Raising money was the easier process in 2016 and 2017. Deploying money was more difficult. Today, it is rightly balanced out, Kenneth Andrade, Founder & CIO, Old Bridge Capital, tells ET NowEdited excerpts: Is it true that you are still running a portfolio with no financials in them? Yes, since the inception of the portfolio, we have not had a single financial named up there. The space where you hunt — the smallcaps and the midcaps — has corrected. I interacted with you closer to Diwali last year and at that time you were not very gung-ho about the valuations. Do you have decent enough confidence and lot of margin of safety to be a buyer once again? Over the last couple of years, markets have been getting a lot of liquidity. There have been no alternative avenues to deploy incremental capital and most of the money has come into equity assets. It has been a challenge to put a portfolio together because you are always chasing good names and quality names which is bidding up the prices or the valuations. Since start of this calendar year till date, things have ebbed out a bit. For the first time, there is a lot of comfort in terms of visiting new business opportunities, taking time to evaluate how sustainable their business models are and how strong their cash flows are. This is a market that works for long-term investors. As I said, the valuations may not have corrected that dramatically but it is giving you time to put your process into play. Going by the corporate India stance, a big part of that balance sheet clean up is already over. The amount of cash that is getting generated in the individual balance sheets are far higher than what was seen in the last couple of years. And this is after you had big financial events happening on ground in 2017.All put together, the environment for investing is extremely good. Not the entire market is up there. There are a large number of companies that are hitting 52-week lows and some of them are hitting all-time lows. These are good businesses and industries which are significantly large. So yes, it is moderately better in 2018 and I am sure if you get a portfolio together this year. the next couple of years should not be such an issue in terms of generating incremental returns. Do you think that the fall that has gripped the midcaps for the better part of May is over and done with? What signs are you picking up that led by variables, you might see midcaps and smallcaps bottoming out with a large portion of the selling being done? There are two elements to it. One is the liquidity that is coming into the cycle. By liquidity, I mean the amount of stocks coming into the cycle and the fundamentals of the business itself. As far as liquidity is concerned, over last two-three years, mutual funds have gotten a significant amount of capital on their books and they have been deploying money into this part of the market. The cycle started off in 2013. So, midcaps and smallcaps started off in 2013 and then on, there has just been a secular run in businesses. Earnings went up. Also, you had valuations steer up. All of that was corrected this year. We need to look for a bounce-back in profitability or earnings. We are seeing that stabilise in FY2018 and FY19-20. Even if profitability goes up by 5% or 6%, which is equivalent to GDP growth, what happens on the denominator depends on the capital employed. Since the capital employed is going to remain static, it effectively means that your return on equity and your return on capital employed is moving up. All the companies that you are talking about, whether they are largecaps, midcaps or even smallcaps, the incremental capital efficiency is going to remain so elevated that a lot of these companies will command a premium in the environment. I am not too worried about quality businesses or good companies out there, going lower in terms of price earnings multiple. I want their profitability to bounce back significantly over the next four-year period.Let us drill it down to specifics because as part of your commentary, you have no investments in technology, pharma and financials. One of your holdings is Hathaway Cables and Datacomp. Explain the rationale because this is a business where a lot of capital is pumped in. It is of long gestation and the costs are high. When we invest capital, we tend to believe that the businesses are at an inflection point where profitability will be ahead of the capital deployment. The capital intensity of the business is not going to go away but incremental number of subscribers that will come on book are going to be reasonably slower than what you have seen in the past. A lot of the build-up of the debt works have already taken place and that is what is happening with the entire space out there.A large part of the networks are already built and most of these companies and most of the assets are already positioned in terms of monetising them over the next two or three years with new streams of revenue and new streams of business opportunities.From a price point and from a replacement cycle also, some of these companies are trading at virtually replacement cost. That is what we like about any business which we touch and this is one business that fits the requirements. As the whole environment is stressed, one cannot get hypercompetitive which means in the medium term, you will have some incremental pricing power. All of that will go to the bottom line that is as far as the income statements are concerned. On the balance sheet side, you have already seen a large part of the investment already in play. So, balance sheet growth will not be as high as you have seen in the past. These are two variables that we look for in any of the categories that we invest in and that is how we put most of our money to work. Currently. markets are rewarding companies which are growing without raising capital, consumer companies may be brand owners. What is your view as you have owned some of these names in the past? Companies like Titan, Blue Dart, Nestle and Page Industries what is happening to that end of the market because markets are giving disproportionate amount of weightage to companies which are growing without raising fresh capital? We were fortunate to be in that decade where the entire consumer basket was going through a cyclical low. In the beginning of the decade or the beginning of the century, companies were struggling with single digit to almost negative growth and we identified a business which is going through a cyclical down cycle and all the consumer names fitted in there. At the same time, a lot of these companies had already consolidated their businesses and they were throwing on enormous amount of cash but the markets lack growth and so they were not getting priced in. The result: you had a lot of the infrastructure businesses and cyclicals getting priced at secular valuations. An infra contractor virtually got valued at 20 times earnings while some of these consumer businesses were getting priced between 12 times to 20 times earnings and they were throwing out cash. We had an arbitrage of valuations there which as an organisation we put to play.Consumer names with high efficiency on capital were available at that point in time and the difference between them then and now is that the price earnings multiples have become higher and as an investor I am not willing to make money from buying a business at 30 times and 40 times multiples. In a country like India, there is a linear growth in demand and a lot of these companies will continue to grow but as an investor, I need low valuations to start with. But such companies have low growth as well. once we position a portfolio in an industry with both these characteristics. When the cycle comes back, then growth goes higher and price earnings multiples expand. We need both these variable working for us to create the long-term compounding story and we have been finding small pockets that exist in markets. We have been able to find it in virtually every cycle. Is this one of those markets where you are feeling like a kid in a candy store? You want to buy everything but you do not have the money to buy everything. I do not think that is the case out here. It is a fairly well discovered market. I do not think there is anything that is not discovered in capital markets today and the easier process in 2017 and 2016 was raising money. Deploying money was more difficult. Today, it is rightly balanced out. You are still getting long-term capital that is coming on book. The ability to buy companies is eased out a bit at this point in time but I cannot say, I feel like a kid in candy store. It is not that environment. You typically like to buy bad news when it is temporary in nature. Let us say you bought into agrarian and rural businesses a couple of years ago because you saw that as the bombed out part of the economy and if that problem becomes better, then the enablers will start making money. Have you identified any other similar theme? It has been just about two years since the rural theme has been in play and that trend continues. In 2017, a lot of these companies had valuations that went against them. All of that has normalised in 2018, which is a good point. From an industry standpoint, there is no fresh capacity that has come into the system in any of those verticals that are there. From a long-term perspective, supply is still constraint, demand is a question mark and if demand grows higher than what supply is coming in, that part of the economy can still expand itself. We all tend to look for is where the supply constraints are and if demand is growing faster than supply over the medium term, that is where the industry has pricing power. We find it in power generation and utilities to an extent. We find it across the media chain because last year was brutal as far as the environment is concerned for both advertising and media businesses. Consumer stocks have bounced back currently. They are almost mid cycle in terms of their rebound. There are spaces that exist. It is not the simplest of markets currently but it is much better than it was in 2016 and 2017 for putting a portfolio to work. You mentioned that some pharma stocks or companies may make a comeback. Qualify that statement. What kind of businesses do you think would be able to work their way through the problems that they are facing with the US FDA back home and the pricing in the generics market overseas. The rupee’s weakness would help in building their competitive advantage towards other supplies in emerging markets. But where is the turnaround expected? The first thing to look for is leadership in the entire industry losing profitability. When that happens, usually the bottom end of the entire market or the bottom end of that industry bombs out and no new incremental capacity comes on board. You are mid-way through that down cycle as far as the pharma business is concerned. We have avoided that segment for a long period of time but we are looking at individual businesses that are not going for further capex. So, that is the first check box. Second, a lot of existing capacities have started generating revenue though at a lower margin and that puts pressure on a lot of the smaller capacities out there. From a regulatory standpoint, pricing is coming down. From a competitive standpoint, prices have already come down and that means that no further capacity will come into the cycle. That makes that sector very interesting. You just have to wait for a couple of years for demands to normalise to the new supplies that have come in. Once that happens, some of these companies will come back fairly strongly. We have been looking at elements where there are pockets of opportunity as far as valuations are concerned. We would rather stick with the larger ones though we have not initiated any trade in that sector as of now but the valuations are far better in that business than they ever were in the last six or seven years. The technology business went through a similar cycle two or three years back and we have seen how that as evolved in 2018. It is a call that you take on cyclical downside and put a portfolio to work and that is what we try to do on a continuous basis.