India's Best Fund Managers 2020

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UTI Mutual Fund’s Ajay Tyagi believes in paying high for quality stocks and waiting long

Faisal Magray

Some may call Warren Buffett a romantic. Why else would he stick to Omaha or say that people thinking well of you is the measure of success. Or is he a realist? What is wrong in living in a place that makes you joyous (even if it means turning your back on the Big Apple) or what is wrong in estimating your life’s progress in affection won? Perhaps the ways of the world make better sense when inverted, like the Oracle of Omaha does. 

Therefore, when Buffett preaches patience, you listen closely. His investment strategy is simple — to buy a handful of good quality stocks and hold on to them “forever”. In one of his annual letters, Buffett wrote, “When we own portions of outstanding businesses with outstanding managements, our favourite holding period is forever.” He learnt this from veteran American investor Philip Fisher, who was renowned for advocating the long-term investment approach in the 1930s. Fisher famously held on to Motorola, which he had bought in 1955, till his death in 2004.

 Ajay Tyagi has been fascinated by this investment strategy since his college days. When he started his professional career as an analyst at UTI Mutual Fund, he continued reading about Buffett’s investment philosophy and sifted through his annual letters dating all the way back to the 1970s. And then around mid-2000, Tyagi heard about Fisher and discovered how Buffett had learnt from him. “Fisher’s philosophy was to be confident about the quality of the business and hold on to it forever,” he says. Tyagi attributes his investment style to Fisher and Buffett.   

Tyagi’s stockpicking and his unflinching faith in “quality” businesses reflect in his portfolio and his investment strategy. When he was managing the India-dedicated offshore fund in 2011, he picked up Info Edge and it continues to be part of his portfolio at UTI Equity Fund. 

In 2011, internet companies were booming across the world. They had superior, non-linear business model that generated strong cash flows. Investment was low, even for promotion or marketing since customer base expanded through network effect. These traits were reflected in India’s first listed internet company Info Edge. It demonstrated a strong discipline of saving and generating cash. The company’s free cash flow was Rs.842 million in 2011, a rapid increase from Rs.326 million in 2009. Its flagship Naukri had a leadership position (70% market share) in the online recruitment segment and its other vertical 99acres was gaining ground in the tough online real-estate space. The online property-listing portal warded off competition from its main rival MagicBricks and had ample opportunity for growth since online real estate space was becoming a two-player market. All this meant the stock continued to scale new heights and the valuation received a further boost in 2014 when Zomato, in which Info Edge had invested, started to grow at a faster space.

 

Tyagi was quick to spot these trends and then held on to the stock even as its valuation shot up. The consolidated price-to-earnings ratio on trailing basis has gone up from 43x in 2010 to 112.34x in 2019. Over the past decade, Info Edge has been a multibagger, giving a whopping return of nearly 14x. The internet company accounts for around 3.35% of Tyagi’s UTI Equity Fund as he is overweight on the stock.

Spotting excellence

While Info Edge illustrates Tyagi’s investment philosophy, how does he pick quality companies with high growth rate? “They must have high RoCE (higher than 19-20%) and cash flow, and should be able to sustain these for a long period,” says Tyagi. He says that, over the last ten years or more, sustainable wealth creators have had one common characteristic — high RoCE. Since he places high premium on cash flows, Tyagi prefers companies that grow organically than those that grow through acquisitions. Further, the company should grow at a rate higher than the nominal rate of GDP. For example, if the nominal GDP of India is around 11-12% on average, then the business must grow at 15%. Once all the these boxes are ticked and the stock is bought, he sticks with it for a long period of time.

This means he does not look around much for mispricing in a stock or for turnaround opportunities. He says, “We are not buying a stake in a business, hoping that the new CEO will make big changes and therefore the company will start to do well.” 

Quality, high-growth companies are expensive but Tyagi insists that they are worth the price. Bajaj Finance is a case in point. In 2016, Bajaj Finance was trading at a price-to-book value of 4.43x, which many would consider to be expensive, but not Tyagi. Bajaj Finance’s loan book was growing at a pace that of strong franchises such as HDFC Bank and Kotak Mahindra Bank. With a relatively small loan book and the rise in demand for personal loans, the company’s assets continued to grow around 30%. At the same time, they managed to keep their non-performing assets low, and hence their credit cost remained subdued. Their NPAs were also kept under check through use of technology, which helped detect early signs of stress in assets. This meant strong earnings growth which helped Bajaj Finance to register RoA and RoE of 3.06% and 21.09% respectively. Tyagi bet his chips on it and it paid off. The company has continued to deliver on all fronts and the stock has given an impressive 66% three-year CAGR return.

Patient play

Tyagi believes in acting boldly and then, the Fisher-Buffett philosophy comes into play. It has paid off many a time, even when things seemed to be going south, like they did with Jubilant FoodWorks. He bought the stock in 2010. The quick service restaurant company was expected to be one of the biggest beneficiaries of the shift towards organised players in this space. But faulty execution such as aggressive expansion of stores, higher wages and rent meant the company’s performance dipped post 2013. 

However, Tyagi didn’t lose faith, stayed put and hit paydirt. In 2017, the management scaled down expansion plans, cut cost and improved same-store sales growth. This reflected in free cash flow, which went up from Rs.179 million in FY17 to Rs.3.06 billion in FY19. In the same period, net sales rose from Rs.25.83 billion to Rs.35.63 billion. Since the turnaround, the stock has given 62% CAGR return. 

Even the best of strategies fail at times. In 2012-13, he had bought into an education company, estimating that “fees are collected upfront from the parents and so cash flow generation should be strong.” Also, India’s young demographics would result in strong growth for the industry and thereby the firm. The prediction about the industry turned out to be right but the company wasn’t up to the task. “Because of faulty execution, the company couldn’t do well and we had to exit,” admits Tyagi. 

Tyagi’s decision to stick to quality companies with high growth rate and strong RoCE means a few sectors, such as infrastructure, commodities, power utilities, oil, gas and aviation companies, are not a part of his portfolio. “We don’t have stocks from sectors which have high upfront investment and therefore have poor RoCE and high debt,” he says. 

Road ahead

Going ahead, what’s he betting on? India’s consumption story, despite the recent slump. “The per capita income is expected to rise, which would lead to people consuming more and better quality products and brands,” predicts Tyagi. The strategy based on this trend reflects in his portfolio with the consumer goods sector accounting for 14.39% of UTI Equity Fund. 

It’s not just consumer goods firms but, he believes, even the financial sector, healthcare and domestic pharma companies will benefit from the increase in spending power. “Ultimately, people will go to a bank to finance a house, car or even an LED TV and mobile phones,” he says. Consumer financing firms Bajaj Finance, HDFC Bank and HDFC are the top three holdings in Tyagi’s UTI Equity Fund. He also sees people spending more on taking care of their health and wellness, and this will have a ripple effect on pharma companies. “India is essentially an out of the pocket market as healthcare and mediclaim policies were not popular over five years ago. But they are becoming more common now and will drive the healthcare sector. This will benefit pharma companies too and so I am focusing on domestic companies rather than US-centric ones,” he says. 

At a time when auto stocks are being looked at skeptically, Tyagi is hunting for quality, high-growth ones in this beaten-down sector. He stresses that the auto sector is facing a cyclical downturn and not a structural one. “People don’t want to spend on high ticket purchase such as a car because of a combination of factors such as job losses and slowdown in economic growth. Also, NBFCs have gone off the table as a source of funding. Adding to this, the country is moving from BS-IV to BS-VI, skipping BS-V. This has created confusion. So customers want to wait for new engines and then buy vehicles,” says Tyagi. In an earlier interview, he had said that auto stocks are close to the bottom, if they have not already passed the bottom. The recovery, according to him, will come through in the fourth quarter of FY21 and first quarter of FY22. 

Electric vehicles are still a long time away, according to him. “In India, if you make consumers spend an extra Rs.50,000, the demand will drop. I don’t think it’s a priority for the government or that the consumers are ready for it. It may happen in India in phases and in areas that have charging station at depots for three-wheelers, scooters and transport buses. But for all the other categories, creating charging infrastructure won’t be easy,” he says.

Tyagi’s UTI Equity Fund, which is a multi-cap scheme, has successfully beaten the BSE 200 over the past three years. The scheme has delivered a three-year CAGR return of 14.58% against 11.53% CAGR for the Index. Can this winning streak continue? “We don’t take any steps consciously to mitigate risk. It’s inbuilt into our philosophy. Because of the sharp focus on cash-generating businesses with low debt, the overall risk of the portfolio reduces. The beta of our fund is around 0.8,” explains Tyagi. And evidently, the low risk, in this case, has translated into high return for the quality hunter.

 

 

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