Being a Tata, Birla, Ambani or Mahindra Group company is not enough for this Indian fund manager

• If you look at the conglomerate in India, they have historically struggled to generate a return on their capital above their cost of capital, said Saurabh Mukherjea.
• Business Insider caught up in an exclusive interview with Saurabh Mukherjea, founder of Marcellus Investment Managers and posed the following questions.

“I haven’t yet found a company in India, which manages to do more than two things well. I am looking forward to the day where I can find an Indian company which can do three things well,” Saurabh Mukherjea, founder of Marcellus Investment Managers, told Business Insider in an exclusive interview.

One of India’s popular fund managers with money worth ₹3,000 crore for investors, Mukherjea explained why he doesn’t like some of the country’s marquee conglomerates.

At a time, when most of the traders and investors are seeking the safety of trusted brands and companies that are part of India’s famous business houses, Mukherjea strategically avoids adding companies from the Tata Group, Reliance Industries, the Aditya Birla Group or the Mahindra Group, to name a few.

You can watch the entire interview here.

These are the edited excerpts from the interview.

• A company like Reliance, which is a competitor in possibly 7 out of 10 spaces you look at from telecommunications to oil and gas to retail and everything. How does it affect other smaller players in those segments?

If you look at the conglomerate in India, generally, not just Reliance, you can take L&T, you can take Hindalco, you see conglomerates in our country have historically struggled to generate a return on their capital above their cost of capital. The simple sign of an effective company which is able to build barriers to entry, the return on capital is consistently above their cost of capital. Conglomerates in our country have struggled to do that. And, I can extend this to even say that the great Tata sons barring TCS, it’s difficult for them to generate free cash flow in the modern India paradigm, they are finding it hard to generate cash flows. They have one or two businesses which shrug out lots of cash, and there are 4 or 5 businesses which guzzle up the cash. And, you as an investor are left none the wiser and our preference, therefore, is to focus on companies which do one or two things well. I haven’t yet found a company in India, which manages to do more than two things well. I am looking forward to the day where I can find an Indian company which can do three things well. So like page Industries, undergarments and loungewear are right, but as soon as you give them three things to do, that one thing is too many. So in that context conglomerates are best shied away from.

Company	Stock returns in 3 years
Tata Steel	-33.24%
Tata Motors	-74%
TCS	78.37%
M&M	-15.10%
M&M Finance	-51.24%
RIL	168.85%
Hindalco	-28%%
Ultratech	-1.7%
Grasim	-44%
ITC	-30.97%

• So you are shying away from conglomerates?
  I think when they generate free cash flow, we will truly, happily look at them. But until such day…
• But that is an opportunity wasted, especially with the stock like Reliance in the last 3-4 months?
  Think about it like this; if a company is a consistent compounder and keeps compounding in the three-four months, I see the free cash flow compound with them. Be it any company, and I am deliberately focusing on all the mighty names. The Tata’s, the Birla’s, Reliance, L&T, and Mahindra’s these are all mighty names. They are the founders of modern India. Free cash flow is something they find hard to generate illusively. It is elusive because we can very quickly see with all of these firms, one or two fire great guns and other ones guzzle up the cash. And the minority investors are left sort off looking for a consistent compounding.
• Is that a reason you left ITC as well? You moved out of ITC?
  ITC, in a way, is a good amplification of that. In a sense, our reckoning was for companies which can do two things well, and ITC can/does cigarettes very well. I think the ITC’s cigarettes cash machine is the mightiest cash machine. In FMCG they were increasingly being successful. And, I think they can continue building the FMCG franchise under the leadership of Mr Puri. The recent acquisition is probably a sign of many more such successful FMCG acquisition to come. But, where we were not able to convince ourselves is with this twin-cylinder engine ITC could gun out 20% earnings compounding. That’s the basic test a stock needs to meet for us. We need to see free cash flow generation, which gets further invested in giving us a 20% earnings compounding.

ITC	Particulars
Last 3 year’s stock return	-30.97%
FY20 free cash flow growth	30%
FY20 FMCG segment growth	5%
FY20 cigarettes CAGR	4.70%

• What makes HDFC Life Insurance a ‘consistent compounder’ in your view?

Obviously, HDFC Life went public a few years ago, and we worked on it for a couple of years before we gripped on the barrier to entry. The barrier to entry here is around technology, around data analytics. But we needed to convince ourselves that there is one. The management obviously if you talk to any company management they will say we built the world greatest company. It comes on us to go check and validate that company both from financial statements and from primary data analysis from distributors, ex-employees and competitors. So, HDFC passed that assessment, and it entered our portfolio.

• So, would you never invest in a disruptor?
  Disruptor is also a thought which I can’t entertain. Our job is to bet on continuity on consistency. My job is not to bet on a new debutant, saying boss, great Ranji track record. My job is to give it 4 years and one-day international cricket until he is proving as the next Virat Kohli. Then we set him to the team that we checked out that he did well in school cricket in college cricket, in Ranji cricket and after 4 years of international cricket, he is hitting out of the park.
• Where you see opportunities in India’s internet businesses, both tapped and untapped potential?

You know the way we think about technologies is we are not so much interested in going to California— if you put it in the Californian gold rush context. Our job is to sell the overall boots and spades. So Asian paints is a technological company, but superficially it’s a paint company. Bajaj is a big data company, superficially it’s an NBFC company. And, HDFC bank is a hi-tech company, Dr Lal path labs use heavy tech to optimise the business, so basically it’s a hi-tech retailer rather than a path lab. Our focus is on finding companies which use the available technology incredibly well far more than anyone else. Our desire is not to find the latest greatest tech company. And, those who are in the area of the latest tech companies they will have to convince people and us that our latest tech companies compete with Google Facebook and Amazon in whichever segment they are in.

Company	Stock returns in 3 years
Asian Paints	48.10%
HDFC Bank	16.20%
Dr Lal Pathlabs	125.90%
Bajaj Finance	87.96%

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