Gopal Agrawal heads the equity investment team for the India operations of Mirae Asset Global Investments, a South Korean mutual fund giant. Excerpts from an interview with Moneylife
Moneylife (ML): You started your career as a chemical engineer and then moved on to investment management. What was the reason for the transition?
Gopal Agrawal (GA): I have a basic knowledge of business because of my engineering background. Adding financial knowledge to it made sense. Because I understand the intricacies of the business and business trends, I can forecast earnings better, instead of solely relying on the past record.
ML: Can you describe how you and your team of analysts identify sectors and pick stocks?
GA: We are a team of five on the equity side, including three research analysts. The five of us have certain sector responsibilities. We cover 200 stocks on a detailed basis and 50-60 other stocks which include Nifty 50 stocks. Whenever we pick a new stock, we look at the past 10 years’ performance, how its book value has changed, how the return ratios have moved, how the business variables are changing and then we meet the company’s management. And, if everything is in tune, we buy the stock.
ML: What are the different parameters you look at?
GA: We are mostly bottom-up in stock-picking. We look at cash flows and return on equity (RoE). That is a strong yardstick; because, ultimately, for a shareholder, RoE is the most important. Then, we look at the size of the opportunity. One would not buy small businesses which can do well only for one or two years. A big re-rating happens when the opportunity is larger. For example, we bought Amar Raja Batteries at a market-cap of Rs800 crore. Today, it has a market-cap of over Rs12,000 crore. And as it was only a two-player market, so there was a huge opportunity.
The parameters used also depend on what kind of businesses we are investing in. RoCE (return on capital employed) is used for capital-intensive businesses. Every business needs to be analysed in different ways. All capital-intensive businesses should be valued on EV/EBITDA and others should be valued on PE basis.
ML: On this basis, are there many opportunities now?
GA: Currently, the market is giving a very high weightage to growth. But, at this juncture, growth of corporate earnings is very moderate. So, companies that are giving you a relatively stable growth, are commanding very high valuation. When you are buying a stock at a high multiple, you should be doubly sure that the trajectory of growth is upward. At the current level, anything available in the market has to be justified by higher growth.
ML: Where are we on the growth issue?
GA: If growth comes back, the domestic cyclicals are cheap. The problem lies in our growth assumptions. Historically, the currency can only be protected by growth with moderate inflation. If growth is rising, FII (foreign institutional investors) flows will be there; debt inflows will be there; FDI (foreign direct investment) inflows will be there; so, the currency will not depreciate. We will have a crisis, if we don’t grow with moderate inflation. Earlier, global growth was very strong; this was a positive for many sectors of the economy. Now, growth is there mainly in India, so the government policies are very important.
ML: When picking mid-cap stocks, would you follow the same parameters or do you have a stronger filter?
GA: We don’t invest in a company with less than Rs100 crore of operating cash flow. Smaller businesses will be more susceptible to fluctuations in the economy such as volatility of the currency, interest rates, etc. So we don’t want to buy businesses which are very small. Secondly, we give more emphasis to our own research and views on such stocks. These stocks are not widely covered by research firms; so we have to be doubly sure on what’s happening in the business.
ML: You also manage schemes which invest in foreign stocks. While looking at foreign stocks, do you have a different set of parameters?
GA: Yes, because the investing style abroad is very different from what prevails in India. Investment in India is based on a growth story. Therefore, we have a different set of parameters. The foreign market is more an institutional investor-driven market. In institutional practices, corporate disclosures are very stringent, which is very good. I am waiting for a time when we adopt the international standard of accounting practices where the corporates have to report all the hedges, all the currency translation, all the inventory valuation. Then, you will get the true picture. On hindsight, would anyone know which corporates were making money in currency when the rupee was appreciating? Suppose you borrowed in ECB (External commercial borrowing) and your currency is appreciating, you are making gains, no company has ever reported this. Other expenses were coming down and it implied that the margin is expanding, which was not so. No IT company has ever reported that it has profited in cross-currency transactions. If you look at the corporate disclosures of companies in Hong Kong, Australia, Korea, etc, it is very comprehensive. This makes the market very efficient. The price discovery will be very high.
ML: When it comes to selling a stock which has done well or reducing its exposure in the portfolio, what would you look at before doing so?
GA: In our view, we will never sell a stock until three things change. Either the top-line growth falters or the margins shrink or the working capital cycle elongates. These are three negative undertones. We will give no weightage to the PE multiple. Therefore, instead of giving a high weightage to valuations, we will look at the business operations—how the cash conversion cycle is affected. If all this is under control, we will continue to ride the stock. We may, at times, tend to reduce exposure at a price, to reduce its overall weightage in a portfolio; but we will not let go of our core position.
ML: What if a stock doesn’t perform and begins to decline? What is the action you would take in such a situation?
GA: We have some internal filters on the downside also. Let’s assume if a stock is down 20% from the purchase price. Then, our risk department will flag it off and we would have to give an explanation why we would like to hold such a stock. And, if it goes below 50%, we may have to exit. In the past, there were just one or two such instances. Those which come to my mind were JP Associates, TV 18 and Opto Circuits. There were mostly balance-sheet issues; the off balance-sheet items, which were not given in the annual report, etc, mainly due to the lack of adequate corporate disclosures. These were a few learnings, and another reason why we give a lot of weightage on returns ratios, cash flows, balance-sheet and not only P&L (profit & loss).
ML: Has your investment style changed after the financial crisis of 2008?
GA: Two main differentiations have happened after the financial crisis. Before the financial crisis, we were looking more at price-earnings-growth (PEG); now, we are looking more into the return ratios and cash flows. In my view, ultimately, the shareholder makes money when the company reports superior returns. So, as I mentioned earlier, we now look at three important factors—top-line growth, margin growth and the cash conversion cycle.
ML: You manage Mirae Asset Global Commodity Stocks. In the scheme, you have a high allocation to energy stocks and mostly of companies based in Australia. What is the reason?
GA: What I have done is to protect the downturn in the performance of the scheme. Liquefied natural gas (LNG) is more of a utility and the reason I chose Australia is because it is a very strong economy and the currency is also relatively very strong. So, I will not lose on currency. Secondly, most of the companies in the portfolio have a very strong growth potential and they have a dividend payout of 60%-80%. What happens is that the stock will not fall below a certain price level. Take, for example, Woodside Petroleum or Origin Energy or BHP Billiton or Rio Tinto. Their payout is very high—around 50%-80%. Thus, the price will not fall below a certain level. And touch wood! We are very lucky; the NAV of this scheme has never gone below par since inception. We launched it in July 2008 at the peak of the energy price.
My personal sense is that, whatever people say, energy requirement will always be there in this world. There may be five-six years of downturn, as it is a commodity. Everything has a cycle. So when super normal profits are there, more capacity will come and prices go down. But, after a period of time, with low prices, no new capacity can come. So maybe three years down the line, oil will boil again. Of course, the exact timeframe could be different. It could be three years or five years. But, for sure, at a sub-$80 oil price, with the world economy recovering, demand is increasing and the market is expected to become tighter.
ML: Is your background as a chemical engineer a reason for a large number of chemicals company stocks in Mirae Asset Emerging Bluechip?
GA: The reasons are two-fold actually. If you look at the past 10 years, the Yuan is the only currency which appreciated over the dollar. It appreciated by 40% against the rupee. So, for any business which has low volume and high value addition, China is no longer a competition. You can extrapolate it to engineering exports of high quality; so China has vacated that space. It should be of low volume and high value addition; that is why, we have specialty chemicals, agro-chemicals, pesticides, etc, those kinds of businesses, especially in smaller spaces where China is not there.
ML: In the Mirae Asset India-China Consumption Fund, you have a low allocation to Chinese stocks. Are the reasons similar?
GA: In this scheme, the stock selection is a little different. We invest in consumption-oriented stocks of India and China; but, because of taxation purpose, we have capped the India allocation at 70%. We normally invest up to 28% in Chinese stocks. The average age of working class people in China is 37 and the per capita income is more than $7,000. Hence, the demand for luxury goods is high. So, we invest in insurance, casinos, gaming, Internet, healthcare, high-quality real estate stocks. Though there may be lots of doubts about a bubble in China in the real estate space, but at the upper end, there is a lot of demand. In China, 870 million people access Internet. So, we have some telecom stocks. They are now in 4G and would be now moving to 5G. It’s a very stable growth situation. China is re-balancing the economy. They are moving from manufacturing to consumption and the government is giving tax-breaks for people to consume more. In my view, consumption in China, as a theme, has a long way to go. At least, for a decade, I do not see any issue there.