Nykaa most likely to emerge as great biz in 5-10 years; still not investing in Reliance: Saurabh Mukherjea

As we are seeing things normalise quite significantly, where would you stand when it comes to multiplexes, hotels and retails?

We never owned any of these things as these had no barriers to entry. We knew it is not very difficult to open a hotel in our country and cannot think of a single hotel chain in Indian history where return on capital exceeds cost of capital. I cannot think of a hotel chain which generates free cash flow.

Similarly, the multiplex chains also struggle to generate free cash flow for very similar reasons. It is true that as the world normalises and we go back on holidays and we go out during the weekends, these companies will do well but can these be bought as a longer term investment? We do not sell companies for over five to 10 years. I am trying my best but I cannot think of a single multiplex or a hotel chain which over the last five to 10 years has generated any free cash flow in India.

What about some of these new age listed tech stocks? Given what we have seen play out with respect to Paytm, Policybazaar as well as Nykaa, where do you stand?
Again most of them do not make any money, have not ever made any money as I have discussed before. Nykaa seems to be the best of these companies. I think Falguni Nayar has built a good franchise, she has build customer captivity as I can see from my own wife and daughter’s shopping habits. So all credit to Falguni and team. They have also built a profitable business but it is early days and we need to do far more work on Nykaa to figure out whether it is an investment proposition. But if you ask me, amongst the IPOs of this season, Nykaa seems to be the best managed and the most likely franchise to build a great business over a five to 10 year period.

Has the time come for you to change your view on Reliance? Maybe that time wise consolidation is finally over?
A lot of credit to them for what they are doing. They are taking up an old style conglomerate which was strong in chemicals and refining and tilting it towards telecom, retail and the modern economy. I do not think I have seen a transmission of this scale anywhere in the world. It is just that the process of changing the engines or jet in mid air is obviously drawn out and fraught with risks. Given Marcellus’s conservative style of investing, we have never quite been able to get our hands around that. So it looks as if that transformation continues to progress in a positive direction tilting Reliance from being an old style chemicals and refining business to a new economy company, but as yet we have not seen the free cash flows emerge from and hence we are still watching it carefully rather than investing.

Are we reaching that typical value zone for good old favourites of Marcellus whether it is Asian Paints or Pidilite? As an investor, are you using the bad news to buy them?

We have been buying Asian Paints very enthusiastically over the last couple of months. Crude is a pass through for well run franchises like Asian Paints, Berger Paints and other holdings. Just to double disclaimer when I say we have been buying them, we are buying them as Marcellus because my money, my parents’ money is also invested in Marcellus. I am therefore indirectly also buying these stocks for myself.

Asian Paints has been here several times before where crude prices doubled in the course of a couple of years. Asian Paints passes the margin impact on to customers, So, the EBITDA margin at around the 20% mark has been incredibly robust for Asian Paints. I think the same will play out again this time. What I think helps an Asian Paints and Pidilite in such circumstances is that not only do the smaller players in adhesives or paint not have the pricing power, they also do not have the ability to deal with the inventory risks that this sort of raw material price volatility poses. So the damage that will be done by the Ukraine crisis to the smaller players in adhesives, and paints will be immense and that further consolidates the position of the market leaders.

As I said, we have been buying Asian Paints fairly enthusiastically through this correction that the stock went through and history shows time and again that the impact of crude is a pass through both when crude is going up and when crude is coming down.