What is Kenneth Andrade doing as market makes a U-turn to euphoria?

“We have not done any significant changes to the portfolio. We are still fairly oriented towards commodity, capex and export linked sectors. Domestic revival has come through and it has been a reflationary trade. So whatever did not do well over the last two years has started doing well over the last six months,” says Kenneth Andrade, Founder & CIO, Old Bridge Capital.

This year we have seen it all; first there was an euphoric start, then came fear and then a reminder that equities could be volatile. Just when they turned volatile, they managed to bounce back. What is in store in the second half?
It is a bit of an interesting year but whatever is happening is expected because quite simply, we had two great years leading up to 2022 and this correction was more or less expected in this cycle. That is what we have got and we are trading fairly where we left off at the beginning of the year. That is how I think the market will move over the next couple of quarters. The data points are quite simple, they are very macro linked and there is inflation and deflationary pressures and we have to see how the central banks globally address the issue. All of that is happening out there.

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Where are you picking your spots now? Is it time to align with very simple commodity consumers? Is the entire cycle in commodity producers, energy, oil behind us?
The peak is behind us for sure but our portfolios or our thought processes/corpuses are consistent. I would not call it an inflationary cycle, a cycle where basically prices of commodities will remain elevated because we are not going back to the previous near normal, where we had large exporting countries across the world exporting deflation. That has come to an end.

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We have got new trade norms and within those trade norms, prices of everything that were deflationary for almost a decade will have some kind of pricing power going into the remainder of 2020s to 2030s.

You always believe in buying stocks which are either in a linear cycle or stocks under stress. Let us identify these two pockets; one where you think that irrespective of the macros or the global positioning there is a compounding linear cycle at play and where do you think there is stress where you are treasure hunting?
Quite clearly, the sector that does not favour us in terms of valuation but has enormous amount of visibility as far as the macro environment is concerned is tech – IT services. Despite whatever is happening across the world, everyone’s capital expenditure on IT and IT services is going to expand and sustain IT services for an extremely long period of time.

If you look at IT services and look at the data, everything that comes under IT services will be linked to the domestic cycle as this industry would be one of the largest employment creators with an inflationary wage bill.

So the top five companies by the end of 2022 cumulatively will require more than 200,000 people and all of this is coming at inflationary wages. The deflationary spending cycle linked to this industry is fairly robust. But I am already conscious as to what valuations some of these companies are traded.

The second extreme of this is also a company which is built into the global economic cycle, but has got very large international footprints which is pharmaceuticals.

So except for Covid, in that two-year period, this industry has been on a down cycle for almost seven years now. In 2015, it was at its peak but it has been on the down cycle for almost seven years and it has fairly consolidated. So most of the Indian companies or all the Indian pharma companies have very robust balance sheets and their product portfolios are significantly higher or larger than 2015. The only challenge to them is that they are working in an environment where there is enormous amount of pricing pressure on their end products. So they have no pricing power as far as those companies are concerned.

But despite that, we are getting them at valuations which are significantly better than 2015 or any time in the last five years. Those are the extremes of businesses; one is linearly doing extremely well which is IT and pharmaceuticals which has not done very well, but offers some value still and still has a macro opportunity which is significantly larger than the previous peak.

We have spoken about IT. You told us about pharma which is still not doing so well. Do you think there will be a new normal now in this bull run? What about banks?
Banks are going through a valuation cycle. You are getting them at a price point which is significantly cheaper than what you have seen for some time and that is something which is attractive for the couple of years or shall I say at least for the next one year. That is the trade out there.

Structurally, we will have to wait and see how the environment actually plays out. So when you look at this industry, it is down to probably five or the six banks that are there out of 30 odd listed banks that are there in the marketplace. They can be a part of your long-term portfolio. That is the way we see it. Now that is not where we are participating in a sector.

There is going to be more stock picking within that industry. So one can pick and choose but this time around, the balance sheet growth will be led by a capex cycle and an inflationary cycle. Why are these two interlinked with each other? When you go through a capex cycle or when you go through a commodity cycle, the asset price actually increases. So if you are putting up a plant or steel plant today, it will cost you close to about Rs 7,500-8,000 crore per million tonnes. That is the new normal cost.

From January, euphoria turned to absolute fear in June and we are now starting to see euphoria again. We are 4% away from an all-time high. Broader markets still have to play catch up. When the valuations were much lower, what kind of big changes did you make in your portfolio, if any? What did you add?
Actually not many. We have not done any significant changes to the portfolio. We are still fairly oriented towards commodity, capex and export linked sectors. Domestic revival has come through and it has been a reflationary trade. So whatever did not do well over the last two years has started doing well over the last six months.

The ones that did not do well were obviously IT, pharma which continues to drag and commodities, reasonably weak at this point in time. We still believe that our portfolios are still very much positioned on the capex, manufacturing, export oriented part of the entire economy. We have relatively low exposure to the consumer credit and to any business in the financials.