How worried are you about what is happening on the macro front? Oil is moving higher. Bond yields are at multi-month highs. So is the basic premise of this bull market getting challenged? Oil was expected to remain low for a long period of time and yields to remain compressed forever!
We think that macro economy wise, even pre-Covid, there has been a bit of disconnect between the markets and the economy. As the year has gone by, several parts of the economy have done well. Corporate India has used this pandemic as an opportunity to grow faster and gain market share. In addition, many of them have been able to reduce costs and improve profit margin significantly. This is getting reflected in the capital markets where a large number of companies are trading at all-time highs.
At the same time, lots of cheap capital has been available because of the liquidity unleashed by the US and European central banks and the low yields are forcing investors to increase their allocation towards emerging markets. Overall, geopolitically, the new US administration is in place and seems more stable and hopefully the trade war rhetoric will slowly fade away and there will be a stable global supply chain. Lastly and most importantly, perhaps the biggest factor that gives us all hope for a more stable future is the vaccine. In the next one or two years, we are experiencing one of the largest vaccination drives globally and I am optimistic that a wider vaccine rollout will usher in the end of the pandemic which will significantly bode well for overall consumption.
While crude oil price has been slowly picking up and increasing over the last couple of months, that does have macro effects on the economy because as a country which imports 86% of crude usage, we are dependent on crude in a significant way. Some of this is expected, given that the crude oil prices will be significantly depressed. As the economy and the supply chain stabilises globally, crude oil prices will also stabilise and support India’s growth.
Some would argue that that is a consensus scenario — that earnings have bottomed out, interest rates are low and it is time to focus on micro not macro. How much of the template that we discussed is already in the price?
Obviously the market runup has been phenomenal and quite unexpected in several ways and to some extent, a lot of it is priced in. I do not think that the kind of growth you have seen from the March lows is something we can expect year on year on a consistent basis. Having said that, there is a significant shift because of this pandemic from the unorganised to organised and that is where a lot of the large companies which the market is composed of have done significantly better and will continue to do better. They have gained more market share. They have reduced their costs significantly and improved their sustainability.
So to some extent, I agree that this sort of euphoric run would not keep happening year on year over time. But this is going to be a market of stock pickers. Some sectors, some areas where there has been a lot of support in terms of government incentives, government policy and overall disruption and change in consumer behaviour, will continue to grow at a measured rate of 15-25% year on year.
What are the pockets of opportunity where you are focusing your attention?
Just to give a brief about Paragon, we are a private equity fund focussed on investing into small sized companies. We look to invest into high calibre founders and management teams who can grow their businesses 25-30% CAGR over an investment period of four to five years. We are long term in patient capital. Apart from capital, given our team’s entrepreneurial experience, we work alongside entrepreneurs to help them grow faster. We launched our first fund in 2015 which was about Rs 760 crore and we have made eight investments out of it across consumer, financial services, manufacturing and infrastructure services. We have just started raising the second fund with the target size of Rs 1,500 crore. Out of the second fund, we have made two investments so far. The first company is called TenderCuts which is an omni channel meat brand and the second company is not yet announced. It is a tech led express logistics player catering to e-commerce sectors.
Coming to your question on opportunities we see in our investments landscape, we look to invest Rs 60-100 crore mostly in MSMEs companies with a broad range of Rs 100-500 crore sales. Today in that sort of range, there must be more than 10,000 companies. So, we have an ample base of companies to choose and pick from. There are not that many funds that operate in our space where they invest Rs 60-100 crore.
There are a lot of funds in the smaller ticket range of Rs 30 crore; lots of early stage PCP, NBC funds and then there are very large funds who invest more than Rs 200 crore in companies. These are large Indian and global private equity funds. We have seen a very vibrant year in terms of the deal flows and investment focus. We like to focus on consumer discretionary, financial services, industrial manufacturing and healthcare sectors which are backed by technology that plays the role of enablers.
Some of the sub sectors that we are studying very closely and will make our fund to portfolio will include beauty and personal care products, packaged foods, education technology, general insurance, apart from the traditional financial services.
During the pandemic time, several home themes have played out well in general. Consumers have spent a record amount of money buying foods, staples, pharma, home improvements, consumer durables, laptops etc. and as the vaccine is successful over the next 12 months, I expect a massive surge in consumption. As a country, we have been bottled up for a long time and I am sure that the vast majority of people are waiting to go out and spend money on travel and entertainment like never before.
So that theme will also play out, assuming that the vaccine science works and is able to control the pandemic in a significant manner. Financial services is a core pillar for us to look at. We invest in NBFCs and typically do not look at large ticket size loans such as real estate or corporate loans. We look at a very small ticket size — Rs 3-5 lakh in personal loans or small SME loans. These loans are a large unmet need because lots of banks find it difficult to serve these sort of customers and we believe that this vintage of NBFCs who have remained resilient this year, will have a significant advantage to grow. These would be the ones which are focussed on efficient collections and manage to keep strong control on operating costs and good asset quality.
What about your own deal activity? What you are looking at currently?
The last deal that we announced is TenderCuts. It is an omni channel branded retailer that serves fresh chicken, mutton, sea food and this is a perfect example of the theme that I was talking about. More than 90% of meat retailing is unorganised which means it is unhygienic, full of hormones and dependent on a series of middlemen. TenderCuts offers healthy hygienic hormone-free, antibiotic-free freshly cut meat and seafood. We believe that there is significant opportunity for a company like that to leverage the supply chain of farmers and fisherman and its omni channel strategy will cater to the mass market at prices which are not that much higher than the unorganised market.
Customers demand convenience and flexibility to buy products and services through online and offline mediums. From a customer’s perspective, online and offline are the two sides of the same coin and they may come across an ad on Instagram and look up a product on a company’s website and use a mobile link for the purchase and expect the product to be delivered to the doorstep from a neighbourhood store. There is a significant interplay between online and offline. A successful omni channel strategy requires a very integrated supply chain inventory transparency across different channels, technology footprint to facilitate that execution and then a good mix of alignment between marketing and supply chain.
Overall we believe that technologies like artificial intelligence (AI) and machine learning (ML) are very important aspects of companies that we are looking at today; perhaps more so in the last 12 months and even a small company like TenderCuts is using predictive analytics to predict the demand. Considering it is a perishable product, you have to get inventory right. Otherwise, your wastages can eat into your profit margins significantly. There is lots of technology which we are using to make sure that the operations are more efficient.
“I would be wary of investing in businesses where the founder and the management team do not have the technology mindset and do not have a data-led decision making and data-led thought process.”
Similarly, our second investment, which is a tech-led express supply chain company basically caters to the ecommerce industry which has been growing at 40- 50% year on year. Some of the large players are growing faster with a large base. Covid has provided a fillip to the industry where the daily shipments have increased about 50% last year. They use lots of technology because the trucks they use are not all their own. There is a asset hybrid approach and to be able to deliver a high quality service level from a vendor and make sure that the progress of the trip and the tracking of the trip and the efficiency of the trip is as good as your own truck, requires a lot of technology interface and analytics.
We believe that this vintage of investments will all have a significant technology aspect and companies which adopt AI and ML quickly and use it as a core operation will significantly over perform companies which choose to remain brick and mortar and slow adopters.
What is the best way to directly or indirectly invest in India’s evergreen theme of consumption? Would the entire thesis gets challenged because of the uptick in inflation in fuel and agri commodities?
In the last couple of decades, consumption has been driven by the listed largecap consumer companies. What you see in the last few years is that many of the small companies are coming in offering much better products or services and being able to engage as a brand with the consumer more intimately. That is playing out in a significant manner.
When a typical consumer looks to purchase, they want to buy products that they can connect to, they want to buy products of the brand where the brand speaks to them and then there is a healthy sort of exchange between the two. And this is something which is a bit unsustainable for very large companies given their own structures and wide distribution. Some of the new age consumer companies have been getting acquired by large companies because they have managed to crack the consumer code and managed to create a niche offering in a very crowded market. Food inflation and agri inflation is playing a small role in throwing a dent. However, many of these consumers today are not just price and value conscious consumers, they want to be seen with a certain brand, they want to be able to talk about the brands they are using and the new products with their family and friends, post it on Instagram and we are seeing a lot of these young brands doing excellent work in different segments in apparel, retail, food beverages and consumer packaged products.
Overall, we believe that consumer discretionary as a sector will continue to grow well and a lot of these other parts of consumer which have been under pressure due to Covid pandemic, will come back very strongly once we are over the vaccine hump.
What is it that you would not buy in this market because of the valuations or because of the business or because of the environment?
As a fund we do not look to invest in asset heavy businesses which require a lot of capex and many years of building. Offline retail, travel, hospitality have all been areas which have struggled in the last one year which I hope will bounce back in the coming years. In a country that is growing at such a high pace compared to the rest of the world, it is hard to see a significant pocket of underperformance as such.
I would be wary of investing in businesses where the founder and the management team do not have the technology mindset and do not have a data-led decision making and data-led thought process. We believe that technology has moved from a niche to a must have. Also, we will look at companies with impeccable corporate governance. In a market like this, it is easy to see the stock market climb up and pay high multiples but we believe that prudent entry valuation and discipline approach to entry is quite valuable and let’s not forget the basics of investing at this point because I see a lot of FOMO in investors mindset where they have missed a significant part of this run.
What are you considering exiting?
There are eight investments in our five-year-old fund. The first investment was made five years ago and our typical holding period is four to five years. Last year, if things were better, we would have started to exit from some of our initial investments. We have one investment in a publicly listed company. It was private when we invested and then it went public called Capacite Infra. We partially exited from a position a couple of years ago but we still have a significant stake left. We will look to exit as per the exit timelines of the fund.
There are lots of interesting opportunities cropping up in the last few months. There are companies in the automotive and aerospace area where there is lots of interest in raising additional capital. Our consumer companies, which had taken a hit during Covid, have bounced back significantly and most of them are above the pre Covid levels now. We want to use this year to make up for last year’s dip, go over the 2020 numbers and then look to exit at the right time. In the next couple of years, we will see lots of exits from our fund one and then distribute that capital to our investors.
