesting part of this company was in year 2002 when you actually saw the companies total enterprise value being equivalent to its gross profitability. Market actually didn’t pay any value for the rubber you purchased and over the last 15 years this entire metrics has converted. The stock currently trades at about 1.3 times market cap to sales. So, that is how the transition took place.
Q: Another stock that you have been associated with is Page Industries. Tell me about that story?
A: Fragmented industry, one company in there consolidating, has been around, return on capital employment was 25 percent. We came in 17 times earnings, at that point in time a little expensive but if I looked at them on a three year cycle you would have double profitability.
Q: Did you ever see pain in that stock or once you bought it, it kept going up, so there was no pain?
A: A lot of these companies don't do anything for 3 or 4 years. Page Industries didn’t do anything for quite some time. On listing it listed 20 percent lower than its IPO price.
Q: What gave you the confidence to sit through that?
A: If you are watching the screen you will hit the button. If you are watching the balance sheet you will probably buy more.
Q: Now when your stocks become winners, you have Page Industries which has doubled and doubled again, when do you take money off the table?
A: We go back to the qualitative part of the industry. When I say we like monopolistic businesses or we like consolidating businesses if I look at the inverse of it all I think one of the biggest successes in my career have come by avoiding the capex boom or we were virtually out of capital goods equipment, infrastructure in early 2007 and valuations were all over the place. You were getting paid for order book and not profitability. Also that inflection happened when you compare two companies, IVRCL was trading at 17 times earnings and Hero Honda was at 5 percent dividend yield.
Q: It is a no brainier to one studying the books, right?
A: Yes. So, if you looked at the price, you looked at the market, if you looked at where all the action was you probably ended up with the wrong company.
Q: 2007-2008, we talked briefly in the last segment, did you sense a bear-market of global proportions approaching?
A: No.
Q: How would you sense it though? As a fund manager, you are looking out for that or you are completely agnostic?
A: I am completely agnostic.
Q: Really, do you not feel that is lacking in your education then, if you do not marry a bull market and bear market to your portfolio allocation?
A: We look for companies that do well and that stays with it. We look for businesses that will continue to accumulate market share on the way down. And as markets go higher, we tend to move your portfolio away from the bottom end of the space and continue to migrate them to the larger companies in the entire business. So, it is not necessarily largecaps, but that is how you do it.
Q: But, history teaches us that in any bull market, when it ends, stocks go down 30-90 percent sometimes. Are you not scared at that time that even your best companies will give up their gains?
A: They do at points in time. They give up their gains, but they do not close down.
Q: What would raise the red flags for you?
A: Leverage. Any business which is leveraging itself up, in think that is something that we have stayed away completely from.
Q: But in this kind of low interest rate, high debt environment, leverage, a lot of companies have used a lot of leverage and why should they not? Money is given so cheap to them, why should they not leverage up?
A: What we tend to forget at points in time is that cheap money is available but capital is still scarce, because the guys who leveraged in the last cycle still do not get the same amount of money that is there. If you have seen that in the 1990’s where you had the metals and the commodity companies leverage up, we have seen that in the infrastructure companies actually leverage up, we have seen three sugar cycles, probably the worst industry to ever leverage.
Q: Boom, bust, boom, bust, boom, bust, yes.
A: At the end of every sugar cycle, the guy with the highest debt has actually gone down. Leverage into the cycle and leverage on top of the cycle and collapsed. If you see the commodity plays at this point in time, every balance sheet is leveraged 2x. The leverage came on when commodity prices were exactly double that, double from they are here.
Q: What are the qualities that you think are necessary to be a good fund manager.
A: I think eliminate the noise because the markets will push you to do a lot of irrational things.
Q: So, at the end of the discussion, through your careers, distil your wisdom down for me. What is the Kenneth Andrade investing philosophy?
A: I think be early in a cycle. Look the other way if you do not understand what it is.
Q: It is okay to ignore stocks?
A: Just ignore stocks. I have not got an idea of pharmaceuticals, but that has not stopped the entire investing process.
Q: And do not waste time on the macro stuff too much?
A: I would not waste time on the macro stuff. I mean you have to identify where your skill sets are. My skill sets are not macros. My skill set is buying a good company, watch it grow, participate with it over multiple cycles into a downcycle and if you get a downcycle, it is even brilliant.
Q: What we do, we are trying to wrap up the show, we will do a rapid fire round with you. It should be fun, so tell me the things that come to your mind. Sensex 50,000, buy?
A: 2021.
Q: I will give you a pair of names, pick one. Elon Musk or Warren Buffett, dinner with whom?
A: Elon Musk.
Q: Paul McCartney or Bill Gates?
A: Paul McCartney.
Q: Next on your bucket list, a place to travel?
A: Iceland.
Q: Tesla?
A: My dream car.
Q: You have electric cars right? You are very fond of electric cars, I am told. The Beatles?
A: A Hard Day’s Night.
Q: Favourite song. What is your favourite book on investing?
A: Peter Lynch – Beating the Street and One UP the Wall Street.
Q: The company that you admire most in India?
A: MRF.
Q: The company that you most admire in the US?
A: Google.
Q: The most important number to look for in a balance sheet is?
A: Cash flows.
Q: Who is the best investor currently in India?
A: That is a difficult one.
Q: That is why I asked you.
A: Lots of them.
Q: Best investor globally?
A: Warren Buffett by far.
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