(Anti) Consensus

There are so many investor letters/blogs these days – domestic and foreign – that I am really not sure how anyone can keep up with the latest and greatest in this area. But themes across most of these letters and blogs remain consistent enough that nothing new can be spoken of an art as old as investing. But in these days (and year?) of low market returns, frustration is also yet another common theme that I’d like to introduce as a leading thinker in banter. Therefore, treat this post as ramblings of a frustrated investor, looking through some of the common themes in these investor letters/blogs.

1) “We continually look for scalable opportunities and opportunity is expanding…” – I don’t know if you are a visionary, but I am – and with my vision I can say that there is no investor in the world who are looking for opportunities which shrink/shrinking (unless the price is so so cheap, that the shrinking business is also worth something along with cash on balance sheet). Every investor that I have come across atleast dreams of investing in a small cap that goes onto become a large cap. If visionaries and leading thinkers like me can’t understand why this ‘scalable opportunity’ thing is written ad nauseam in every investor letter, then how will the small investor understand.

2) “We continually look for mispriced opportunities..” – Like, who doesn’t? Like who in their right mind (except mutual funds) and take investing seriously look for fully priced opportunities? Like the wise old men have said, ‘don’t double count’ – if it’s at greater than 35-40PE, then fully-priced; if it’s at 12-20PE, then ‘mis-priced’; if it’s 7-12PE, then ‘dis-priced’; if it’s 2-7PE, then ‘ill-priced’. The defense to such blabber seems to be that PE ratio doesn’t capture the full ambit of cashflows that the business is going to generate – and we are the only ones that can identify this. First of all, like really first of all, nobody knows how to calculate cashflows (everybody adjusts earnings and ebitda and do some random approximations and call as cashflows). Second of all, unless you are in the kicking-can-missionary business, in a fairly robust market like India, PE is a decent approximation (other than exceptional scenarios like Covid/Demon). Visionaries like me can clearly see that most of the guys writing the letters ask for the PE multiple first/look at the chart and then dig deeper into the business. ‘Start with As..’ is basically starting with Amrut Fusion.

3) “We are neither value investor nor growth investor…we don’t like getting labeled as any particular type of investor” – Also, called ‘we are opportunistic investors’ by the more sophisticated junta. The other variation that I personally use liberally with all novice investors is that ‘value and growth need to be joined at the di…hip’ and appear as a visionary to the fools (which obviously is more important than being a visionary). I have no idea what the statement means. It probably means, that I will invest and depending on the return an idea generates, I can justify that I am value also, growth also, visionary also, kicking-can also. If it doesn’t generate a return, then I can call ‘we made a mistake’ and move on with life. AUM is anyway sticky, so why label oneself as a certain type of investor and invite unnecessary and incisive questions from the fools.

4) “We could see that the opportunity could expand in the next 10-15-20 years” – This is usually written/said by older investors (by age) where they were in this insane opportunity period in which explosive returns were made. I am firmly of the belief that ‘great investing returns % is a function of when one is born, good investing returns % is a function of luck, average investing returns % is a function of following an investing process and bad investing returns % is a function of investing in either fraud/debt’. Look back, and it is probably true of every asset class. Your neighbour uncle who couldn’t multiple 3 x 4 bought 30×40 land parcels on the real cheap in the late 1990s (because he had the privilege of being born in 1970s and having disposable income by late 1990s), and now is a multi-crorepati touting infinite wisdom of his vision of how he could see the city/district/country grow. Equity investors born in 1970s and who had disposable income in late 90s-early 2000s made returns %s which you or I will never be able to make in your lifetime. And hilariously, and given the demographic decline across the world, our kids will probably never see returns % like us – maybe 20-30 years later, they would be competing between 8% return and 10% return. These multi-stellar returns that the older investors made or the decently good returns that our generation has made in the last 10-15 years has nothing to do with things like vision or some crap like that – it was just a matter of ‘staying in the game’ and ‘avoiding fraud/debt’.

5) “Our investing process…” – I basically skip the paragraph where this is written, essentially because everyone writes about mispriced opportunities, large scale of opportunity, management integrity, improving return ratios/balance sheet strength and crap like that and none of the insight. And as individual investors, why are you even bothered about things like investing process when the idea is to continually look over multiple businesses and position size rightly in where you think good returns can be made. I personally believe our individual personality and thinking/traits has an outsized influence on the eventual investing process you land on. Like, I can’t understand for the world, why any small investor would take positions in 30-40-50000 cr market cap companies as an entry position (if it has grown to that market cap from a smaller market cap when you had invested, you’d obviously not be reading this visionary blogpost but be spending time in Goa). Churn is good process, buy and hold is good process, buy and sell is good process – like, I really go numb when people start talking about investing process. Strangely, no one is investing in compressing businesses, or fraud management or fully priced opportunities – no investing process speaks about investing in such opportunities – but majority of MFs and PMSes underperform the index. Hilarious. And then they write about ‘oooo..battle scars’, ‘we admit that we made a mistake…’ etc. etc.

The End. None of the above is applicable to me of course, because I am a visionary investor, and my investing is multi-strategy, multi-cap, multi-year and eventually multi-amazing obviously and that you need to measure me not in the short term, but long term, so long a long term that even long term doesn’t believe it is long term.

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Forced Stockholm Syndrome

Portfolio pe to paisa nahi bann raha, to global gyaan hi sahi.

Everyone who has traversed through the Behavioral Finance twisted forest would have come across the term ‘Stockholm Syndrome’. Just in case you were lucky enough to escape the Behavioral Finance hydra learning onslaught that happened a few years ago (think of it like the “pharma/chemical onslaught of 2020-22”, but worse because you didn’t make any returns), Stockholm syndrome is named for a bank robbery in Stockholm, Sweden, in 1973. Four people were held hostage by the robbers for six days; when they were rescued, the hostages attempted to protect the perpetrators, with whom they had an amicable relationship.

In our case, it is a forced syndrome because of the direction the Budget has gone by for investors of India (not ‘in India’, it is ‘of India’ – ergo, citizens/individuals of India). Of course, I will rate the Budget 11/10 (or we can also rate it 91/10 to make it more contemporary with cricketing terms), but let’s look at the direction of taxation travel objectively:

1. Old Tax regime vs New Tax regime: The number of papers that have been wasted, inks that have been spilt, twitter threads which spanned infinity and the number complex flowcharts drawn which would have made your computer professor proud on this regime vs regime is just incredible. The summary, ergo the direction of this regime vs regime and the prodding towards new regime is that the Govt. is essentially saying you spend the money (don’t bother with all those pesky income tax sections on saving) and we will collect taxes
2. MLDs: All the wealth firms in India have cried hoarse privately that it has resonated into a Pathaan level blockbuster of tears, but essentially, the direction is that all sorts of tax arbitrage instruments (either existing or going forward) will be rationalized to be taxed at marginal rate and will move to whatever regime will get us more taxes. This is even better because we will collect taxes deducted at source
3. TCS: No, not your good ol’ friendly neighbourhood firm Tata Consultancy Services. This is the other TCS (taxes collected at source). Previously if you wanted to expand your exposure to international markets, you could do so by paying a tax of 5% TCS for amount beyond Rs. 7 lakh and claim it back while filing for your income tax. Now, it is 20% TCS – you can still claim it back while filing for your income tax but that’s quite a massive blockade of capital impacting your IRRs (given the timing difference between TCS and eventual filing of return). The direction is, we want you to invest more and more directly in India – and if you want to invest in international markets, we will collect taxes (MFs/ETFs investing in international markets via INR exposure is still not under this ambit – in that sense, there is a tax arb – but hey, we are all Sir John Templetons here who will want to invest in international stocks directly and not those pesky MFs/ETFs). And what’s more, we will not even let you enjoy your overseas tours because we will collect taxes at TCS via this route.
4. Market buybacks vs Dividends: Dividends have already been plugged, by adding to your income and taxing at marginal rate. Unfortunately, there is not much left there. However, investors are now clamouring for market buybacks – because clearly there is a tax arb – for the same amount of money, a shareholder can make better % returns via market buyback than dividend distribution. But hey – the US of A recently enacted The Inflation Reduction Act provision levying a 1% excise tax on the market value of net corporate shares repurchased starting in 2023. Now, if there is one thing that all countries across the big table agree on, is to implement the best and leading practices of how to collect more taxes. Of course, there are 1000s of rules in India today that a corporation has to satisfy before it does a market buyback – but if this buyback due to tax arb clamor by investors becomes a trend, expect a radically new provision in the Finance Act by implementing the best practices from US of A to ensure we will collect taxes.

Now, the common theme running across – and essentially the direction of taxation travel – seems to be ‘we will collect taxes’. This is frustrating, right? But why is this a Stockholm Syndrome? Well – you might be frustrated, exasperated, defeated, infuriated, discouraged, angered – but the underlying nature of the problem is “tum kya kar sakte ho?”. The answer is broadly “ghanta, kuch nahi kar sakte” – if you run towards debt, there is TDS; if you run towards international markets, there is TCS; if you spend more, there is GST; if you spend less (and save more), there is TDS yet again; even worse, post vote to account in 2024 and come budget of 2025 (irrespective of the party), if STT increases, or LTCG increases or STCG becomes marginal rate, what can you really do other than Twitter andolan? If you andolan more, suddenly a EEE scheme will become EET and then you will have to do (andolan)-cubed in a cubicle.

So, if you can’t beat them, join…err..love them. Think of how all the taxes at every digital footprint, every digital transaction, at every digital buy/sell, at every overseas tour you take gets spent on beautiful infrastructure, roads, upliftment of the rich and downtrodden agricultural farmers and learn to love the Government for its well thought-out, comprehensive and incisive taxation regime and taxation direction of travel. If the Stockholm people fell in love with their perpetrators within just 6 days, we are here for another 60 years – we have to have our own advanced version of Stockholm Syndrome, and must love the Government for it – we are after all a ‘of the people, by the people, for the people’ proud nation.

P.S: Of course, you might think that you will shift to other countries and live a lavish life of low taxes. Unless you are from Mars, you will realize that most developed countries tax higher than here on most things. So, eventual tax% is very similar across countries.

The ‘Trishanku’ Year

–personal post and looonng post. Nothing to do with investing. Please skip reading if you are here to decode how to gain in the lost decade for equities.

In the Hindu folklore/mythology, there are different authors of The Ramayana, of which ‘Valmiki Ramayana’ is the most famous. As the name suggests, Sage Valmiki wrote, what is thought to be, the original Ramayana story.

In this ‘Valmiki Ramayana’, there is a very interesting story about King Trishanku who wants to ascend to the heavens (‘swarga‘) in his physical form (when alive), which is prohibited. After Sage Vashishta denies him, and Sage Vasishta’s sons curse him, he is banished from his own kingdom. He eventually seeks refuge with Sage Vishwamitra (who is jealous of Sage Vasishta) and decides to help Trishanku and uses his sagely powers to send Trishanku in his physical form to the heavens. A fight ensues between Indra (the king of Heavens) and Sage Vishwamitra and eventually settle on giving Trishanku his own Heaven in between Earth and the actual Heaven. Of course, this in colloquial Hindi is also called ‘latka ke rakhna’ – which in regular Indian discourse is the norm where we convert deep mythological stories/meanings into a simple local language colloquial everyday form. That’s how we roll.

This year 2022, then, was a Trishanku year for me – between heaven, hell and everything in between.

Heaven – At first, there is ‘paapa ka sapna’ which is Engineering and then there is ‘MBA ka sapna’ which is reaching a leadership position in a large organization. ‘Paapa ka sapna’ got done long long ago, so long ago, nobody remembers how long ago, and post that, Paapa really stopped caring what I do with my life 🙂 ‘MBA ka sapna’ got done this year and this update got posted on Twitter earlier this month.

Of course, I should ideally be writing about top 10 leadership lessons for this year given the above happened, but needlessly and uselessly writing about this Trishanku year. The key takeaway though, after so many years of consulting and investing is that, a.k.a Buffett, I have been a better management consultant due to investing, and a better investor due to management consulting. Management consulting teaches a lot in terms of due diligence, asking the right questions, skirting the obvious answers, getting to the heart of the problem, trusting or not trusting people, building a team which has mutual respect and ownership, P&L ownership, how difficult scaling is, how incredibly difficult expectations vs reality is, and how large the gap between strategy and execution really is amongst many many more. Obviously, there is no perfect answer or a perfect solution to anything and there is nothing which is 100% true all the time – so, I am more unsure of my “leading thought leadership” articles/talks than when I passed out of my MBA.

Making a Partner in a multi-billion dollar firm was a very special feeling. It was an insane struggle to get there juggling between career, family and investing, and therefore, to earn a place on that leadership mountain truly felt like Heaven. Does it really matter in the long run? Nobody knows and nothing really matters in the long run long run, so just sitting back, relax and enjoying the feeling, however fleeting it might be.

Hell: Hell then, is finding out that your Paapa contracted cancer. Thankfully, detected at Stage 2 in the Esophagus region. He had difficulty swallowing, and what was thought to be a routine fungal infection turned out to be cancer.

It was devastating at first to learn about it, but then it got worse. We realized that cancer per se can be treated (to a large extent these days with chemo and tomo), but the after-effects are very very debilitating. He is 75 now – he was a state government employee in the revenue department and he routinely walked about 20km/day surveying various fields and crops as part of his job till he retired at 60. Post the cancer treatment in the last 4-5 months (palliative was not an option, given swallowing food would go for a toss without the treatment), now he is not even able to walk 200m without a crutch – which probably breaks his heart. The physiological, psychological, food and medical habits and behaviors have changed to such an extent that it’s a constant struggle to keep him motivated – putting a strain on the entire family. So, Cancer per se is not the issue – but everything affected and surrounded by the Cancer issue is the real issue 🙂 We have seen marked improvements in the last 2 weeks, which gives me strength to write this, so hopefully the worst has passed in this hellish phase of life.

We are living with our parents since we returned from US about 10-11 years back and therefore, to see them day-to-day progressively losing strength is quite painful. From a distance, say living in the US, its great to have a iPad video conversation and they will obviously tell you only the good things in life on the video – but day-to-day living and breathing especially with difficult health conditions is difficult. It’s like saying we are going to have a lost decade for equities – which may eventually happen or not happen – but to live through that day to day is a completely different perspective (and you are 10 years older 🙂 ).

Thankfully, the wife has been super-supportive and love has been all-encompassing to pass through this phase of life. Enriching experiences and all that, but it would have been more enriching without the cancer 🙂

Everything in-between: Then, the markets. Uh oh the markets. Like every other year in markets – everything happened and nothing happened. Some stocks worked, others didn’t and the portfolio for this calendar year did ok (definitely not great like last year). Markets, given their returns over the past few years, have obviously become more competitive with a ton of smart players getting in. You have stocks which you know will mostly deliver very good earnings over the next 2-3 years but are already at 40-50 PE. Then you have stocks which are cheap (and 5-15 PE) but have some or the other issues (either promoter-led, or cyclical-led, or export market structure-led etc.). Then again, you have other stocks in raging theme (e.g., defense) where a 3-4% EBITDA margin player get 50-60PE just because they are in a theme.

Essentially, you don’t know what to do – the stocks which you have (don’t want to sell because you see good earnings, but they are already at a decent PE and therefore upsides are limited), the stocks which you don’t have (don’t want to buy because promoter-this-that, US market consolidated-this-that, raging theme-high PE-this-that). Nobody is scared of Covid (China, anyone), nobody is scared of currency crisis / debt-GDP (Turkey, anyone), nobody is scared of money printing (ehm, look at portfolio cagrs over last 10 years), nobody is scared of FII selling (lol, retail/SIP buying!), nobody is scared of leverage in the system (Credit Suisse lol, and SEBI amazing) and finally nobody is scared of crypto ripple effect (RBI amazing). Given all this nobody-cares-nobody-scares theme, the portfolio is also kind of stuck – latka hai – which is basically back to the main theme of Trishanku.

In summary then, across career, life and investing, this was a Trishanku year.

Wish all you folks a very very happy new year, and may your porfolio reach the heavens in 2023 and we move on from the Trishanku year!

Meet the older one, not the younger one.

This is going to be a short post. More as a reflection, than any insight about investing.

I recently met my uncle and aunt as part of some family function a few months ago – they had met me after 20 years. The way they were talking to me – it almost felt like they were treating and talking to me like a young kid just out of grad school – it was endearing as well as frustrating at the same time. I am 39 (going on 40) having grown (de-grown?) in worldly experience, and they were pulling my leg as if I was still that bumbling 20 years old.

A very similar thing happened when I met my first boss / mentor a month ago (who had a phenomenal influence on the way I work today) after 15 long years. It almost felt as if I had never left – the way he spoke, the way he bought lunch for me, the way he treated me – he still saw me as that young analyst who, on his first day at the job thought he knew everything, but didn’t know shit in reality.

I am not sure if any of you felt the same way, but this episode repeats across a wide variety of scenarios. You meet people after a long time, and they cannot really place you for the person you have become – good, bad or ugly – but can only relate to what you were when they last saw you. It’s kind of a photograph-in-time feeling and they have a very very hard time seeing beyond that.

I was recently looking at a stock that I had sold off 7 years ago. Of course, like all good investors, I also claim that I read ARs every year of all businesses I bought/sold previously – but let’s reserve such utterances for public appearances. I didn’t know what happened to this business post I sold (other than broad numbers which is easier, thanks to screener). Here is a business that I knew previously and I thought it’s a short jump from there to understanding the business in entirety in a day or two. As I kept reading ARs one after another, I had a very very hard time reconciling what I knew about the business before, and how it has taken steps – good and bad – to become the business it is right now. It was just insanely difficult to put on a fresh pair of eyes, with fresh thinking and treat it as a completely new business that I didn’t know and learn – I was still being prejudiced putting business steps in stupid buckets that I knew from before.

“Investing is 90% psychology, 10% intellect” etc., is all psycho-babble because anything and everything that you do in investing/trading can be attributed to psychology while investing is predominantly predicated on odds and luck. However, the issue with investing (and life in general), is that what you think you know is not really what exists in reality – whether it be your kids, someone else’s kids, or the stocks you bought/sold in the past – need a really fresh pair of eyes and thinking for a reality check.

The end.

Incremental execution

So, welcome to 2022 and all that. Even if you don’t welcome it, time will pass by and incremental years are inevitable (if one continues to live that is). So, you might as well welcome it for the sake of positive energy and all that.

Anyway, too many “10 ways to buy the dip”, “100 books that I read in 2021”, “1001 things I achieved in 2021”, “1 million things you can learn from the 2021-me” twitter threads aside – my personal learning is that I have increasingly found implementation of incremental learnings in investing execution incredibly hard.

1. Buying on the way-up: For example, one thing that I consciously tried to do (and it makes logical sense in every possible way – you don’t have to read a lot of books for this) is to incrementally buy more as and when the company delivers numbers / business model improves. For the past 10 years, I have always been the “buy at one low price and pray to Mother and Father God that I am right” kind of investor. Early in 2021, I kinda realised that’s the stupidest thing that I probably have done in the last 10 years (and it’s not the praying bit – that still continues – only more types of Gods have been added). Why not continue to average up (in price) when business model / numbers / competitive dynamics keeps getting better over the years? It’s purely logical – and not that I didn’t realise it before. But as an extension of that logical understanding, the logical execution of this logical understanding was missing making my investing style and returns totally illogical.

To correct this illogical fallacy, in 2021, I tried buying on the way up for some of my businesses, but found it incredibly hard – as in, cannot meaningfully add to the position that I already have. I am learning that incremental execution of a very logical thing is very difficult to do – intellectualizing it is very easy and for some, even execution must be very easy. For me, it is proving to be difficult, but baby steps, one step at a time right now.

2. Smaller allocations: I have always been a concentrated investor in the last 10 years (8-12 stocks at most times, with rare exceptions). Obviously, I’d end up with fairly high allocations for most stocks. The logical extension of this philosophy is that – a) how do you know what you bought will actually work b) what happens if an unknown unknown strikes your company and the stock is down 50% in no time and b) there are too many good fish in the sea, so are you stupid? (the short hand abbreviated version of these 3 questions can be – “afaik, r u bsdk”?)

Given we have concluded above that 2021 was the year of learning and incremental execution, I tried allocating smaller portfolio bets (< 5%) to some other long tail companies that I found to be interesting. Results are too early to call, and it’s been a very easy market in 2021 to execute this strategy given the broader market was fairly expensive. However, jury is still out on a) if I’d sell all these smaller portfolio bets first the moment I find a good concentrated bet or would I still continue to hold these smaller portfolio bets and b) if I’d actually do this in the longer term when the markets are not so easy – yet to be seen. Incremental execution on this has been easy for now, but don’t think it’s easy to maintain this as a continued strategy in the long term.

On a more serious note, CNBC is claiming 2022 to be the year of the stock picker’s market in India. Given CNBC is the gold-standard in erudite thought process, I should give full weightage to their statements and continue to do what I have been doing for the past 10 years – “find stocks which will give me returns” – but with execution of the incremental learnings in 2021.

The other goal for 2022 is to learn about NFTs and DAOs and CBDCs and all the fancy financial architecture that is proclaimed to be built that will change the world. Something new needs to be added to my LinkedIn profile – become too stale and old-school these days – and why not claim to be a “leading thinker” of such thoughts nobody actually has comprehended well.

Be well 2022, and stay safe! Wish you all a very happy new year!

Only 2 things matter!

This post is mostly valid for investors with lesser capital (less than Rs. 1 cr) than bigger/HNI/institutional investors who have other things to worry about. If you are the latter, you can obviously skip this post.

In this 2-year ongoing pandemic, apart from boom in the stock markets, there has been a big boom in these online conferences where investors of all shapes, sizes and interests come and dispense gyaan in all jazz and form. There have been more transcripts of these conferences than what you can read in a lifetime. First thing that you need to do, as a ‘small investor’ (as in lesser capital), is stop attending them.

In this 2-year ongoing pandemic, apart from boom in the stock markets, there has been a big boom in Fintwit (financial market experts – ‘wizards’ they call themselves – on twitter – fondly called fintwit) where everybody and nobody have claimed massive gains given their ‘unique thought process’, ‘clear vision’, ‘in-depth insight into business dynamics’, ‘amazing chart reading ability’ and many other talents with ‘nazar, jigar, sabar’ hints galore (arey bhaiyya, only 2 years have passed!). First thing you need to do, as a ‘small investor’, is to stop reading / taking Fintwit seriously (unless you know the person personally of course).

In this 2-year ongoing pandemic, apart from boom in the stock markets, there has been a big boom in behavioral sciences, biases and books related to them. There is every possible bias that has been documented and hammered with a million examples that you start doubting if you were under some bias or other even while going to the bathroom. First thing you need to do, as a ‘small investor’, is to stop reading these behavioral sciences books and throw every kind of bias in the dustbin.

As a ‘small investor’, the only objective is multiplying your capital. The only way to multiply your capital significantly is to laser-focus on only 2 things and 2 things only – “growth in earnings” and “theme” as a fundamental investor:

a) Figuring out growth in earnings is 80% of the job really. Different ways to do it in terms of understanding business dynamics, management ability to read the market, changing product profile, changing product dynamics, changing competitive dynamics, growth in the overall market etc. Any aspect which is not helping you figure the above is not worth your time. If earnings are going to grow (especially, a business insight you can derive via research/scuttlebutt etc. which will help earnings grow more than what the market has factored in through existing valuations) is what will multiply your capital.

b) Theme is critical for a quicker PE re-rating. There are obviously various kind of themes in terms of marketcaps, sectors, fraud-themes like ESG etc., but the best kind of theme to latch on is where earnings are growing/will potentially grow because that’s when the wealth generated will be more sustainable. You can also make money via these themes like ESG and anti-ESG and what not these days, but the basis of holding on to these stocks becomes increasingly threadbare and therefore, not much money (3x-5x-10x) can be made on larger amounts of capital.

And that’s the summary really – earnings and themes where earnings will grow/are growing – don’t listen to anything else, don’t read anything else, don’t waste time on anything else. Everything else is probably important, but not at the stage of capital you are in. All of that – ‘protection of capital’, ‘playing offense + defense’, ‘understanding every stock that moves’, ‘behavioral sciences’, ‘this bias and that bias’, ‘management culture’, ‘re-investment risk’, ‘FII flows’, ‘DII exits’, ‘only 20-30 stocks expected to have FII flows and hence XXX P/E’, ‘fancy investors buying certain stocks’, ‘float mop’, ‘why 100 PE like coffee-can and not 20PE like tea-can’, ‘kya lagta hai market’ – all of these and many more are useless at smaller capital sizes. You can read “Thinking, Fast and Slow” later in life and espouse endlessly about how beautiful yet complicated our mind is and how many biases exist which blew your mind when you have larger capital (like those speaking at various conferences) – for now, you need to “work hard, think hard, think fast”.

Of course, you can do all of the above as well being a small investor if you want to show-off on Insta/Twitter and show how intelligent and insightful you really are (like many known ‘super narrative’ people), but it’s almost a guarantee if there is one that all of the above will not multiply your capital. To multiply your capital, only 2 things and only 2 things matter and hope that luck/serendipity walks along with you.

The End.

P.S: I would not know what to focus as a ‘technical investor’ in terms of charts (other than randomly claiming breakouts and breakdowns for fun), but any advice from @nooreshtech or @prashanth_krish is probably worth its weight in gold

P.P.S: My good friend ‘O’ has a wonderful, visual example to explain all these ‘narrative’ folks that you find these days. Once upon a time, there was a street-rowdy who uses all means to make money – literally all means. That street-rowdy slowly graduates to Sarpanch where he still uses most of the horrible means to make money and then some but slowly starts giving speeches about ‘the good of mankind’. That Sarpanch slowly graduates to become MLA at which point he spouts narratives about GDP per capita, biases, quality, culture of workforce, re-investment risk etc. We need to understand at smaller capital we literally should not have time for narratives or marketers who peddle narratives or that WA/Twitter acquaintance who will give you specious logic which is seemingly intellectually true but that’s not what he does in reality (there are too many in the market!). Don’t confuse marketers with investors.

P.P.P.S: Last one really. As much as I dissed Fintwit above, love so many folks on twitter from whom I learnt a lot, especially after I have known them personally for some time now. As a fundamental investor, @prabhakarkudva and @gordonmax have some amazing threads and blogs which force you to think long and hard (and bloody deep!). If you have found such fellows in your life, what else is required but to ignore my fintwit dissing.

End of a super decade!

In the current world where “everybody knows everything” thanks to the internet and especially the gurus of Twitter and PMS-es, it takes me a while to appreciate what I didn’t have in the early 2010s.

I didn’t have any ready-made brokerage reports (of mid/small cap firms), didn’t have instant Whatsapp alerts on stocks-too-many, didn’t have gurus enumerating global gyaan on twitter/whatsapp and obviously didn’t have ready made tools like screener/tikr/tijori/trendlyne. What I did have were starting valuations which were loaded in our favor (of course, not so clear at that point in time).

Just a bit of quick personal history for context (not that anybody should care): I was a dabbler in the markets for 2-3 years (like everybody else) in the stock market boom of 2005-7. More career-oriented than markets-oriented, I always believed (like any young man passing out of MBA would firmly believe) that building a company/career/becoming a CEO quickly was the main goal in life. Moved to the US, worked for a few years, came back from US due to personal reasons and started investing seriously only since 2010 (October 2010 to be precise). Too little capital, too many investment options across asset classes but somehow, through pure fortune of luck ended up completely into equity investing. Even today, more than 99% of my networth is in equities

This post got triggered ironically, due to one Whatsapp image that was shared today morning – which said that Avanti Feeds moved up 214x, Caplin Point moved up 115x and so on and so forth – essentially stocks which would have made one fabulous returns only if you could identify them back at the start of the decade. And everybody starts discussions around what could be such stocks for the next decade (because, you know, this was the past decade, we couldn’t identify these stocks and no benefit brooding over them – but we somehow now believe we have a magic wand to identify stocks for the next decade like WA social investing/Twitter guru-ing).

What the image doesn’t or will not tell you are the starting valuations across the market in many many pockets across various sectors. They were very cheap. I made 20x of my initial capital in those 5 years between 2011-15. By 2015, the markets had moved up quite a bit, and that capital moved up only by 6x in the ensuing 5 years of 2016-20. All of this was no skill at all – just that the starting valuations were insanely cheap for an exponential rise in market prices when the earnings eventually came (atleast in 2011-15 period, earnings did come).

Some of the stocks were at unbelievable valuations really – ISGEC was at negative working capital, quoting close to cash (which eventually became 7x in 1 year) post a buyback trigger; Mayur Uni was consistently growing at 20% with 25% RoCE at 8x PE (again, a 10x in 3-4 years); Tasty Bites was so cheap and when earnings for 1 quarter came through in Aug 2014, the stock went 3x in 1 year (and eventually a 20x in 3 years); and I can go on and on. Avanti Feeds, Shilpa Medicare, Astral Poly, Bharat Rasayan, Kaveri Seeds and many more. Looking back, it was a matter of choice to decide which stock to buy for more returns than which stock to reject because of downside risk (of course, I am oversimplifying some complications, but not by much because of valuations). The most important thing, and this is the most important thing – was mistakes were made, but the cost of those mistakes was very less, and re-investment into some other attractive stock was much easier. However, in the last 2-3 years given the increased valuations across the market, only Alkyl Amines (6x in last 3 years) and HLE Glascoat (7x in 1 year) provided such asymmetrical opportunities where one could deploy large capital.

Of course, there is insane selection bias when I say multiples have moved up substantially across various sectors in the market but there is general consensus that we now have multiples awaiting earnings over the next few years rather than the other way round at the start of this decade. You make a mistake now at these valuations with large allocations, and it can set back one’s CAGR for many years. That’s the key difference.

Which comes back to my main point. The past decade, whoever started investing in say 2009-12 period achieved super-normal returns in this decade not entirely due to skill (and no skill in my case), but because the starting valuations were so cheap that, like that advertisement goes, all one had to do was sit back, relax and click on ‘Buy’ button. Whoever started in 2014-16 period achieved very good returns (but not super-normal) given the starting valuations were not so cheap. As close to certainty of bet there is (which is obviously dangerous in markets like ours), I am fairly confident that the next decade’s returns will not be as attractive as this decade (neither ‘supernormal’ nor ‘very good’) just purely because of starting valuations across sectors of the market (except for small cap/mid cap infra/cap goods/power, valuations across the board are higher even accounting for Covid abnormality). One will get 2x-3x (in 1-2 years) opportunities periodically even in this market (with more drawdown risks), but for investors with smaller capital, 2x-3x doesn’t change lives.

And that’s the rub. Information explosion + up-to-minute stock updates + twitter gurus cannot beat starting valuations. And we have no choice but to make do with it. Of course, like any good/bad MBA will vouch for (as we are CYA experts), we will always say that there will be exceptions and exceptional people who will find hidden gems which will grow exponentially especially if they have a large opportunity and fire in the belly and therefore have supernormal/very good returns. But they will be very few and far in between over the next decade.

Thanks to this super decade of returns (and thanks to all the close friends from the investing world I have I had the privilege to know personally over the past decade who have made my investing skillset look sharper than it is in reality). Every decade turns up new, churns up new, chews up the old. So, here’s bidding goodbye to 2020 (and the decade of 2011-20) and here’s cheers to 2021 and the new decade to follow!

Disclosure: I have owned stocks mentioned in the blogpost in the past, and may continue to own some of them now (and sold many of the others mentioned in the past already). I am NOT a registered investment advisor and these stocks are NOT a buy/sell recommendation. Kindly don’t base your Buy/Sell decisions based on the above blogpost. My returns have not been audited by any blue-blooded accounting firm, nor do I have any PMS to sell to you – so, please consider all the returns mentioned above as fiction.

HLE Glascoat Equipment – Stock Analysis

Given GMM’s steep valuation of 6000 cr (and wide coverage), there has been a lot of curiosity around HLE / Swiss Glascoat amalgamation and how it stacks up against GMM. I had written the note below to myself back in November 2019 before investing into the stock (I hardly write detailed notes like this – but wanted to be a bit more clearer in my mind before I increased position). Hopefully, this note answers many of the questions that exist currently.

Before I proceed with the note, please note that I am NOT a registered investment advisor. This is NOT a stock recommendation. This is NOT an advise to buy/sell. This is just to layout my readings and learnings about any particular business in a couple of pages – and hope to learn from the blog readers if there is any new angle to this. To reiterate, I have written this note in November 2019 and don’t know if it is a Buy or a Sell today/tomorrow – in that sense, as is the case with all my blogs, it’s pretty useless to read anymore from hereon. I have avoided mentioning any future financial projections in the post deliberately (making it utterly useless to scroll to the bottom immediately to check the projected numbers).

Disc: I own a position. No buys/sells in the last 30 days.

–note starts

Risks (or why should one not invest in this company)

• Fortunes of this business are tied to fortunes of its customer industries- Pharmaceuticals, Agrochemicals and Specialty Chemicals. If you believe that these industries are not going to invest and grow, one should not invest in this business
• There are massive tailwinds visible due to China shift. There is a tremendous amount of capex that’s being incurred by all the chemical/agrochemical companies due to this marginal China shift. If you believe that this capex will stop all of a sudden / slow down considerably and this shift from China is only temporary, one should not invest in this business
• If you believe only in liquid large cap (or liquid any cap), then one should not invest in this business as this is illiquid (although there is enough liquidity at a price)

 However, if you are interested in understanding (and/or investing) an Oligopoly business with a visible China shift resulting in strong tailwinds in a relatively robust capital goods equipment company serving this tailwind, please read on.

What does this company do?

First of all, HLE Glascoat is a merger of 2 companies – HLE (which was unlisted, and is a market leader in filters & dryers) which bought Swiss Glascoat (which was listed and is the 2^nd largest player in the reactors equipment space)

First about Swiss Glass (given it was listed earlier), and we will then proceed to HLE.

Swiss Glascoat Equipments (SGEL) specializes in design and manufacturing of carbon steel glass lined equipment [GLE] (reactors, receivers / storage tanks, columns, valves, pipes & fittings). These products are sold to Pharmaceutical / API, Specialty Chemicals, Dyes/ Colours, Agro Chemicals, Food Processing and allied industries.

SGEL manufactures both smaller sized reactors and very large reactors and the general replacement in this industry happens over 7-10 years. Corrosive conditions and client mistakes determine replacement.

Glass Lined Equipment (GLE) are used where lot of chemical reactions are to take place. Any other material would get corroded in those harsh conditions.  Glass lined equipment is a corrosion resistant material used in varying processes of operation from production of pharmaceuticals to specialty chemicals and polymers. Glass lined equipment prevents materials exposed to harsh chemicals (acids, alkalis, water, and other chemicals) from getting corroded and thereby preventing failure in the equipment.

GLE is an integral part of Pharmaceutical, Agrochemical and Specialty chemical companies. Removing & replacing it is not an easy process & downtime in case of quality issue costs the companies a lot of money. As a result, companies don’t compromise in quality for GLE.

A 4 minute video on SGEL – https://www.youtube.com/watch?v=uDz3y7575ZE&t=1s

GLE equipment is an oligopoly, with GMM being the market leader (50% market share) and Swiss Glascoat being the 2^nd largest player (25-30% market share). The remaining market in the GLE segment is captured by Die Dietrich (acquired Nile Ltd’s glass lining business in 2012 – and now up for sale – either will be bought by GMM or HLE), Sachin Industries and Standard Glass lining – all these 3 players have marketshare in lower single digits.

What are the industry tailwinds?

Fortunes of this business are tied to fortunes of its customer industries- Pharmaceuticals, Agrochemicals and Specialty Chemicals. All these industries are growing at 10-15% CAGR due to various industry-specific factors –

• Very well-known news that China has been making its pollution norms stricter, which is making India as the new hub for Chemical Industry. Even a 5-10% shift will lead to significant volume shift to India. GMM in one of its concalls stated that Gharda Chemicals (one of the largest agrochem companies in India earlier used to order 10 GLEs per year, but have now started ordering 30-40 GLEs per year)
• Cost of production in India is significantly lower than the developed world which gives it a competitive advantage and hence, a strong boost to outsource work (make/ produce/ do R&D) in India
• India has among the world’s lowest usage of Agrochemicals and initiatives from the government and agrochemical companies is increasing the awareness in farmers, thereby boosting the agrochemical usage
• 100% FDI is allowed in the Chemical industry
• The current run rate of capex in these segments in FY20 should be around 6,000 odd crores and of that around 2% to 10% should be coming for the GLE players. Another 2-10% will flow to filtration and drying equipment. In all, looks like about ~600 cr worth of GLE and Filtration equipment per year that is majorly going to flow to 2 oligopoly players (GMM – market leader in GLE and Swiss/HLE – market leader in filtration/drying). This opportunity (if the China shift continues) will grow by 10-15% atleast for the next 2-3 years

So – what changed and why now?

SGEL was run by Mr. Sudarshan Amin till Nov 2016. Mr. Amin was the promoter of the company with stake of around 35% in SGEL. Due to succession issues (both daughters living in the US), he sold the business to HLE Engineers. HLE Engineers (run by Mr. Himanshu Patel and Mr. Aalaap Patel) took a majority stake in Nov 2016. HLE Engineers is a leader in Filtration and Drying equipment in India (> 50% market share) with a similar set of customers as SGEL (in fact, there was a 60-70% overlap in customers between HLE Engineers and Swiss). HLE Engineers decided to amalgamate SGEL in Jan 2019. Post all shareholder/SEBI/lenders/NCLT approval, HLE Engineers business will now be a amalgamated entity within the listed entity SGEL starting 25^th Nov 2019.

SGEL had 65 lakh shares. HLE Engineers valued itself to ~150 cr (very reasonable in my opinion considering it’s a market leader in a growing segment) for amalgamation (including preference shares). HLE Engineers amalgamation will add another 65 lakh shares – thereby taking the total equity base to 1.3 cr shares (apart from preference shares (which will result in a 1 cr outflow every year starting FY20)). From multiple secondary checks and cross-references with customers, there appears to be no corporate governance issues in the group.

Essentially, our estimate is that the tri-criteria of lower sales, lower margins and lower multiple will move to higher sales, higher margins and higher multiple leading to decent returns over the next 2-3 years

Ok, tell me more about HLE Engineers?

Introduction

A 2 minute video to start with on HLE engineers – https://www.youtube.com/watch?v=xkw0Y6bH31U

Initially, HLE Engineers started with the name Indosal chemicals based out of Thane by Dr.Kushalbhai Patel (got doctorate in chemical engineering from USA) in 1950. Indosal used to manufacture salicylic acid (Aspirin) and faced lot of issues due to labor and political issues.  Hence, moved to Navsari. Based on Indosal’s requirements, the management slowly started manufacturing equipment needed for our chemical manufacturing and gradually, started catering to others as well. Over the period of time, Indosal have gained knowledge and leadership in Agitated Nutsche Filter (ANFD) and Rotary Vacuum Paddle Dryer (RVD). Therefore, Indosal started the journey as a chemical manufacturer and eventually evolved as an engineering company in HLE Engineers.

Why is HLE Engineers exciting?

HLE Engineers are market leaders in India in the Filtration and Drying equipment with more than 50% market share in this segment. ANFD and RVD which contributes eighty percent of engineering segment (the rest 20% being contributed by the chemical segment which is run with minimal capex and working capital). HLE sells about 350-400 units every year which is increasing at a rapid rate due to the ongoing chemical/agrochem/pharma capex. Every API, agrochem, and specialty chemical plant needs this product. These products are evolving by replacing centrifuges. This ANFD and RVD products used to be exotic previously (being bought only by larger companies) but due to ongoing increase in complexity of chemical reactions across the value chain, almost all companies have started using this (and higher the complexity, higher are the realizations for HLE filtration and drying equipment). There are operational efficiencies as well in using ANFD/RVD over centrifuges due to which demand is expanding exponentially. For example, multiple centrifuges have to be employed to clear out single GLR (glass line reactor) reaction batch, whereas with the use of ANFD, the entire batch can be processed in one go. Centrifuges also require regular maintenance with the bearings breaking down frequently, which is not the case with a ANFD/RVD.

So, clearly, a market leader with exciting economics in an increasing opportunity.

What are the economics of this business?

Based on the complexity and volumes in chemical/pharma/agrochem plants, ANFD/RVD products give higher cost advantage over the time. For a 100 crore plant, both products cost can anywhere between 2-10 percent based on corrosiveness, usage of exotic material etc. Unlike Swiss Glascoat (or GMM), these filtration and drying equipment are completely order driven business although, HLE Engineers are trying to get lower-priced standardized equipment to sell at a mass scale for the smaller and medium sized enterprises who cannot afford a customized order (for its price point and advances that need to be secured to HLE).

And market share?

From a market share perspective in the filtration and drying equipment space, HLE has a > 50% market share, and Bifriends Filters having 10% market share. Advances for this business range anywhere between 0% and 30% depending on client relationships. Currently, only 10% of HLE business is coming from exports. There is a renewed focus on exports, and HLE is quite confident of making deeper inroads and grow exports significantly from hereon.

The expectation from HLE business (filtration and drying) is that they will grow at 15% CAGR in revenues with increasing realizations and can grow till 300 cr revenues without any further capex. The management in the AGM mentioned that “It is not about physical infrastructure, skilled people availability is big issue. We need to maintain quality with through inspections. Along with capacities, organizational culture needs to improve. Every project is different. With increasing ticket sizes, sense of urgency in capex, significant increase in number of enquiries, we are confident of scaling this business along with growing our team and culture”

The other business within HLE Engineers

HLE Engineers also has a chemical business. However, all these are old products with minimal margins and running at 40-50 cr turnover. Given that the chemical plant is in the same shared infrastructure as HLE engineers, the management has decided to run it minimal capex, minimal working capital and at breakeven till they shut it down eventually in short order. They are focusing on improving yields and running at high capacity. They primarily manufacture Sodium Nephthionate, Dichloro aniline (DCA) which is an intermediate used in food colors, dyes and pigments.

Back to Swiss Glascoat. How does HLE coming in change things here?

HLE management, post taking over SGEL have undertaken multiple initiatives (as the previous management was not very focused on efficiencies and capturing the opportunity):

• Spent 15 crore capex and increased capacity by 30-40 percent. Initially SGLE used to have 900-1000 units capacity, but now increased to 1400 units and will further increase to 2000 units in short order. At maximum capacity utilization, SGEL can reach 250 -300 crore turnover and given the industry tailwinds, will also have increasing margins
• SGEL under the previous management was dependent on a single supplier for raw materials (specialized carbon steel) and therefore pricing was dictated by the supplier. Inventory days in SGEL were always high due to this reason. However, post HLE taking over, they have developed one more supplier and are slowly bringing the inventory days down. HLE would require stainless steel for filtration equipment and the management opines that they can get buying efficiencies due to a larger scale and a consolidated list of suppliers for both
• Installed gas furnaces instead of electric which will improve cost efficiency as well as quality of the end equipment
• Spares contributes 5 percent of the turnover (vis-à-vis 10-12% in GMM). HLE management is actively trying to increase the percentage of spares sales
• Substantial debottlenecking done in the plant
• Changed lay out of the plant for better operations

Competition

The main competition is GMM – who is a market leader in GLE (50% market share) and competition in the filtration/drying equipment of 20%. Enough and more reports are available on GMM, along with multiple quarterly conference call notes over the past few years. GMM has 2800 units capacity for GLE (while Swiss has ~1600-2000 units depending on state of current expansion). With similar industry dynamics and tailwinds, market leader in Filters/Dryers and close competitor in GLE, HLE Glascoat (on an amalgamated entity basis) quotes reasonably.

The other competitors (unlisted) is Suryamani in GLE equipment and Bifilters (unlisted) in Filtration and Drying apart from Die Dietrich who is reducing its presence in India (and the plant may be bought by either GMM or HLE – and given it’s plant’s presence in Hyderabad, might work very well to serve as a hub for all pharma companies in Telangana, AP and Karnataka).

A quick comparison of past financials tells a story:

Few observations clearly stand out:

• The gross margin profile of GLE equipment is very similar (+/- 100 bps). Indicates that on ‘product selling to various customers’, there is very little difference in terms of pricing/customer profile/product range
• PBIT or EBITDA margins are much better in GMM compared to Swiss. This boils down to efficiencies of operations and the plant. With the new management at Swiss taking over and incorporating changes, expanding capacities, changing layouts, gas furnace instead of electric furnaces etc., and therefore should ideally expect Swiss margins to trend up
• There are other operational efficiencies that come with scale of operations – GMM has 2.2x sales of Swiss, which points to and validates the market leadership of GMM

Summary of Amalgamated Entity

 As per AGM interaction:

• They expect SGEL to clock a 30% CAGR growth for the next 2-3 years with increasing margins (~op margins of 15% are achievable)
• They expect HLE Engineers to clock a 15% CAGR growth for the next 2-3 years with increasing margins
• They expected to reach 500 cr turnover by FY22, but looking at the wave of orders, they are expecting a combined 500 cr turnover by FY21

As an aside, we continue to see medium-to-large capex from all pharma and agrochem companies – referencing multiple EC documents along with the Govt. announcing a lot of sops for taking advantage of the China shift in the near future.

The core of the thesis is as below:

• Given that we don’t have to track any chemical prices but still want to participate in the chemical/pharma/agrochem tailwind story, we are comfortable investing in an Engineering company – where we might get more predictable earnings and returns if the capex for these companies continues to happen with not many variables
• This seems to be the classic capital goods story where pricing power increases basis market tailwinds and valuation multiples can re-rate  given HLE Glascoat is a market leader in the non-GLE segment and a close 2^nd in the GLE segment.

–note ends

Please note that the above note was written in November 2019. Kindly don’t base your Buy/Sell decisions based on the above note. I am NOT a registered investment advisor and this is NOT a buy/sell recommendation.

A Strategic View of Pharma (Indian Pharma)

I work for a strategy consulting firm (not in the pharma domain). And often, industry outsiders primarily look at us as ‘hawabaazi’ /’seeing our watch and telling us the time’ – which is an extremely good place to start with. Sets low expectations. And as we all know, low expectations is the key to happiness as well as over-achievement. So, here is the ‘hawabaazi’ view of how I am seeing Pharma as of today – mostly will try to delineate the Hope vs Reality of the current situation. As usual, any of the stocks mentioned below are NOT stock recommendations and I am NOT a registered investment advisor. This is for learning and exchanging views.

The Return of Pharma Growth

The Hope:

Indian pharma companies were in deep capex mode from FY15-FY19. And there were also pricing pressures in the most lucrative market (US). Now

a) the pricing pressures are easing because of Covid

b) more FDA approvals are forthcoming which means FDA will not be as strict as they were in the FY15-FY19 period

c) pharma is a recurring consumption (in most parts) and no lockdown has affected this spending and therefore predictable growth than other sectors atleast for FY21

d) Most pharma companies have ended their capex and are re-looking at their capital allocations vis-à-vis the markets and are focused more on emerging markets and India where pricing isn’t so bad and hence RoCEs will return with lesser capex and better pricing and

e) somehow we are in a ‘strategic’ position to help US scale up on their manufacturing.

So, large growing opportunity. Hence bullish.

The Reality

I will try to answer a) and b) in detail below, but just to answer the other questions (c-e) quickly.

c) is a temporary phenomenon – but might be important for flows

d) opportunity size is limited and too many players are focusing on it all at once (which essentially means, increased competition, ergo reduced returns) and

e) is in the category of ‘what are you smoking’ (Mylan itself has 8 API manufacturing facilities and 2 formulation facilities in India – with enough US incentives, they can help a whole range of mfg scale)

So, coming back to a) and b).

So, a) why did pricing pressures come about?

• In the year 2007, there were 11 distributors who would buy your products – wholesalers (Amerisource Bergen, Cardinal Health, McKesson), Retailers (Walgreens, CVS, Rite Aid, Pharmacy benefit management (PBMs) (Express Scripts, Caremark, Medco) and Key global distributors (Alliance Boots, Celesio) covering 80% of the generics market
• And then, buyer consolidation started happening. From 2015-16, there are only 3 wholesalers/retailers (Walgreens Boots alliance having 31% market share, Red Oak (erstwhile Cardinal Health + CVS) having 27% market share and McKesson (Celesio, Rite Aid merged with McKesson) having 24% market share. That’s 82% market share between 3 players
• So, when people talk (or more likely give goli) about pricing pressures easing, the one question you need to ask is – what has changed? Did any of the Big Three break their alliance? Have the Big Three become more lenient than ruthless? Is there a 4th major player emerging who will buy your products? What exactly are the factors that will lead to pricing pressures easing? Even if they ease for certain products due to Covid (or due to certain supply shocks which will close quickly), there is no strategic rationale for pricing pressures to ease over the longer term
• Add this to the surge in ANDA approvals from almost all Indian pharma players in 2015-19 period (ergo, more competition, lower generic prices) and combine with buyer consolidation – why will the pricing pressure suddenly ease off?

The generics market in the US has been in the range of USD 75-80B for the past 5 years – and I don’t see a reason why this will suddenly increase when there is no new segment (like biosimilars) that are folks are getting into (we have had high hopes of making our mark in ‘complex/specialty generics’ and therefore increase this number – but as I elucidate below, that’s a pipe dream as well).

So, b) More FDA approvals forthcoming

I am not sure why market participants are excited about this development. No one getting the approval is almost the same as everyone getting an approval – the whole point of making profits is scarcity and exclusivity. Time was ripe for compliant-players to make a lot of money when everyone else was getting FDA VAIs and OAIs. But everyone getting a FDA green signal – why would you be excited? So essentially, more approvals -> more supply -> more competition -> no

That being said, if you analyse the FDA approvals coming by, except for Lupin and Aurobindo plant, most of the EIRs that were received were for VAI plants and not OAI plants. But people will also point out specific events like Ipca’s HCQ being exempted from a OAI plant? But folks, this is not the first time. FDA had exempted 10 molecules from Divi’s plant when it received a OAI (Ranbaxy and Wockhardt were provided similar exemptions in the past inspite of OAI on their plants, depending on the criticality of the molecule). Some sharper folks will also point out to expedited ANDA approvals as a sign that FDA is easing (or the company in question is a visionary or both) like it happened for Cipla’s Albuterol inhaler. But the point to note is that this inhaler was needed for patients with respiratory issues when Covid struck – we can’t really extrapolate this generic data to all of pharma, just because we think Pharma is a ‘Buy’.

The overall strategic point being – don’t be excited because neither has buyer consolidation gone away and neither has competition intensity decreased (and definitely don’t go by the golis in webinars by pharma MFs). And people will definitely not consume more medicines because there is Covid. 

Specialty Pharma:

Of course, these days every drug is a specialty drug – even paracetamol and metformin are called specialty drugs by anyone bullish on pharma. But what is the true definition of specialty pharma? Specialty pharma is usually oral or injectable medications (which are complex medications) usually used to treat complex chronic conditions. Their features typically include a) high cost ($1000/day for 30 day supply) b) high complexity (complex R&D, biologic/biosimilar, orphan drugs etc.) and c) high touch.

The Hope

Specialty pharma is a large market (USD 1000B globally) of which specialty pharma share is about 28%. US is a USD 400B market, of which specialty’s share is about 36%. India lags, with only 8% of specialty pharma share in a USD 15B market. The top three therapies globally in specialty pharma are Oncology (30% share), Auto-immune disorders (28% share) and Anti-viral medications (17% share).

There are many players in India doing specialty pharma, and there have been some very attractive exits as well in this market (Gland pharma to Fosun, Claris to Baxter, Agila to Mylan etc.). Given these exits, coupled with high growth and large market size, no wonder everyone in India’s pharma industry wanted to get on the bandwagon on specialty pharma and just leverage it to the hilt (and everyone singing praises as usual).

The Reality

Indian pharma companies (save for Biocon) have traditionally had a DNA of generics-at-scale. A few of the better ones tried and have been successful at branded-generics-at-scale. But a lot of them didn’t have the DNA to do specialty pharma – and given the attractive nature of the specialty market, especially in the US – tried acquiring the DNA.

• Some of the large acquisitions over the past decade – Cadila (acquiring Sentynl for Rs. 9B in 2017, and already wrote off 30% with more to come), Dr. Reddy’s (acquiring lot of Teva’s ANDAs at $350M and writing off 75% of it), Lupin (acquiring Gavis pharma at $880M, writing most of it off), Torrent (acquiring Bio-pharm) etc.
• We have traditionally lagged with the lucrative part of the specialty segment like inhalers, transdermals and long acting injectables. However, broadly, Dr. Reddy’s has announced exit from specialty front-end (sold off all neurology brands and most of dermatology brands – had targeted $400M revenue by FY22 – which now of course is not achievable), Cipla has spoken about reducing complex/specialty pharma investments (with focus primarily on respiratory/inhalers), Lupin of course has written off most of Gavis (and exiting Japan completely – a geography which constitutes 20% of Lupin’s sales), and Sun Pharma unable to launch any complex generics after Doxil and Gleevec (their US specialty revenue of $400M coming primarily from only 2 brands)
• With the changing US pharma industry’s dynamics (more below), almost all pharma players are pivoting completely and now directing their capital to the double-digit growth and faster capital turnaround spaces of India and Rest of World (read China, Brazil, Canada)
• Conclusion being – not many pharma players will continue their investments in the complex/specialty pharma space as the market dynamics are extremely difficult. So, the lucrativeness of ‘specialty pharma’ – next time you know what to say.

The overall strategic point being – almost everyone has bolted from the specialty pharma market in the most lucrative geography (US). Don’t let anyone tell you otherwise 

Biosimilars

The Hope

Biologics are a USD 300B market globally, and there are 4-5 companies in the top 10 pharma companies whose sole claim to fame is biologics. Everyone thought that we would replicate the successes of brands to generics in the biosimilar market as well.

I mean, why not, right? Biologics was a fast growing market and many biologics have gone off patent in the last 10 years and US alone is a USD 11B market, with rest of the world growing much ahead of the US. Biologics was solving some unique problems that chemical-based drugs weren’t able to solve earlier (several auto-immune disorders, rheumatoid arthritis etc.) and the insurance companies (and payers) were looking to reduce this ever growing cost.

So, what gives? Why are our pharma companies not making money hand over fist? Do you know large companies like Sun Pharma don’t even have any publicly known biologic/biosimilar development in place? If Sun Pharma doesn’t want to expend resources, who else has the capability to do it? Will we ever get on the biosimilar gravy train?

The Reality

• First place to understand the present is to look at the past. So, why did chemical-based generics succeed? Even better, why did the Indian pharma companies succeed in the generics space? That’s because there was an extremely mature Hatch-Waxman act of 1984 that had an extensive framework of time and litigation for branded patent drugs to convert to generics. Almost the entire success of our Generics industry can be boiled back to this one act that the US enacted. 30 months delay for litigated drugs, ANDAs, 180-day exclusivity, state laws allowing generic forms to be substituted automatically by pharmacists for brand-name drugs prescribed by physicians, so long as physicians have not specified that the prescription must be ‘‘dispensed as written’ (also called ‘interchangeability’ – remember this!) and so on and so forth. Extremely mature framework and predictability for both the patent owners as well as generics
• Compared to the mature Hatch-Waxman act, the US implemented the BPCIA act for Biosimilars. BPCIA was enacted in 2009, but the first USFDA approved biosimilar came in only in 2015. I have read quite a few articles on this act, and my basic understanding is that the act is so poorly written that there have been litigations at every stage of a biosimilar evaluation (for example, naming of biosimilars, scope of patent dance protocols, and of course the big one ‘interchangeability’. There are many conflicts and cases around this, but one of the primary reasons seems to be ‘principle-based litigation’ (read up Sandoz-Amgen case for more clarity on this topic). But it basically boils down the litigation costs, and more than costs, it is the timeline that’s killing most of the biosimilar pipeline. So, very capital ineffective so far because the litigation and the basic act for this litigation is not very clear and can be interpreted in various ways (Industry insiders call it the ‘time-climb’). US currently has only 12 biosimilars approved and 3 commercialized – 11 years after the Act came into place
• Just to be clear, the approval timelines for biosimilar applications have come down to 10-12 months. However, almost all firms (and not just Indian firms) underestimated the amount of resources required to fight litigations in the US market. Given this ‘time-climb’ and the associated costs, the generic player wanting to launch a biosimilar will not want to cut price steeply to launch. Imagine this – when a chemical-based drug goes off patent and if there are more than 4 filers for that drug, the price post patent cliff is 80-90% lower in most cases. In case of biosimilar, the price cuts have not been more than 10-20%, which basically is not an incentive enough for the insurers in the market to push their payers down this route (And as cases of Humira and Remicade are proof, the original biologic player themselves shave off the price by 10-20% to prevent the biosimilar player to make any money). Of course, with ‘interchangeability’ a mandatory guideline for the US markets, the doctors are also not willing to take a risk on the biosimilar – resulting in very poor risk-reward for the generic player in biosimilars
• So, does that mean Biosimilar potential is dead? Not necessarily. Let’s look at Germany for instance. Insurers incentivize hospitals and clinics to use cheaper options like biosimilars. The regulation in Europe around ‘interchangeability’ is fairly clear which means lesser litigations, which means the cost-to-market is lesser, which means there is a combination of price-cuts and market acceptance. Add to that, there are marquee players in Germany like KfH, the largest network of dialysis in Germany (30% of dialysis patients) who actively promoted the case of biosimilars (in this case, Epoetin). Therefore, the crucial play is lower regulatory hurdle (lesser litigations, not necessarily lesser stringency) -> lower time and cost of clearing the molecule -> cost benefits passed on to payers (forced by insurers and marquee players) -> rapid acceptance
• So, what does this mean for Indian pharma? If I look down the list of biosimilar filers, most of them are global MNCs Pfizer, Amgen, Merck, Sandoz etc., who are huge multinationals with deep pockets. The cost of bringing a biosimilar to the market is estimated to be $100M-$200M (with the attendant risks listed above) vis-à-vis $1M – $5M in case of a chemical-based drug. Our Indian pharma players have had successes in the emerging markets (for example, Dr Reddy’s with the world’s first Rituximab biosimilar, Zydus Cadila’s Exemptia etc. and other players like Intas, Lupic, Cadila making headways in the emerging markets. However, Biocon is the only player with a US/EU presence (that too in partnership with Mylan) and Intas-Apotex partnership in this area is also promising (given Intas’ amazing presence and distribution) in Europe. But the real money is in the US – and unfortunately, not many players have even invested in the pipeline (Cipla exited the biosimilar pipeline in FY17 with a Rs. 2.5B write-off in Cipla Biotec, Cadila wanted to enter US with the biosimilar pegfilgrastim, but have stopped burning cash on this, Lupin is probably the only player having some pipeline in Enbrel (with EU approval) and Neulasta, Dr. Reddy’s targeting only emerging markets, Glenmark looking for a partner for bXolair, Sun Pharma has no investments in biosimiars, and neither does Natco (the only probably strategy seems to be ‘acquire some company once the regulations/BPCIA is more clear – else, can’t understand their decision-making)

The overall strategic point being – Indian players have consciously avoided the Biosimilar markets primarily because of complexity and aukaat reasons. So, the question is where is the next leg of new segment growth going to come from for these players over the next decade (ergo, higher valuations)?

Conclusion

Essential summary of the entire blog – No structural changes for easing of pricing pressures in the US market, no specialty pharma traction, no biosimilar traction, extreme competition in the India (and RoW) markets building up – so, why is everyone excited about pharma?

P.S: Hope it was worth the time of reading a long blog post. More importantly, as you can see, it’s not too difficult to cross the ‘hawabaazi’ barrier 🙂

P.P.S: Lupin bought Gavis Pharma for $880M. Gavis had a manufacturing facility (which would be Lupin’s first in the US), 66 products pending approval from the US’s Food and Drugs Administration (USFDA), and another 65 niche dosage forms in the pipeline. Impressive filings and seemed like a strategic buy. But what went wrong that Lupin had to write-off of the whole thing? Well, the US government’s increased scrutiny around opioids (drugs that use narcotics in their formulation) – and Gavis had a lot of valuable filings in Opioids which Lupin was hoping to leverage. Given the regulatory scrutiny, it made getting USFDA approvals for some of Gavis’s products more difficult and shrunk the opioids market as well. And hence the write-off. But why was Lupin so confident of pulling off acquisitions? Because Lupin bought Antara (from Oscient pharma in 2009 – with sales of $85M) and AllerNaze (nasal spray from Collegium pharma) – both of which were runaway successes – which obviously induced them to go for bigger and bigger bets. Thought will leave you with a story, than just ‘hawabaazi’.

 

The Angst, The Truth and Everything-in-between

Angst

I like the word ‘angst’ – without going into the exact definition in Webster’s dictionary – conveys anger, frustration, desperation, exhaustion, anxiety, dread, worry etc. This one word – one word is all you need to know about what happened in March 2020 in the Indian markets (and world markets in general). Angst.

The Angst of Knowing: By now, you would have received letters from multiple PMS fund managers (either as their client or the very dependable Whatsapp forwards) talking about how they couldn’t see the havoc Corona would create in markets (and in life), and that they certainly understood the disease (having graduated from Whatsapp university) but underestimated the magnitude of the fall. In the same breath (as in, in the very next paragraph) will go on to tell you about how they think it’s only a 1-2 quarters disruption and that life will slowly get back to normal.

Of course, the discerning and erudite readers of this blog (haha!) will certainly notice a certain irony in those 2 paragraphs of almost any and every PMS letter you have read in March. But that’s their superpower – knowing, but not really knowing, and yet showcase that they actually know with sufficient disclaimers – and thereby the angst.

The Angst of Not Knowing: There are other sets of investors in the market where their stated position is ‘I don’t know’ / ‘I am not sure’ / ‘God knows what will happen’ which in summary can be termed on angst of not knowing. But why is it angst when you don’t know? Well, to start with, these ‘I am not sure’ investors are either in majority cash / majority invested. Mostly, majority cash. If you really don’t know – in the sense of ‘economy would go up or down’, ‘markets would go up or down’ – what would one truly do (keeping opinions aside)? The person would move to a 50:50 in terms of debt/cash : equity. That’s the true definition of ‘I am not sure which way things will go’.

So, the opinion (people take offense to the word ‘opinion’ these days – so, let’s say ‘stated position’) is ‘I don’t know’ but the action / positioning is ‘I think it will go to dogs’ (if you are mostly cash) or ‘I think we will recover well’ (if you are mostly invested). And to top it, all the ‘I am not sure’ investors are edgy – either to buy (so that they don’t miss the next upmove) or sell (so that they don’t miss the next downmove). And thereby the angst.

The Truth

Truth in this Kali yuga has multiple hues and meanings. For the purposes of this blog, let’s assume that Truth is something that can be stated with facts, but truth and facts are not the same. If that doesn’t cause you angst, I don’t know what will – because ‘you can’t handle the truth’ (A few good men reminder!)

The truth of knowing: I mean, and the truth is there for everyone to see (with a little Google search) of how some star and worshipped fund managers spoke about ‘leadership-wonderful-analytics-leaders in sectors are built on amazing culture-holding this for 15 years secular theme’ etc. have bailed out of financial services at the first sign of trouble. The truth then, irrespective of what their history and geography have said in the past, is almost all who spouted the above are ‘momentum investors’ and don’t need to be held at a pedestal. Every past interview is laced with hindsight bias and information asymmetry.

Everyone knows and talks about sector rotation these days. And the sector rotation broader opinion (from groups and twitterati) is to move from ‘the-red-hot-financial-services’ that has given folks stellar returns over the past few years to the ‘much-safer-pharma-because-you-know-Corona-and-healthcare spends will increase’ or ‘tailwind-chemical-and-magical-specialty-chemical’ because ‘China shift’ and ‘consumer-staples-is-expensive’. But you know, that’s not generally true – as in the reasons, not sector rotation per se. Sector rotation to these exact same sectors is as old as the hills as the image below depicts (between, somehow ‘rotation’ is a bit offensive these days – because it implies you have completely sold out on the previous theme which you had claimed in your 1001 ‘letters to the investor’ that this is the theme for 15-20 years (as true as it is that you bailed on this theme, like I said, ‘you can’t handle the truth’ and hence the new, taaza jargon is ‘sector tilting’ – implies…you know what it implies…))

 

The truth of not knowing: In these days of Internet and rampant Whatsapp groups, there is nothing that is not known. I mean, people have become expert epidemiologists in about 2 weeks, in what generally takes 10-15 years of hard work. So, what is there to not know?

– Somehow, folks seem to know exactly where Nifty will end up in 6 months to 1 year (6000-6500 on the bear side, and 12500 on the bull side), but cannot for the world of it, state about 4-5 stocks that will give them 25% CAGR returns with reasonably high probability in 3 years.

– Somehow, folks seem to know exactly what kind of stimulus and how much stimulus India should give and why FRBM is not relevant in this Covid era, but cannot for the world of it, know how to become anti-fragile with their own finances.

– Somehow, folks seem to know how human behavior is going to undergo radical change because of Covid (and thereby the resultant businesses and endless discussions around it), but cannot predict their own behavior in a bull / bear market the next day.

Deep down, we all think we know it. Like everybody knows everything. But in reality, the truth is nobody knows anything. Or is it…

Everything-in-between

One of the wisest investors that I have had the privilege to know, asked me recently, after I told him a long story/thesis about a particular stock, ‘kuch action kiya kya?’. On reflection, that’s a perfect statement to balance the angst and the truth.

– If you are convinced / positioned (for the ‘I am not sure’ investors) that market is going to dogs and Nifty to 6000-     6500 (or pick any figure below the current figure), have you acted accordingly? In fact, to take the                     Soros/Druckenmiller route, have you bought puts/shorted futures to that effect?

It is general human behavior that if you are in majority cash (means negative on the market), you’d kind of secretly hope that the situation deteriorates further and you can then come as knight in shining armor and scoop up a lot of businesses at dirt cheap prices.  You can in fact write a lot of eloquent and erudite pieces on the 2^nd, 3^rd and 4^th order effects of any event (in life or in markets), especially a negative one. So, why not leverage this negativity and buy some puts / short the market for a small percentage of your portfolio to really drive a home run?

– Similarly, if you are convinced / positioned (for the ‘I am not sure’ investors) that market is going to back to near normal, FY21 is a washout for sure but most if not all businesses will be 70-80-90-100% there fully operational by FY22, have you acted accordingly? In fact, to take the Soros/Druckenmiller route, have you bought calls / long futures to that effect?

It is a completely abnormal human behavior to be optimistic in the face of such humanitarian crisis. Unlike the bear theory articles, you will hardly have any convincing arguments of why the market will go back up or why the businesses will go back to near-normal by FY22. The difficulty in such markets is not to find stocks which go up, but you want them to disproportionately go up – and that’s where the thinking gets stunted. If you are in the optimistic-bent camp of near-normal from FY22, and that bear markets are where stocks move 3% or 5% per day on the up (and missing out on certain days on some stocks will draw down your return significantly), then the key questions to ask are do you have a pipeline of stocks-at-certain-prices (realistic – not like HDFC bank at 200 rupees), why aren’t you buying stocks, shifting stocks and in general buying calls/long futures to drive a home run?

 

It’s not the opinion that counts – between the angst and the truth – because the opinions are too many, but it’s the action that counts. ‘How are you positioned’ / ‘What are you buying / selling’ is a much better indicator than ‘kya lagta hai market’. People can still lie, or tell you the partial truth, but that’s much better than an opinion and a narrative. Like the wise investor said, ‘kuch action kiya kya?’ – that’s the absolute truth in investing life.