Fund manager's hits and misses from Q1 earnings

In an interview with CNBC-TV18, Rajesh Kothari of AlfAccurate Advisors talked about the hits and misses from the first quarter earnings season, including Bajaj Finance, Shree Cement and Infosys.Kothari is the Founder and MD of AlfAccurate, whose AAA India Opportunities PMS Fund has delivered 240 percent returns since inception (till March 2015), compared to 66 percent for its benchmark.Below is the transcript of Rajesh Kothari’s interview to Sonia Shenoy and Anuj Singhal on CNBC-TV18.Anuj: Let us start with a company which keeps coming out with good numbers quarter after quarter, but there is a lot of debate about its valuations, Bajaj Finance. How would you approach it now?A: Definitely, it is a big hit during this quarter with a stellar performance of 40 percent plus growth in book and very strong net profit growth. One of the most important thing for Bajaj Finance while the company keeps growing at a very robust growth, the asset quality has been maintained, that is number one.Number two, the equity dilution probably, it may not happen till fourth quarter of late of FY18, so equity dilution is sometime away, that is the second important thing. Third most important thing is the cross selling which Bajaj Finance is probably one of the expert of doing cross selling and that keeps pushing the return on equities (ROE) to new highs. And fourth, last but not least, the cost to income ratio, the way in which the management has given the guidelines on cost to income ratio, it seems that there is still some more room to improve this cost to income ratio probably by 100-250 basis points over the next 1-3 years. So, company is definitely a very strong growth company and we are still maintaining in our portfolio. Having said that, you are absolutely right. The valuations have moved up significantly in the last 1.5-2 years. And therefore, we are right now, not adding at current levels, but we are holding on to our existing positions.Sonia: In your hits and misses list, the other big hit for you is Shree Cement and this has been a part of your portfolio as well. But here too, a lot of the money has already been made. At these levels, do you still see wealth creation over the next 2-3 years?A: Even Shree Cement is just like a case like Bajaj Finance. It is one of the differentiated companies within its own cement universe probably with the lowest cost per tonne. If you look at the earnings before interest, taxes, depreciation and amortisation (EBITDA) per tonne of Shree Cement in this first quarter, probably in highest in last four years if I am not wrong. FY12 to FY16, this is probably one of the best first quarter ever in terms of EBITDA per tonne. Shree Cement, like Bajaj Finance, has a very strong operating matrix, lowest cost per tonne, lowest incremental capital expenditure (Capex) cost per tonne which is very important. The next wave of capital expansion which Shree Cement is doing probably close to about 15 million tonnes over the next two years or so is going to come at around USD 65-70 per tonne versus most other players, industry average which is probably about USD 110 per tonne in terms of the Capex for the incremental capacity.So that also means that going ahead, not only next two years, three years, but probably going 3-5 years at least, the cost per tonne will remain under control, because depreciation will be lower, interest cost compared to industry average will be lower, while cement demand and cement pricing is depending definitely linked to overall economic cycle, the operating cost per tonne, depreciation in interest cost per tonne is going to be the best in the industry. And therefore, like Bajaj Finance, here also valuations have sky rocketed, probably right now it is trading at close to USD 300 enterprise value (EV) per tonne on FY18 basis. It is surely very high and it is no more cheap compared to three years back when we bought at close to Rs 3,500. So, we are holding on to Shree Cement in our portfolio and it will continue to create wealth over the next 2-3 years.Anuj: The stock of the morning, at least not in terms of the price behaviour but in terms of mind space is Infosys. Of course, the earnings were a bit of a mess, but now we are starting to see some more accidents, this Royal Bank of Scotland (RBS) contract getting terminated. Do you get a sense that the stock will see further derating or do you think all the bad news is in the price now?A: If you remember from the last two and half years we have been seeing that information technology (IT) and healthcare are the two sectors where we are basically becoming a little bit cautious from the last 1.5-2 years. However, having said that, we are holding Infosys in our portfolio and probably we thought that Infosys was one of the few ones which will able to move to the next level without much hurdles in earnings shock. But unfortunately, post this Brexit event, even Infosys is going to bear some pain because of this. Having said that, yes, it remains on a strong wicket from the longer term perspective, but short-term definitely, FY17 revenue as well as earnings after one guidance cut already in the first quarter, probably there is a possibility of a further revenue and earnings cut for FY17. The market is becoming very volatile for these kinds of companies. And right now, the certainty to predict the revenue growth probably even from the management perspective, it is not probably very healthy. So, it is going to have some pain at least for next couple of quarters till the time the management gets clarity on overall how the IT spending is going to behave probably for FY18 and FY19. And till the time I do not see any significant probably upside in the short-term for IT sector in general and probably even for this company in particular. But if you have a 3-4 year view, then it is a solid company.Sonia: The other miss from your end is Dr Reddy's Laboratories. That stock has fallen quite a bit though. It has already gone from Rs 3,600 back to Rs 3,000. Do you foresee some more price erosion there? And at any point do you think Dr Reddys becomes a buy or do you think there are better opportunities in the pharmaceutical space?A: We are being cautious on healthcare and we do not own Dr Reddy's for quite some time, because we believe that the regulatory clearance and the opportunity cost and the cost for meeting regulatory compliance is going to increase significantly for the entire space.So, while yes, the price decline has already happened but it is not a valuation decline because earnings per share (EPS) cut has been sharper than the price cut. Another 2-4 quarters, we think that entire sector is going to go through this pain from meeting compliance norms and losing out on opportunities because till the time you cannot launch a product from that particular plant and more importantly, there are many one-offs in capitalising opportunity. If your plant is not allowed to export, then you lose those one-off opportunities, which are huge in terms of your earnings build-up. So, it is going to take some time for healthcare space and therefore, we are extremely underweight on this sector from quite few quarters from last 3-4 quarters.