First Mover

Dhiraj Sachdev of HSBC learnt his lessons very early when he bought his first few stocks about two decades ago. While he was working with India Infoline as an analyst in the early ’90s, he picked a hardware company HCL Infosystems, where he went on to lose money. “In a hardware business, I did not realise that the character of the business was entirely different. Hardware is a business characterised by falling prices on rising volume. So, you are constantly on a treadmill as a result of competition. One of the biggest learning was that you cannot get attached to a stock and hope for a recovery. You need to cut your losses when things are changing. If the facts change, you need to change,” says Sachdev.

Nevertheless Sachdev’s regret was partially negated with handsome money he made in a software company. “Around the same time I also invested in Infosys. I liked the IT business since there was no need for major capex and India’s IT skills were getting demonstrated. It was a scalable business, extremely capital efficient and generated a lot of cash. That coupled with the huge IT outsourcing opportunities in the US excited me,” says Sachdev.    

Immediately after completing his Cost Accounting and Chartered Accountancy course in the year 1997, he joined India Infoline as an analyst. “Being a chartered accountant and a cost accountant I could have joined some manufacturing firm which would have paid me better but the interest in fundamental research held me back,” says Sachdev. “It didn’t pay very well so you had to have a passion for what you were doing. In fact I had shifted to an IT company after a brief period. However within six months, I realised that it was not my cup of tea. My interest and passion was always in equities, so I returned to the capital market,” he adds.

Sachdev, who is 44 now, realised the importance of research early on. While in India Infoline, he did a lot of primary research on industries and companies. Meeting managements, forecasting financials and writing detailed reports on companies helped him understand how companies worked.

This laid the foundation for his journey into investing. Sachdev joined HDFC Bank in 1999 as head of research in private banking and treasury. As part of the treasury team that managed equity investments, it was his first brush with managing a portfolio. Sachdev spent close to 4 years and picked up and advised clients on stocks like L&T and PSUs such as BHEL, BEML. “Around 2001 and 2002, everyone was running behind tech stocks. On the contrary we invested in some PSU stocks and others that were trading at very depressed valuations. They were really cheap and offered a lot of value,” says Sachdev.

 The biggest breakthrough in his career happened when he joined the PMS of ASK Group run by Bharat Shah and Sameer Koticha in October 2003. Sachdev says much of his investment strategy and the process of picking winning ideas was developed at ASK. Sachdev joined HSBC Asset Management in October 2005 as head of equity portfolio management services after spending two years at ASK. But the two years had a huge impact on his investment thought process. “At ASK, we used to have a collective approach where the entire team shared their individual ideas, helping build a bigger perspective. If you are specialising just in one or two sectors you cannot appreciate or gauge the opportunities in other sectors. However when you share your ideas across sectors, many ideas, which you may or may not have looked at before, come up. That sharing of knowledge really works in the equity business,” he says. 

His investment mantra is simple — buy growth, be early in the game and buy at the right price. The fund bought PI Industries in early 2013 when its market cap was less than Rs.1,000 crore. It is now close to Rs.12,000 crore. The company which is into crop protection and specialty chemicals gained prominence due to under penetration and low awareness about crop protection. PI Industries sourced molecules from Japanese companies to help improve crop yields for Indian farmers. Besides, its specialty chemicals business, which supplies agrochemicals molecules to global companies, benefitted due to increased outsourcing. 

Sachdev believed that there was a good growth opportunity in the agrochemicals business. This was also reflected in the numbers. Since FY12, the company has grown its sales at an average of 24.3% and profit by 32% every year. The company saw its return on equity (RoE) improve from 23% in FY13 to 31% in FY16. “Strong earnings growth and attractive valuation is a deadly combination for any stock. Think of a scenario where the earnings are compounding at the rate of 20-25%. Expansion in price-earnings multiples driven by earnings growth alone would multiply your stock return,” says Sachdev. Besides PI Industries (9x) stocks such as NBCC (8x) BEML (8x), HPCL (8x) Motilal Oswal Services (3x) and few others have worked wonderfully well for his portfolio.  

According to Sachdev, if you are able to buy the right company, the portfolio works for you, you do not have to work for the portfolio. So, how does he find the right company? Sachdev says he follows what he calls the MBV framework; management, business and valuation. When it comes to management, he tries to understand their pedigree, competence, passion to run the business, ability to allocate capital and ethical standards. While they are subjective, he believes these qualitative aspects are important. The second aspect is the business potential itself. He checks if the opportunity for growth is large enough, whether the business is scalable, demonstrates superior capital efficiency and generates cash. The third piece of the puzzle is the valuation: at what price should one buy the business? Whether there is enough margin of safety. Here, he looks at RoE and valuation ratios like price to book and price to cash flow.

While many of the stocks that passed through this filter such as PI Industries, NBCC, Motilal Oswal and few others have done well, Sachdev has reduced their weightage in his portfolios in recent times. “It is the whole process of portfolio management. Some of these multi-bagger stocks where we have reduced our exposure are now playing like Rahul Dravid for the stability of the portfolio. You have to keep on searching for the next Virender Sehwag, Sachin Tendulkar, Yuvraj Singh. A part of the portfolio is always reserved for a emerging player. If you buy all the popular names for the portfolio, you cannot generate alpha,” he says.

But selling winning stocks comes with its own disadvantage. The fund sold some of its good ideas like Bajaj Finance very early. When he entered the stock, the market cap was around Rs.600 crore compared to its current market cap of Rs.60,000 crore. Had he not exited the stock it could have given a 300x return. Sachdev initially bought into Bajaj Finance to take advantage of long term growth, which was largely untapped. Players who had the advantage of technology on their side could now reach customers in more innovative ways. He also believed that gradually NBFCs would take market share from public sector banks. “It was one of the biggest mistakes we made. While we identified the NBFCs and bought it right, we sold too early. Though we got a 3x return, it could have turned to be 100x,” says Sachdev. The learning from the whole experience for him is to stay put in a business that is doing well even if the stock becomes expensive. “Importantly what may look expensive in the near term may still reward you handsomely in the long term if the business has the ability to grow. The market constantly moves from being in an under-valued zone to an over-valued zone from time to time. And when stocks move to the over-valued zone, the tendency is to book profit and take money off the table. But it is equally important to keep reassessing the assumptions and fair value of the business with a long term approach. That is how you get the power of compounding,” he says.     

Sachdev prefers to buy into high growth companies early. And he is ready to pay up for growth because he believes that the real return is made when you are early in the game. So, would he buy something that is cheap but may not have a great growth story? “That’s possible. We bought an oil lubricant company before the business was being split up. It was available at a market cap of about Rs.1,100 crore. Now after the split, the oil lubricant business has a market cap of Rs.3,500 crore and the business that was spun off and listed separately is valued at Rs.1,700 crore. That is almost Rs.5,300 crore or 5x in three and a half years. The lubricant business was growing at low double digits. But we knew there was great value. It had an RoE of 60%, generated free cash flow and was the second most prominent brand after Castrol in its space. The market was mispricing it. There was an embedded value too of the separately listed business and a land parcel that the company owned.” The company in question was Gulf Oil, which demerged its lubricant business in January 2014. Before the split, the lubricant business which was earning a better return and generating cash was overshadowed by the other loss-making capital intensive businesses such as infrastructure, real estate and mining. Post demerger, the market’s apprehensions eased and the lubricant business got the higher valuation it deserved. “We look at the holistic picture of the entire business. Even if growth is low but the valuation is attractive, you can still make money. We don’t mind buying such companies. However one caveat here is that the quality of the business should be high so you are not falling into a value trap,” he points out.

Another stock that he picked using this filter was Motilal Oswal Financial Services, which is also the largest holding in his mid-cap fund, accounting for about 5.31% of assets managed. “In 2014, no one really wanted to own broking businesses, which were trading at throwaway prices. We bought one of the leading broking houses at the time when it was available at a market cap of about Rs.3,000 crore. We were getting a great business run by a capable management having several growing verticals like investment banking, home finance and others. Today that business is worth more than Rs.9,000 crore and we still own that,” he smiles.

Sachdev also ventured early into some PSU companies such as NBCC and BEML sensing they were sitting on huge growth opportunities. “When we bought the government-owned civil construction company, it was 1/7^th the price today. Our investment premise was that the government has a huge land bank and it would continue to require a construction company acting as a nodal agency for the civil work,” he says. There is a huge opportunity for government-related civil work with respect to low-cost housing and others. Compared to its sales, it is sitting on a huge order book, which provides very high revenue visibility. His fund has been holding NBCC for a long time now. The company reported an order book of close to Rs.75,000 crore which is more than 12x FY16 sales. It is a debt-free company, has negative working capital and generates free cash flows, which is largely distributed through dividends as the business requires almost zero capex except for its own real estate. The company is a civil services consultant and service provider, which award projects to other civil construction companies on behalf of the government. It gets an advance from the government and the capex is undertaken by the developers to whom it awards the projects thus making a consultancy revenue.   

Sachdev continues to look for absolute opportunities. While some of them have worked well, some have contributed more to his learning like J&K Bank which the fund has now completely exited. “We kept away from the PSU banks and invested in private sector banks that met all our hygiene factors. However in this case it did not play out well for us as the bank was hit because of its corporate loan book. Moreover, we thought the opportunities in NBFCs on a relative basis were higher so we switched to a leading gold loan provider,” he says. The fund entered Manappuram Finance in March last year and now has 4.29% allocation. Since then, the stock has delivered a 3x return. On the contrary, J&K Bank is trading at the same level of Rs.68, making it seem like a smart switch. 

While the fund was able to exit J&K Bank well in time, some other stocks like Sanghvi Movers, Inox Wind, Ramkrishna Forgings, Aban Offshore, GMDC and Power Mech Projects have been dragging the fund’s performance. “That part of the portfolio is largely stocks whose fortune can be reversed with the revival in the industrial cycle,” says a hopeful Sachdev. He believes that these companies have all the right ingredients. Most of them are number one or two in their segments and once the recovery happens they will benefit as a result of higher operating leverage. He expects this to happen from the next fiscal as the capex scenario is already improving helped by government spending. He expects private capex to kick in over the next 9-12 months leading to a overall recovery in the investment cycle. 

Sachdev is an avid follower of leading investor Howard Marks of Oaktree Capital. He hardly misses his investors letters, which he describes are full of knowledge and wisdom. If there is one thing that he lives by, it is Howard Marks’ rules for investing — “Rule No.1, most things will prove to be cyclical. And rule No.2, some of the greatest opportunities for gain and loss come when other people forget rule No.1.” And so far it has worked really well for him.