MC Interview | This fund manager believes ITC should be trading at Rs 200

What is your current market outlook? Do you believe the Indian markets are overvalued?

Our markets are about two standard deviations above the long-term average. Look from a macro-economic perspective. There's a war raging on with uncertainty in oil prices, there’s churn in fiat currencies, and volatility in the dollar index. In the US, the yield curve has not been as inverted in the last 40 years as it is now. There are a lot of unknown variables in the global stock markets and a bad news might come any time soon.

So, are you sitting on cash right now?

Yes. Overall, we are sitting on 10-15 percent cash. But in some accounts, we are almost 80 percent in cash. These are clients who joined us in the last six months.

You don’t believe India has decoupled from the global markets, do you?

If India has truly decoupled, then why are we discussing US interest rates and Fed commentary every other day. So no, it has not decoupled. But, I believe, it can happen in the next 10 years. India’s young demographic and economic prospects give us 20-25 years of growth runway.

However, a robust equity market can only be sustained when there’s ease of doing business. And for that, contract enforcement is key. People need to be held accountable if contracts are not being honoured.

Last year, ITC had slapped a defamation lawsuit against you. It is the best-performing Nifty stock this year. Do you hold the stock in your portfolio?

I still hold a large chunk of ITC in my personal capacity. That allows me the opportunity to voice my concerns as a shareholder. However, MRG Capital has negligible quantity of ITC shares as a percentage of total assets.

What are these concerns (against ITC)?

I believe it's a great company. But the company’s long-term strategy and capital allocation policies leave much to be desired. As a shareholder, I hope that my logic and data-backed opinions help them put their house in order.

Their cigarettes business is a cash-generating machine. But most of this cash is being used in the FMCG and hotels businesses, where EBITDA margins are in single digits. Meanwhile, ITC's FMCG peers Britannia, HUL, and Nestle are operating at 20+ percent EBITDA margins. Similarly, IHCL, and Lemon Tree have ~40+ percent EBITDA margins.

ITC should stick to its core business and not destroy any more capital. I believe, the stock is overvalued right now.

What is the stock’s fair value at this point in time, in your view?

With its present EBITDA profile, the stock should trade at ~Rs 200 levels.

Why then do you still hold ITC ?

If the house is put in order, with serious changes being implemented in the near future and the elusive demerger of various subsidiaries done, the stock could go up to Rs 1,000 in four or five years.

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Let’s talk about Infosys, the stock which has the highest weightage in your fund…

Infosys is still managed and very peripherally overseen by the founders. They still love their company. The company generates copious amounts of cash and gives out copious amounts of dividend. What more could a shareholder want?

After the 2017 Vishal Sikka crisis, I think, the stock plunged to Rs 700 apiece. Analysts said ‘Sell Infosys’. Instead I took a loan, leveraged myself and invested 30-40 percent of my wealth in the stock. Following that, there was a 1:1 bonus issue. Essentially, the stock has risen from Rs 350 apiece to Rs 1,600 in less than five years. Not bad, no?

Do you believe Infosys should be commanding a premium over TCS?

Of course, and there's a logic behind it. Since the last four or five quarters, Infosys’ profit margins are better, operational leverage is better, and cash pay-out to shareholders is better than TCS. There’s no reason why TCS should have a 4-5 percentage edge over Infosys, when it comes to P/E valuation.

A large part of Infosys’ revenue comes from its banking solutions software -- Finacle. Almost all banks in India and many banks world-over use it. Changing a vendor, in this case, becomes difficult. So, that’s where the stickiness of revenue comes from.

So, I don't see any existential threat in Infosys. But the second-best choice or an equally good choice would be TCS.

Also Read: India is fortunate to have large amount of population scale systems generating data: Nandan Nilekani

Tata Chemicals has the fourth-largest weightage in your fund. Of all the Tata companies, why this?

After TCS, Tata Chemicals has the healthiest balance sheet in the Tata group. The debt on Tata Steel and Tata Motors’ books will never allow me to buy those stocks.

Tata Chemicals is one of the biggest soda ash manufacturers. Soda ash is used in the making of soaps, glass and cement. Plus, they are expanding their capacity, and Tatas’ corporate governance is unmatched. It is a no-brainer stock, trading at 11 P/E. You can’t go wrong with that.

As a fund, we invested a large part when the stock was at Rs 350-400 level. Now, the stock is above Rs 1,000. Sometimes, you just need a boringly amazing company to keep doing what it does best.

So, at this point in time, do you still think Tata Chemicals is undervalued?

Well, it is reasonably valued. As and when soda ash prices spike, the company will clean up its balance sheet. I feel Tata Chemicals will be a Rs 3,000-stock in the next five years.

ICICI Securities is another heavyweight in your portfolio. What is the rationale for that?

Our fund has the biggest exposure in Infosys, ICICI Securities and Tata Chemicals. We keep juggling these three in our top holdings.

Coming back to ICICI Securities, there is no counterparty risk in the broking, investment banking and advisory business model.

Second, only 3-4 percent of the total population of India is invested in the stock market. In the US, 52 percent of the population is invested in the stock market in some form or the other. The potential to grow is immense. ICICI Securities is truly reliable for online initiation of first-timers in the stock market.

The company is into investment banking, it is underwriting IPOs, and it has a wide product portfolio. I believe, it has the potential to become the Goldman Sachs or JPMorgan of India. In other broking platforms, I see practices being followed that are not in regulatory compliance.

What about Zerodha?

If it was listed, it would have definitely been a part of my portfolio, because they too don't have a counterparty risk. They are purely into brokerage and lending. And, they have really grown very well.

Finally, do you have a Nifty target?

There are only two people who know the Nifty target. One is God. The other is a liar. No one knows where the markets will go.

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