Q1 2020 Letter

Just when it looked like the Indian economy was finally getting back on track, the entire nation had to go on a lockdown - an extraordinary move for a country of 1.3bn people, with a case-count of less than 500, and hardly any deaths.


Given the exponential spread, the government was likely correct in doing what it did. Cases were doubling every 3 days. Hospitals were wholly unprepared. Testing was close to nonexistent. Epidemiologists were predicting a 1,000-fold increase by end of April. In other words, 500,000 cases.


Instead, we have 28,000 so far. Growth rate has settled around 8% a day, with recoveries growing at the same pace. In fact, by all accounts total mortality in India has DECREASED. Car crashes, train accidents, homicides, have all come down meaningfully. We have the lockdown to thank for all that.


But thanks to the lockdown, we also have unemployment north of 25%, discretionary spending down to zero, and mass immigration from urban to rural areas, which puts a quick reversal at risk. There is enormous pressure now on the government to start opening up, at least partially.


We don't know what happens next. No one does.


But we know the pandemic will end. Bill Gates recently said, “This pandemic is like a world war, except we are all on the same side”. The entire planet is laser-focused on solving one imminent problem. You can go long the virus or you can go long humans. We’ll go with humans.


And when this ends, India will still have thirteen hundred million people waking up every day striving to live better, earn more money, and spend more of it. The virus will not stop that.


In the meantime, we must own assets which will survive a long-drawn onslaught, and fully participate in the recovery. This is best done by staying focused on the micro details while the entire world goes nuts about the macro stuff.


Silly-macro-stuff Exhibit A


On March 16th, when the US case-count was still around 3,500, Fiverthirtyeight.com, a top-notch polling website, conducted a survey of virus experts. They were asked, "How many cases will the US CDC report by March 29?" The experts had to make a two-week prediction.


They came back with this:



The best estimates range from 10,000 to 75,000. The 90% confidence intervals range from zero (??) all the way to 500,000. Now imagine you could get a bunch of economists in the room, show them these results, and ask them how the economy would do. Then get a bunch of policy experts and ask how might the national and local governments react. And finally ask some money-managers what the markets will do based on all that. Do you really think you would get any actionable insight from such an exercise? We don't either.


And yet, the investing world is almost entirely fixated on some form of this exercise or the other. We believe there's a better way - analyze one business at a time, make sure that it makes it to the other side, and prospers once there. Detailed, sometimes painstaking work. But important work.


To start with, we want to be certain that our businesses can support their leverage. Even well-run businesses will find it hard to service debt if we continue down this path. We tend to underweight financials for this very reason. Our sole financials position - HDFC, by far the best run financials business in India, makes up 10% of our portfolio. Compare this to NIFTY, which holds ten financials making up 36.51% of the weightage.


Furthermore, in times like these operating leverage also works against businesses. Cash collections will dwindle faster than expenses. No business can survive this too long but some do better than others. We are appraising the cash burn runway for every business we own and looking to own. Figuring this out requires a handle on expenses, maintenance vs. growth capex, ability to extend payables, etc. In other words, basic, detail oriented, micro-level research.


We are evaluating businesses along orthogonal axes of shelf-life vs. throughput. Shelf-life determines whether a lost sale is lost forever. For an airline seat that is certainly the case. For a motorcycle, not so much. Throughput measures the degree to which the product moves under a partial lockdown. Again, an airline seat is a low shelf-life, low-throughput product. IT services, food and beverage are all perishable but they move. Medicines and personal care items have long shelf-lives and high-throughput. All things equal, long shelf-life, high throughput businesses will have higher survival rates.


Finally, as always, we are weighing this analysis against the business’ moat and its intrinsic value. Several good quality businesses were suddenly available for cheap during March. We were net buyers throughout the month. Currently we own 28 businesses in our portfolio. Given the situation we are okay with higher than normal diversification. We will consolidate positions over time. As we do, we will start writing more about the individual businesses. Our sectoral composition is as follows:


Autos 12.1%

Commodities 6.8%

Consumer 11.3%

Credit Ratings 13.0%

Financials 10.3%

Homebuilder 5.4%

IT 3.1%

Others 1.1%

Pharma 22.2%

Telecom 3.5%


The long-term prospects for India have not changed in our opinion. In fact, on a relative basis India will be higher on the investing podium than it was.


Investing is a relative game - liquidity looking for the best opportunity. Trillions in global stimulus is bound to create a lot more liquidity, and India will come out of this crisis looking far more attractive in relative terms. Unlike the ageing Europe and Japan, we have a huge and growing domestic market. Unlike, our emerging markets peers, we have very little external sovereign debt. Unlike Russia, Africa, and the Middle East our success does not require a high oil price. India was a great investment destination before Covid-19. The virus will just make that more obvious.


We wish you and your family good health. If you have any questions regarding this letter or your portfolio, please do not hesitate to ask. By now, you would have received your reports from NAV Consulting.


Sincerely,

Rahul Bhatia Aniket Khera