The Three Sectors Karma Capital’s Rushabh Sheth Is Betting On

Rushabh Sheth: So, just a quick one-minute background. We are India public market-dedicated firm. We have been doing this for 16 years now and we have a 16-year track record. We have been till now running a single strategy which is bottom-up completely.

In terms of the way we look at investing, we are ‘growth at reasonable price’ investors and we look for opportunities at reasonable prices. That's really our basic philosophy in terms of how we look at it. We look at it in the long-term and our average holding periods are pretty long and we run constructive portfolios, so just kind of giving you a bit of colour. 

Rushabh Sheth: Just to give you a flavour, our average holding period is five years. Once we buy a stock, we hold it for five years on average. Just to again give you a flavour, in the last about 10-odd years, we would have owned about 80 names. So, that kind of gives you a reasonable flavour of the concentrated nature of the portfolio and we would have lost maybe less than 10% of those names. 

Rushabh Sheth: So, as you have been managing money for a long time, as we have been doing for the last 26-27 years, you always keep learning and you always keep on making tweaks to your process. I think the process is more sacrosanct for us in terms of how we look at our research, how we look at our investing. The ground-holding periods have served us well.

As you rightly put it, the environment has always been volatile, maybe a little bit more now and maybe little bit less earlier, and what we look for are companies which are very steady in cash flows and profitability.

Look, at the end of the day the stock prices might move but the underlying profitability, underlying cash flows doesn’t move with that kind of volatility. The idea is to buy steady cash flows over long-term and hopefully at a reasonable price and of course they will also go through their own bit of volatility. It’s not as worrisome, as you see in terms of stock prices.

Rushabh Sheth: Look, the environment has some impact, but we have bottom-up investors completely. We look at the company, where the company is headed, how the business model is, what is the capability of the management and what is going to drive that business in the next 3-5 years. So, from our perspective that is far more important than the macro environment.

As you rightly put it, macro will keep on changing. The idea is that you have a business that can manage the macro, because you cannot manage the macro. So, we are basically looking for management teams who will go through the volatility but hopefully will emerge stronger at the end of it.

So, that's really our way of looking at it because at the end of it, we are not bogged down macro investors and we don't really know what's going to happen tomorrow whether in terms of economics or politics, but we definitely want to know what's going to happen in the terms of company’s business and how is it going to look like in the next two-three-five years and we are fairly confident of that.

Rushabh Sheth: Basically, at the end of the day we end up owning companies in a particular sector, maybe more than one company in a particular sector and that comes with our understanding of the sector and understanding of the companies.

It is not by design; it is by process that it shows that kind of outcome. So, if you look at our portfolios today, maybe unusually compared to many of our peers, we might have three or four pharma companies, which is one of our largest weights or for that matter media companies which are again one of our large weights.

So, from our perspective, it's a process which throws out those kinds of outcomes and we are not looking and saying that look we are going hunting for these kinds of companies in this particular sector.

Rushabh Sheth: So, from our perspective at the end of the day we are small firm, so we only interact with so many investors, the flavour that we get or that we are getting now, is that clearly India is better placed when they look at the rest of the world.

What's happening not only within emerging markets, but if you compare the larger top five global economies of the world, they clearly also feel that India is better placed. Having said that, a lot of these guys are fighting their own challenges at home and so right now the bigger priorities what's happening.

And of course, there are larger allocations in developed markets and in markets like China within the emerging markets which are not doing well. So, for them lot more attention is going there and also the fact that they are not seeing this kind of fixed income needs. So, that is also a little bit of a challenge in terms of the cost of capital going up therefore equity allocations per se, going down.

So, I think those are the kind of challenges which every large foreign investor that we speak to is facing right now, but relatively, I think over the medium-term clearly India is really well positioned, and that's the feedback that we also get from the investors that we speak to.

Rushabh Sheth: Look, we don’t take cash calls. Our cash will generally vary between maybe zero to six or seven percent at max, maybe in extreme circumstances 10%, because we might have sold a large holding, and we might not immediately be able to buy something to replace it. Again, it’s very bottom-up, there is no cash for saying that I think markets will become cheaper in two months’ time and therefore I will deploy the cash.

In fact, just to give you a kind of example, we have bought something new last month when markets went through the kind of turmoil and from our perspective we are buying for long-term, so one or two quarters doesn't impact us.

Overall, we size our position so we start small with a new position that we buy will be 1-1.5% and then we kind of size it up, if it is a large-cap to 7-8% at best. So, clearly from our perspective this volatile environment is very fertile ground for looking at opportunities.

Rushabh Sheth: So, as I mentioned, the media entertainment is a large holding, pharma is a large holding, communication services/telecom is a large holding.

Financials is generally a larger holding for most of our peers and also in the index has much larger weight, is reasonably small for us, could be less than 10% right now and then we have bottom-up ideas across logistics, auto ancillaries and across the board.

We have an airport play, very unique in terms of the kinds of companies that we often have. We have a small consumer play, so we have bottom-up ideas across various sectors, but these are some of our larger holdings across sectors.

Rushabh Sheth: Wonderful question. Most of the companies that we own in pharma are domestically oriented, so we are actually buying companies which have very strong domestic businesses and that we are most bullish on.

We are not that bullish on the global side of the pharma, it will do well for some companies that we own but it is not something that we think is going to be a major growth driver. According to us, the domestic pharma business will be a large growth driver and that's really what we are playing and those cash flows again are very steady. you don’t see too much fluctuation in the domestic form of cash flows.

Capital allocation was, I think, the bigger challenge for these companies, you know, a lot of these companies had made capital allocation decisions which were not the best and a lot of them have corrected and then the course corrections have kind of ensured that the capital allocation efficiency improves dramatically and I think that is very positive for the whole sector and as visible in terms of their free cash flows as well, as lot of these companies now having zero debt on net cash on the balance sheets.

Rushabh Sheth: Not that I know of it currently. I think our players are more domestically oriented. So again, the PLI is more focused on domestic and export kind of thing. Even if there is something which I don’t know of in one or two of our companies, it will not be something that is very significant for any of them.

So, from our perspective, it is more than existing and the visibility of the future consolidation in the industry. We keep joking internally that pharma is where maybe FMCG was 10 years back in terms of the growth opportunities at least domestically I am saying. And healthcare overall clearly as the economy grows to maybe three-four-five thousand dollars per capita, one of the things that will happen is increase in healthcare spends and the second thing is the consolidation because the top 20 pharma companies even today have less than 45% end of the market. So, you know, for us, I think those are the opportunities we are playing on.

Rushabh Sheth: No, we don't have any presence apart from pure pharmaceuticals right now. So, if you look at total healthcare market, about $40 billion in India, about $25 billion is pharma and $15 billion is everything else including hospitals, diagnostic centres, you talked about.

Our sense is that maybe we were not early enough and valuations of some of these names still look very expensive. As you know, we are more ‘growth a reasonable price’ and underline the word ‘reasonable’ which is very, very sacrosanct for us.

So, I think we are looking at them closely, but we think we are still not in a zone where we can find them attractive in terms of their prices.

Rushabh Sheth: So, to answer the first question everything goes through a cycle. If you look at the media, it went through a very strong cycle in the early 90s up to even early 2000s. When the satellite came through, a lot of these companies which started early like even Zee or Star made a significant amount of money in that cycle. It’s only been the last five to seven years that the media has seen a down cycle, due to various reasons and I mean, I don't want to get into it, but I think the whole cycle is starting to turn now.

So, you see significant consolidation. So, you saw a lot of profitability which attracted a lot of new entrants which led to fragmentation of the market and lower profitability which has now turned, and this is now leading to significant consolidation of the market and hopefully should lead to very strong profit growth over the next five to seven years.

Our sense is that media is at an inflection point in terms of the cycle and our sense is in the next five to seven years we will see very strong growth as the top three-four guys now control nearly 75 to 80% if not more of the viewership share, and the viewership share is not just across linear platforms, it is across digital platforms as well.

Unlike the West, the Indian media companies also control significant amounts of digital viewership as well. So, from our perspective, you are absolutely right, in the last five years if you look at seven years, they don’t look great, but I think that's a part and parcel of a cycle. I think the cycle is starting to turn and we think that there is very interesting opportunity for top three guys to control 75% plus of the market.

We own the broadcasters to answer your second question and some bit of cable companies because cable has a very interesting play on the broadband and broadband is a very, very large, and significant opportunity, which will play out over the next decade.  So, cable will give cash flows and broadband will be the main driver.

Rushabh Sheth: GEC is one part of every broadcasters bouquet. You are absolutely right that what we see on smaller screens is not what we see on the larger screens, and I think that is something which is now well established.

I think all the broadcasters and OTT players are therefore making content, which is relevant to the audience, whether the audience is coming through OTT, watching on the smaller screen or sometimes you come through OTT but still watch on the large screen. So, I think the beauty of the media business is that it is completely driven by content and the content creation is something which the Indian companies have perfected, in the sense that I consider Disney as Indian as you can get, because of their long presence in India, same thing for Sony for that matter.

So, my sense is that the Indian broadcasters have a very good hang on creating content and content across maybe 20 regional languages, which is not easy. Globally, what happens is that you have one or maybe two languages in the country or maybe three at the best. In India, we have 20 languages, and we are creating content across 20 languages, which is not easy. So, my sense is that's a huge edge that the incumbents have over every new guy who comes in on the OTT space and that has started to manifest itself globally as well.

So, after the whole ground Netflix has, it is like the empire striking back. You see Disney gaining market share, Hulu gaining market share, you see HBO gaining market share, even on the OTT side. So, my sense is that you know, in India these guys had little bit of head start because they saw what was happening in the West and therefore, they kind of iterated ahead of the curve in many ways.

So, my sense is that you are absolutely right, the content is different, but the screen proliferation is the next field of operation because first you were only paying for TV on linear TV basis, now you are paying for every possible screen more or less, and that kind of screen proliferation will get big and leverage to the media companies. 

Rushabh Sheth: So, look we have a company in the capex, and we acquired it almost little over two years back when we were right in the middle of covid when actually nobody was talking about capex cycle. That's the reason why we got it at a very attractive price and we made a lot of money out of it.

Yes, the capex cycle has to happen at some point of time. Only thing is that we still don’t know in terms of external environment, which continues to be challenging, especially the external environment from a global standpoint, and any new capex if that’s going to happen also for global requirement, will be kind of take a pause before it actually kicks in. So, the good thing is that the company’s balance sheets are looking very strong so now they don’t need so much of leverage, they can do lot of that capex of their own, without actually borrowing too much and therefore that capex cycle whenever it is trigger can happen very quickly.

But we think that it might be still some time away, because of the kind of external environment we have run into in the last six months. Had the environment been more positive, I think you would have seen a significant conversion of that capex, I think whatever had been planned turned into actual reality. But if you look at the hard numbers, the hard numbers are still not showing any uptick except for the government’s interest there.

So that's the reality on the ground. So, we can debate on the capex cycle; we have been debating on it for a couple of years now but the fact is on the ground, it's still not starting to kick in, at least on the private side but hopefully it will, at some point of time. 

Rushabh Sheth: We think that there is a large opportunity opening out, no doubt. I think this is the first time historically that something like this thing is happening in this country and we have not seen anything like this in post Independent India, the kind of push that we are seeing from the government, and this is completely government led.

At the end of the day there is only one buyer here, there are no multiple buyers here. So, there is only one buyer that decides you know, what is that what I am going to buy. But yes, this one buyer has become very cognizant of the fact that they want it to be manufactured domestically and to a very large opportunity in the long run.

We don't know how this is going to play out. Honestly, we don't have any names right now in our portfolio. We are also looking at it very closely, but we will see how it will play out. At the end of the day the worry still remains about the one buyer, you are at the mercy of that one buyer.

Rushabh Sheth: We bought it for this reason, we bought it for a much lower price before covid and then we had for covid for two years so it kind of went through a lot of pain. But I think you are right.

Airport is a very classical monopoly, duopoly kind of business, at best duopoly. So, it's very rare for you to see three airports in a city, maybe exceptions being London and New York, and a few others.  So, from our perspective, air travel will explode in this country, you will run short of capacity at the airports which were already running short before when covid came and we see every large airport expanding in India to kind off keep up with the capacity.

You will run short of runways, you will run short of parking space, you will run short of aircraft. So, you know, this is one sector where supply will actually chase demand. Demand will be created but the supply will keep on chasing the demand and we think that there's no better way to play than airports. You can play it in multiple ways, but we think that airport is a very good play.

Rushabh Sheth: Absolutely. The company that we own has a 49% stake by foreign multinationals and they are doing very well in their part of the world. You have seen people bid at crazy evaluations for airports which are hardly growing.

So, if you are looking at Sydney, there was a hostile bid for Sydney airport, I don’t remember but by some crazy multiples. So, then covid came, and it was a different ball game altogether but because these are, as I said, these are monopoly, duopoly assets across the world and once you own it, you have a very strong stream of steady cash flows coming to you.

Generally, they don’t get disrupted, pandemic happens once in 100 years, so generally you don’t see these revenue streams being interrupted and the revenue streams are only growing. The airport is only one part, duty-free car, parks, infrastructure around it, hotels around it. It is a whole package that you get when you buy an airport.

Rushabh Sheth: We don’t own any of it. So, it’s kind of an easy answer.

Rushabh Sheth:  That’s a good question. We missed out maybe three years back on IT and then we were playing a catch up and so we didn’t own at any point. So, to be fair we have not owned it since the last three years, and we still don’t own it.

Rushabh Sheth: My sense is that external environment is challenging. That’s the only thing I would say, and we don’t know how the external environment would play out.

I will go back to the question that you asked earlier regarding pharma, I think it applies far more to the IT because more than 90% of their business is from outside India and the environment and the currencies, both are so volatile, which kind of plays a very complex issue from a business perspective. So, that’s the reason why we did not buy when the prices actually declined.

Rushabh Sheth: Look at the end of the day cost of capital is going up. Risk-free rate of returns are going up across the world. Okay, so very simplistically, a very simple capital asset model will tell you that as soon as the risk-free rate of returns go up, the discounted cash flows will therefore take that much more taper.

So, my sense is that clearly the result expectations will kind of tempered down a little bit across the world, on the equity side. On the debt side you are getting the returns which you have not got in the last 30-40 years. So, a lot of people will therefore also balance out the portfolios, maybe increasing allocation to debt because the fixed income gives them a much better return.

So, my sense is that as the risk-free rate of returns go up, the equity return expectation has to be tempered down. I don’t have any doubt in my mind.

Rushabh Sheth: I read all kinds of books. One of my favourites is ‘Thinking, Fast & Slow’ by Daniel Kahneman. I think a lot of people I mean; a lot of investing is far more behavioural in psychology than actual investing because actual investing you can learn very quickly. But it is only behavioural and the psychological part that keeps posing challenges at you, even after 25 or 30 years of doing so. I think that is one of my favorite book, all-time favourite book and other one I really loved is ‘Margin of Safety’ by Seth Klarman.