2021 Annual Letter

P&L wise, 2021 was a great year - India did well and we did materially better. In just about every other way though, 2021 was nuts.


It was exactly this time last year when the case count had plummeted all the way down to 15k per day. The vaccines were right around the corner. India had proclaimed victory over the virus. We had proclaimed that we wouldn’t be writing about it anymore.


And then this happened ...


New confirmed COVID cases across India in 2021 – 7 day rolling average


Source: Our World in Data


But this also happened ...


NIFTY Index in 2021


Source: Bloomberg


We didn’t foresee cases spiking 10x within 3 months, causing widespread misery, hard lockdowns, and so much stress in the healthcare system. We didn’t foresee NIFTY rallying 24%. And we certainly didn’t foresee the later happening while the former did.


Why did the Indian market do well? We hear the words Fed and Liquidity quite often proffered as explanations. Maybe that’s just it. India’s private market was certainly gushing with liquidity - 46 private companies became unicorns, same as the total in a decade prior. Transition into public markets through IPOs was easier than it’s been in 20 years.


Indian Unicorns in 2021


Source: ET Research

But contrasting India to other countries paints a different picture. Here are a few comparative returns in USD:


India: 26%

Russia: 20%

UK: 16%

Indonesia: 10%

Japan: (4%)

MSCI Emerging Markets: (5%)

Brazil: (17%)

China: (22%)


Surely, the US Fed wasn’t selectively pumping India. Investor Dollars were available to every country. They just chose to come to one country over the others. Maybe the Dollars came looking to participate in the future earnings prospects of Indian corporates - that’s what we argued in our Q3 letter. Or maybe it’s just random. Regardless, here we are.



Caution through Valuation


"Don't get high on your own supply"

- Elvira Hancock’s advice to Tony Montana in Scarface


A few years ago, it’s hard to say exactly when, a notion took hold that valuations are not important as long as the company keeps growing. There’s some truth to this. If a business earns high returns on capital, then even small increases in growth rates lead to massive increases in the total value of the business. We’ll spare you the math but for folks who want to dig in we highly recommend Michael Mauboussin’s writings at Morgan Stanley. Here’s a chart from his paper called The Math of Value and Growth.



Yes, the multiples on the y-axis look absurd but they are mathematically justified if your hurdle rate is 6.7%, the business earns 20% return on capital, and delivers the x-axis growth for 15 years.


The math however goes viciously against you if the business earns less than the hurdle rate. The faster such a business grows the more wealth it destroys. In that case, you’d want the business to aggressively shrink and give the capital back to you.


There’s a third category of businesses - the ones that currently earn sub-par returns, even negative returns, but promise to make stellar returns far into the future. And to get there, they grow like wildfire, while constantly burning cash. Their premise being that once they achieve scale, they can raise prices, cut costs, squeeze suppliers, or do whatever else is needed to increase returns on capital. It’s a good story and folks pay top Dollar for it - after all, who wants to miss the next Amazon. The problem with this story is twofold:


1. In many cases it’s not real

2. And even when it is, it assumes that the stock market will continually fund the business through its years-long, sometimes decades-long, journey


But we know that Mr. Market is fickle. Sometimes he just doesn’t feel like funding anyone. What then? Lower funding = lower growth = reduced scale = worse future prospects = lower funding = lower growth, and so on. We might be seeing the early signs of this play out for several loss-making US companies trading at nosebleed sales multiples. 70-80% off their highs and they still don’t look cheap relative to what they’ll earn 5-10 years from now.


Capital markets in India are nowhere near as insane as they are in the west. There are no meme stocks. No SPACs. The new age companies - a cutesy term that SEBI uses for internet enabled businesses, are still mostly sitting in private hands. Just about half of the NIFTY components are trading at or below their decade long average valuations. Corporate balance sheets are in the best shape they’ve been over the last 10 years or so.


But still, it’s time to be selective. The widespread bargains of early 2021 no longer exist. If the performance of recent IPOs is any indication - one third of the 2021 vintage trades below the listing price, life’s about to get tough for the Indian story stocks.


Being stingy value investors somewhat naturally prevents us from flying too close to the sun. We have thus far stayed away from paying up for perpetual loss makers (we’ve done plenty other stupid things). Our portfolio companies were purchased cheap. They don’t need to constantly raise outside capital. And yet one of them is growing earnings.



Portfolio Updates


Our consumer goods companies, led by KDDL, were the biggest contributors to our return. We wrote about KDDL in our Q3 letter. It started out as a contract manufacturer for watch makers and later branched into luxury Swiss watch retailing. That retail business, called Ethos, had a great holiday season after a gap of 4 long years. The company recently filed papers to carve out and IPO Ethos. It’s a great step towards independent value discovery of a business which is now 3x the size of KDDL’s traditional manufacturing business. We’ve been in constant dialogue with the company. As we get more color on the IPO pricing, use of proceeds, and growth strategy we’ll likely rebalance our position - there’ll now be two distinct businesses to choose from. Stay tuned.


Another event we eagerly look forward to is the success of Hindustan Oil’s (HOEC) B-80 offshore drilling campaign – the company’s largest project till date. Here’s an excerpt from our HOEC update from a year ago:


2020 was awful for HOEC. Their drilling campaigns had to be postponed due to COVID. Parts of their campaign require narrow weather windows, so the delays were significant. Moreover, gas prices went to 5-year lows and oil prices went to their lowest level ever, with WTI briefly turning negative. HOEC is only now getting back on track. Our original thesis partly hinges on HOEC’s excellent management team, which remains focused on completing the drilling campaign by April. If successful, HOEC will at least double their EBITDA this year at current oil & gas prices


After some more cyclone-induced delays in 2021, the company finally got back on track last quarter. Their drilling campaign is now in its final stages. We expect the early sales of oil and natural gas in this quarter with full field utilization in another 3-6 months. HOEC currently produces 2500 boepd of oil and natural gas. If things go as planned, this number will increase three folds. Meanwhile crude oil and natural gas prices have moved up 65% and 80% respectively over the last year.


We consolidated our healthcare holdings to 5 companies (from 7 in the previous quarter and 9 before that). The sector overall still remains our second biggest allocation. The COVID crisis laid bare the underinvestment in healthcare in India. Between the government push, higher health awareness, increasing lifespans, and early disease diagnosis, the healthcare spending as well as the supply is bound to rapidly increase in India. We will likely increase our allocation to the sector over time.


Portfolio composition ex-cash



Outside of these developments there were no major changes to our portfolio quarter. Q4 was another uneventful quarter – the second in a row. We hope that India can maintain this streak for many many quarters to come. In our Q2 letter, we described our portfolio’s progress broken down by sector. The progress continues uninterrupted.


In closing, we wish you and your loved ones a happy and prosperous 2022. If you have any questions regarding this letter or your portfolio, please do not hesitate to ask.