Until a few years ago, there were 100s of hidden gems/emerging companies available at throw-away valuation, however, since the beginning of this bull market in mid-2013, all those low hanging fruits got slowly taken out. As always pendulum did not stop in the center rather went to other extreme re-rating emerging companies to astronomical levels (~2x of their larger peers).
There is a difference between a great business and a great investment- no matter how attractive a business may appear, as investors, we have to be cognizant of the price we are paying for it.
Every market cycle teaches the same lesson to new investors, whether it was those who bought Technology, Media and Telecom (TMT) stocks in 2000 or Infra in 2007.
Realizing this we also started exploring large caps over the last couple of years. However, when investing in large caps, there is no information arbitrage as these companies conduct regular conference calls/analyst meets and share detailed investor presentations & annual report. Large institutions like domestic mutual funds and FIIs own large chunks and 100s of sell-side, as well as buy-side analysts/sector experts, track every minute development in the company very closely. Since they are fairly liquid the new information gets quickly adjusted to stock prices. All this makes investing in large caps very different from emerging companies in small & mid-cap space.
The mantra which we believe works in large-cap investing is to go contrarian- when you take out sell-side reports on a business and most of them are negative, that’s the time to look at it.
You don’t have to be contrarian for the sake of it, rather you have then try to understand the business better than others and look for green shoots. You generally get such opportunities at very attractive valuations as nobody is interested in them.
One such business where we deployed 8% of our portfolio in Mar’16 is Crompton Greaves. We bought this pre-demerger at Rs 146 and sold both entities at a total price of Rs 292 during Oct’17, a 100% gain in 18 months.
Markets were too worried about the group level issues, however, we focused on 1). Value unlocking of consumer business with new management 2). Revival in the domestic power sector and 3). Restructuring of overseas operations to clean balance sheet.
Under Consumer Business, CG sells every year more than 1 Cr. fans and commands a whopping 25%+ market share while the market share in water pumps is 27.5% and in LED and conventional lighting it is 10%. The business has strong competitive advantages – a household brand which is 75-year old and country-wide distribution network which reflects in negative capital employed (not just negative working capital). This essentially implies theoretically it could generate an infinite return on capital employed.
Under new management, we expected a renewed focus on branding, new product launches and premium products to aid margin expansion, over next 18 months this played out as per expectation.
The thesis on the B2B business side has also been playing out, however the story has now caught market fancy re-rating both businesses handsomely. CG Consumer has now become a consensus BUY with valuations already discounting all the positives, which is why we decided to move out and switch to another contra large-cap opportunity we found in 2017 where risk-reward is very favorable with strong potential for earnings growth as well as re-rating.
The initiating coverage report on CG Power and CG Consumer which includes in-depth analysis of both businesses and scuttlebutt insights is now available to access for free under our guest user account:
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Disclaimer: This is not a recommendation to Buy. Read complete disclaimer here.