March 2020 / Q4 FY20

01COVID-19 Eats Into All The Green Shoots: Fear And Uncertainty Loom Again

Just as the Indian economy was beginning to show early signs of a recovery, COVID-19 arrived and reset the clock. Lockdowns, demand stoppages, and supply chain dislocations have folded into one of the sharpest synchronised drawdowns in the history of public markets.

The Nifty 50 fell roughly 35% from its January 2020 peak; the Dow, FTSE, and CAC 40 each fell around 30–32% over the same window. Our portfolio took a major dent of about 29% in the month of March alone. The drawdown is real. The reasons offered for it change every week.

02Questions Galore And No Answers In Sight As Of Now: Only Fearmongering Going On

Will the lockdown last six weeks or six months? Will the virus mutate? When does the curve flatten in India? How deep is the second-order damage to small and mid-sized businesses? Will fiscal support be enough? Nobody — not policymakers, not epidemiologists, not strategists — has confident answers right now. The information vacuum is being filled by fearmongering.

In moments like these, the temptation to time the market is at its strongest and most expensive. A simple "buy after a 10% drop, sell when a new all-time high is hit" rule, run from 1959 through 2018, leaves an investor with a fraction of the wealth that buy-and-hold delivers — even though the rule looks rational on a single drawdown.

03Our Approach To Investing In Businesses Rather Than Stocks

A stock price is what someone else thinks a business is worth at this minute. A business is what it earns, what it owns, what it owes, and how reliably it has compounded those things across cycles. When the gap between the two opens, our job is to act on the business — not on the price.

We do not own ticker symbols. We own thirty-year-old industrial leaders with revenues between Rs. 400 crore and Rs. 9,000 crore, with low leverage, with promoters who are buying their own shares at these levels. The market quote on a Tuesday in March is not the same thing as the going-concern value of those businesses.

The 2008 cycle is the closest analogue. A 58% fall over fourteen months was followed by a 138% recovery over the next fourteen months. The investor who sold near the bottom realised the loss; the investor who held through the panic recovered, and then compounded for another decade.

04Longevity Of The Businesses Of Our Portfolio Companies To See Through These Uncertain Times

We have stress-tested every portfolio company on eight dimensions — tenure, scale, prior growth, leverage, cash flow, ownership, insider behaviour, and governance. The picture below is what gives us the conviction to stay put and to deploy incrementally rather than retreat.

4A1. Thirty-plus years in business

Almost every business we own has been operating for over thirty years. Resilience is best gauged by tenure. Weaker companies typically die out within ten to fifteen years. The promoters of our holdings have already endured prior cycles and have emerged stronger from each one[4].

4B2. Mature scale, not fledgling start-ups

Revenues range from Rs. 400 crore to Rs. 9,000 crore. Several enjoy market leadership in their respective segments. These are not fledgling start-ups or sub-scale businesses that would be most vulnerable in a demand collapse[4].

4C3. Healthy growth before the shock

Barring FY20, most portfolio companies grew profit before tax at roughly 20% CAGR over the prior three years. The franchises were compounding into the slowdown, not limping into it[4].

4D4. Very low leverage

Average debt-to-equity is roughly 0.4x, and most of that is working-capital lines rather than term debt. Low gearing leaves headroom to raise additional working capital if cycles elongate[4].

4E5. Positive operating cash flow

Every portfolio company was generating positive and healthy operating cash flow as of September 2019. Cash generation is the first defence against an extended demand pause[4].

4F6. High promoter holding, low pledge

Promoter holding ranges from 35% to 75%; several have institutional PE funds as co-investors. Pledges, where any exist, are largely additional collateral against working-capital limits, not personal-funding pledges that face margin calls in a drawdown[4].

4G7. Promoters buying, companies announcing buy-backs

Most promoters are currently buying from the market and shoring up their holding through open-market purchases or buy-back announcements. The insiders, who know the business best, are taking the other side of the panic trade[4].

4H8. No corporate governance issues

No eyebrow-raising governance flags have surfaced across the portfolio despite the drawdown. That reinforces our reading that the correction is panic-driven, not fundamentals-driven[4].

05So What Now?

A marginal increase in equity allocation, deployed in a disciplined and staggered manner, rather than going out and buying in bulk. Catching falling knives is rarely rewarded; staying engaged through them usually is.

We are activating the option of deploying up to 25% of allocation in large caps and larger mid-caps. Our mandate has always permitted this, but the option had never been used because large-cap valuations were too high. The COVID drawdown has brought several blue-chip names to mouth-watering levels.

As always, please feel free to reach out to us with your comments, suggestions, and queries. Please take care, stay at home and stay safe.

Sources

01

Index drawdowns from exchange data as of March 2020 (NSE for Nifty 50; NYSE for Dow Jones; LSE for FTSE; Euronext for CAC 40). Equitree portfolio drawdown of approximately 29% for March 2020 from internal performance records; portfolio-vs-benchmark performance is not disclosed in this issue.

02

Ibbotson; UBS, as of 30 September 2019. Buy-and-hold versus buy-low / sell-high cumulative return comparison, 1959 – 2018, log scale. Series values digitised from the source chart for native rendering; magnitudes preserved at the order-of-magnitude level (~100 → ~30,000 buy-and-hold versus ~100 → ~400 timing rule).

03

BSE Sensex public history. Approximate monthly closes from January 2008 to October 2010. Peak around 20,300 in January 2008, trough around 8,500 in March 2009 (-58% over fourteen months), recovered to roughly 20,300 by October 2010 (+138% over the subsequent fourteen months).

04

Equitree Capital internal portfolio analysis as of March 2020. Tenure, revenue range, prior-three-year PBT CAGR, debt-to-equity, September 2019 operating cash flow, promoter holding range, pledge characterisation, and governance assessment are all firm research; no external citation.