Navigating This Uncertainty Will Be Expensive For Indian Businesses: Kenneth Andrade
Tackling the ongoing uncertainty stemming from the coronavirus outbreak would be expensive for Indian businesses, according to Kenneth Andrade.
“There is a small component that comes in from China and your entire working capital is locked up just because of that small component,” Andrade, founder and chief investment officer at Old Bridge Capital, said.
“If you hit the ground and see the number of smaller businesses that are there, there is an inventory issue and there is a payment cycle that is extending itself,” he said. “That’s going to be a little expensive in the near term.”
And this has come at a time, especially for India, when "bottom-end" corporates are struggling with higher working capital requirement, he said on BloombergQuint’s special series ‘Navigating Through Uncertainty’. “So the timing of this is probably not perfect.”
India’s benchmark indices have tumbled more than 20 percent since their Jan. 20 intra-day peak, entering the bear market. They tracked the worst global selloff since the 2008 crisis as coronavirus threatens to stall trade at a time the Indian economy is growing at the slowest pace in a decade.
Andrade said “none of us knows how it will evolve. The markets may witness issues on the demand side tomorrow if they are seeing supply disruptions today”.
That’s why he is careful in deploying cash in the market. And while Andrade said he can’t predict where capital will go, he cited the dot.com crash at the turn of the century to suggest that “businesses that have participated will get the initial amount of capital until that cycle eases itself out”.
“When tech corrected in 2000, the first that came back was tech before they handed [capital] it over to everyone else… That's how they behaved historically. My sense is it may not be very different this time.”
Watch the full conversation here:
Edited excerpts from the conversation:
Are people second-guessing the impact of the extent of the virus damage to business and otherwise, and thereby, what the equity markets could do in the near term?
Markets are second-guessing in the near term because the experience says so. If you hit the ground and see the number of smaller businesses that are there, there is an inventory issue and there is a payment cycle that is extending itself. That’s going to be a little expensive in the near term. Practically, some challenges are there in the near term.
It works this way: there is a small component that comes in from China and your entire working capital is locked up just because of that small component. Everyone is reacting to that environment.
There are near-term challenges and it will be a little expensive to navigate through it. But I don’t think it is going to be perpetual.
All the conversations we had with the companies in February suggested that they have inventory till March or even April and if the situation worsens, then we don’t know. But the point is even if China may be limping back to normalcy, it is spreading at an alarming pace across the world. It’s not a financial responsibility that we give to this right? We don’t know what the extent of damage could be. Would that be a fair assumption?
Yes. We do not know as to how this will emerge in the medium term. Today, you have supply-side issues, tomorrow you will have demand-side issues. Because it’s more from the supplier to where the demand is. So none of us knows how it will evolve itself.
One thing we need to take for granted is it is going to be expensive navigating through this cycle. We probably will not go back to the way the businesses are done in the past.
But not perpetuity in the near term.
I hope it is not.
What is the second-order effect of this? One is that the company will have to let go of some demand if there is demand and if they cannot meet supply. But I heard you mentioned that it is going to be expensive to navigate through this because the company will have to arrange an alternate source of back-end supplies, manpower issues, or a mix of everything, including a higher cost of credit as well. What is it?
One is that the payment cycle is going to get delayed. The inventory cycle right now is high and will get higher if you have to restock and make sure that these contingencies don’t evolve. Your credit cycle has to come back to normal.
This has come at a time, especially for corporates in India when the bottom-end of corporate India is struggling with the higher working capital requirement. So the timing of this is probably not perfect.
OPEC has done its bit to add to this volatility as well. How critical or important from sentiment stroke are the perspectives you give? The larger argument is that the crude fall is great for India and it is. But for businesses, for the companies that you look at, how does this volatility matter?
It matters for the economy as a whole and the global economy as a whole. When you look at the energy prices are falling, energy prices are the largest part of your expenditure basket and that has a deflationary impact on the cost of manufacturing. If the amount is passed on to you, i.e., the drop in crude prices is passed on to the end-user, that is a question mark when it comes to the economy which is struggling with their deficits.
The falling crude prices are good for certain segments of the economy or the part of the economy. But if it is not passed through, I think corporates will not be able to pass on the incremental cost down to their end-user. So it is a global shift in pricing and it has to come down as it is deflationary.
How confident is an investor about his/her assessment about what could happen next? With the confidence taking a bit of dent right now and is it difficult to predict what would happen next? Would you reckon that the money would move towards safe havens until all of this subsides, and therefore, is that net negative sharply in risky assets including equity?
First, you have to define risks as to where the assets trade and then probably find your haven in those assets. Traditionally, every market is to buy low and sell high. And once you have done that multiple numbers of times, we know essentially how the returns will get generated over the long term.
Today, we are in an environment, where, in the “risky assets”, the flight of capital is from those to something else. So there is always a bubble gazing created at the other end of the flight of capital.
This is an ongoing process. To measure all of these, everyone uses a certain quantitative factor called valuations.
But purely from a numerical point, not just from India, but also globally in equities, you've got indices coming back to 2007-08 levels and in the last 10 years, we have indices that would have returned a little lower liquid fund returns.
So I’m sure from the peak of 2007, we are a lot better.
From a number point of view, the peak number of companies that made losses were in 2017, compared to where we are today. I believe that they are already behind us unless there is some unquantifiable event or a prolonged lockdown of global trade for a while.
So that’s how the environment is emerging.
Now whether the risky assets are priced in, you probably may have some way to go. But, I sense that you are mostly there and when there is so much noise on the street, usually, these asset prices find their bottoms.
You would sense that because it is nearly impossible to time the bottom all the times, maybe a good strategy is to stagger out the purchases if you want to. But try and find the value because as you mentioned that the risky asset is risky at particular values at certain valuations, the risky asset also becomes safe. And we might be in that zone right now for equities.
If you look at individual companies that are there, I think you will go back to the granular level of corporate India.
When you put down most of the commodity businesses, they are already trading at a book or below book. When you put down most of the utilities, they are trading likewise. When you come to the financial system, except for the five large banks, not even large, I mean most of them are in the private sector, everything else is around the book or below book. So you come to a situation where how do you define valuation.
The problem remains is why we are here. This is because there is very little underlying growth in the recovery and that is not a quantifiable or a predictable number.
And there is a flight of capital to another extreme side of the market which is perceived to growing or to be safe. That's what is happened.
But from a balance sheet perspective, we have come a very long way.
At least on the asset side of India, manufacturing and commodities, etc., a lot of companies have gotten the act into place and have been cleaning up except for the period of cleaning up has been extremely prolonged. The entire risk is transferred to the financials or the lenders or the capital providers and we are seeing that.
Once we find a solution for that, what we need is the transmission of the interest rates to the end-user.
Once we have it, we will start the cycle all over again. The timing of the cycle is going to be next to the near-medium term.
To somebody like me, when I look at the situation, the reason why I think its a bit different. We have a situation wherein growth domestically is sharply contracting or has contracted. At least the headline numbers suggest that. We have money flowing out from all emerging assets, and not just India. In the past, whenever we had these issues, demonetisation or IL&FS, etc., wherein we have seen some risk aversion, the global markets were at least a lot more stable. But this time, it is not. A lot of people are predicting that Trump’s announcement or a coordinated action by central banks to turn this around. Do you think it could be s simple? or not?
I don’t think it will move in any orchestrated manner. Each economy is struggling with their issues. If you go back to the liquidity crisis you had in 2007 or 2008, it was the world’s largest economy that went to the cycle. But here, the smaller economy is going to the cycle and we all have to individually deal with it.
It will hurt the largest economy. But they are also in the election year.
My sense is, it will behave differently compared to the past and more or less it should ease itself rather than give you a very V-shaped recovery. Of course, there could be a minor blip in the large recovery because you will always get a valuation bounce. And then you will separate the growth companies from the rest. And that's how it moves on.
If you are getting fresh capital or if you are sitting on cash, are you now in the throes of trying to deploy large oodles of it or are you staggering out your purchases?
Firstly, there is less capital which is available. If there is anything on the sidelines is now as good as tomorrow.
If you get it, would you be happy to deploy it?
Carefully. No doubt about it.
So you are finding value.
Value has been there at least for the space we have been operating for the last 12-18 months. If it only accentuated itself right now and that is because we have been through this before as there is no growth in the underlying economy. If you price these companies around 8x or 5x, there is no answer to that.
There was a legitimate argument six months ago for buying into value because the ones which were depicting growth and liked by the markets were exorbitantly priced. But by virtue of this correction, even that has come down. Do you reckon that when all of this stabilises, the cash will move back to the companies that have shown performance in the last 18 months?
I am not going to predict where the capital is going to go. But it’s always that businesses that have participated will get the initial amount of capital until that cycle eases itself out. So that’s normally that has happened.
If you go back to when tech corrected in 2000, the first that came back was tech before they handed it over to everyone else.
You go back to the investment cycles, the first companies that bounced back were all large asset-based companies before the consumer part of the economy or private financials took over. That's how they behaved historically.
My sense is it may not be very different this time. But we don't know what's going to be on the other side of the decade. It might be the same sub-set of the companies. Because if you see every 10-year cycle, the participants and leaderships always change.