Generating Alpha in India’s dynamic markets

Over the past few years, Indian equity markets and investors have had to navigate various domestic and global challenges. In addition to global macro developments and geopolitical shifts, the transformative effects of demonetization and GST, the burgeoning Indian e-commerce sector propelled by a sharp jump in smartphone adoption and the surge in demand for digital financial services have brought about sweeping changes.?

We at Premji Invest have identified and leveraged several themes and opportunities to generate alpha. Examples include:??

• Shift from the unorganized to the organized
• Changing trade patterns:? China +1
• Business turnarounds in the context of a growing economy

Unorganized to organized: The formalization of the economy has empowered organized players in several industries -- financial services, retail, etc., to name a few -- to capture market share from the unorganized sector. This has, for example, allowed Non-Banking Financial Companies (NBFCs) to shift towards scorecard (and Artificial Intelligence) based loan appraisals at the cost of informal money lenders. Similarly, organized retailers with robust supply chains have aggressively expanded their footprint in the growing Indian retail market. We have benefited significantly from these seminal shifts, as evidenced by our successful investment in apparel retailer Trent.?

Changing Global Trade Trends: With deglobalization gaining momentum, we recognized the shift in supply chains and positioned ourselves to benefit from India's rising position as a reliable supplier. The government's tariff adjustments and initiatives, like the Production-Linked Investment Scheme (PLIS), align with the evolving dynamics of global manufacturing. Our investment in auto supplier Craftsman, which reaped significant rewards, validates our belief in this theme.?

Turnaround stories: A key area we have studied and benefitted from is corporate turnarounds. Even as a company attempts to steady the ship, profitable growth may not see a corresponding near-term upside in stock performance.?

It is often a test of patience as investors are forced to play the waiting game.? Any significant upside may have to wait until sustainable improvements in underlying fundamentals, combined with management's steadfast commitment, serve as a pivotal indicator for the likely success of the turnaround. Eventually, the stock value surges, buoyed by stronger fundamentals and improved confidence in the company, bringing cheer to investors. CG Power and Industrial Solutions is one such turnaround story.

CG Power and Industrial Solutions: Resilience and Transformation

In 2020, diversified Indian conglomerate Murugappa Group acquired ailing CG Power and Industrial Solutions. This development piqued our curiosity and encouraged us to explore CG Power as a potential investment.

Before Murugappa Group firm Tube Investments of India bought CG Power, it was under stress, burdened by a heavily leveraged holding company that hurt cash flows, leading to execution woes and erosion of market share. Also, suppliers had started cutting their exposure to the company due to credit issues at the group.?

Despite these worries, a host of positives boosted our confidence.

1. Strong order backlog at CG Power and smooth functioning of plants. The company enjoyed cost leadership in LT motors, switch gears and transformers, which remained intact.?
2. Though the financial turmoil at the group level hurt employee morale -- the company’s board of directors had terminated the then Chairman, CEO and CFO after a financial scam came to light? – CG Power managed to retain most of its key operating members and middle management, ensuring that operations remained unaffected.?
3. Despite the turmoil, the company retained its customers and did not lose any large project, though to be sure new order wins did drop.?
4. CG Power’s distribution network was twice as strong as all its competitors together. Our checks confirmed the company received robust support from its channel partners with 100% advance payment for orders. This allowed the firm to keep its plants running despite the difficulties.?

All these were validated by extensive channel checks and due diligence by our independent research team.

In addition, Murugappa Group's proven track record of successful turnarounds, together with the significant time and capital it had invested in CG Power, further bolstered our confidence and commitment.?

Post the takeover by TI, CG Power saw a sharp recovery as working capital limits opened up and suppliers’ comfort improved. In the industrial segment, CG Power quickly reclaimed its market leadership with over 35% market share in motors supported by macro tailwinds in private capex. The power segment also saw a strong demand revival with robust investments in renewables and the exit of Chinese manufacturers. Moreover, strategic moves in railways, including forays into EV motors and consumer durables, diversified the business and expanded the addressable market.

Serendipity, too, played its role in changing the fortunes of CG Power. For example, the power sector, which was a drag for the company due to oversupply issues and was thought of as dead wood, turned around quickly, aided in no small measure by the government’s decision to discourage Chinese suppliers in favour of domestic players. That apart, the revival of capital expenditure in the power sector improved utilisation, allowing this segment to drive growth.

Our strategic approach to business turnarounds, exemplified by the success story of CG Power, demonstrates the importance of foresight, meticulous monitoring, and a commitment to long-term value creation. Embracing these transformative opportunities could be the key to unlocking alpha in an ever-evolving investment landscape.