CM Focused Portfolio: Increasing Mid & Smallcap allocation

In a nutshell:

• We buy AARTIPHARM, DATAPATTNS, NH, and KSB

• Increase allocation to some existing holdings

• Reduce cash from 30% to 10%

• Q4FY23 (Jan to Mar 2023), the Focused portfolio was down -2.6% as compared to Nifty 50 at -0.6%

• 1-year returns are -4% versus Nifty’s -0.4% as of Mar 31st, 2023

Capitalmind Focused performance since inception

The chart shows the cumulative performance of the CM Focused Portfolio starting Jan 2019.

Reading this chart: ₹100 invested on day 1 in Jan 2019 be worth ₹204/- in Focused vis-a-vis 171.7/- in Nifty 50, as of Apr 13th, 2023

The better way to visualize returns is to look at rolling returns. The chart below shows 1-year rolling returns, i.e. the 1-year returns as of any given date. If that green line stays above the grey lines more or less consistently, it’ll be a job well done.

The chart shows 1-year rolling returns from Jan 2020.

A shift towards Mid & Small caps

Indian equity markets have interpreted the Reserve Bank of India’s recent interest rate pause as an indication that rates may have peaked. This interpretation, along with a similar trend in the bond markets, has led to increased market strength over the past two weeks. As a result, we are considering deploying a portion of our cash holdings back into the markets.

Moreover, we aim to move away from large caps and towards mid and small caps, which currently show promising growth prospects at a better valuation point following a recent correction. Bearing this perspective in mind, we are implementing the following portfolio changes:

New entries: Aarti Pharma, KSB Ltd, Narayana Hrudayalaya, Data Patterns

Increased positions: APL Apollo, ICICI Bank, Varun Beverages, Sirca Paints

Aarti Pharma

Aarti Pharma is a recently demerged entity of Aarti Industries, focused on the manufacture of active pharmaceutical ingredients (APIs) used in the treatment of hypertension, cardiovascular disease, oncology, and other areas. With 50 new products in the pipeline, the company is poised for growth.

Of its revenue, 64% comes from APIs and intermediates, with the remaining 36% from Xanthine, a derivative used in beverages and nutraceuticals. The company operates three USFDA-approved plants and has recently expanded its Dahej plant’s intermediate capacity. It also has a planned capex of around 350 Cr.

*Source: Aarti Industries Q2FY23 Investors Presentation

Since its listing on January 30th, 2023, the company has faced selling pressure from mutual funds holding Aarti Industries. However, over the last three months, the promoter has continuously bought shares from the open market, increasing their holding by 0.8% to 44.1%.

Currently trading at 20 times PE (FY24E) and EV/EBITDA of 13 times FY24E, the company’s valuations are reasonable, and its growth prospects over the next three years are promising. Therefore, we are initiating an initial portfolio position of 3%.

KSB Ltd: A Pump Manufacturer with Steady Growth Prospects

KSB Ltd has been focusing on one thing for over half a century - pumps, and has earned a reputation for delivering the best. The company, a subsidiary of KSB Group, Germany, holds a 10% domestic market share and is cash-rich.

KSB India primarily manufactures pumps (71% of revenue), valves (18%), and other control systems (11%). The company has seven manufacturing units across Maharashtra and Kerala. Domestic markets contribute 80% of overall revenue, with exports contributing the remaining 20%. Like all other multinational corporations, KSB is debt-free and has a strong balance sheet. Its export share has continuously increased from 15% to 20% over the last few years.

Click here for the KSB Ltd Q3FY23 presentation

What’s interesting about KSB Ltd is its simple and straightforward business model, which would appeal to investors like Peter Lynch. KSB holds approximately 10% of the market share in the pump segment and has INR 260 Cr in cash reserves. The current order book stands at INR 900 Cr, which is around 60% of FY22 revenue.

The company currently trades at an enterprise value of INR 7,574 Cr, PE of 43 times, and EV/EBITDA of 25 times. KSB has shown consistent growth in terms of revenue (5-year CAGR at 13%) and PAT (5-year CAGR at 18%). Given the planned capex and order book, the company’s growth story still looks promising. Therefore, we are initiating a portfolio allocation of 3%.

Narayana Hrudayalaya: A Hospital Chain with High Growth Potential

Founded by Dr. Devi Shetty in 2000, Narayana Hrudayalaya is a hospital chain headquartered in Bangalore. It initially began as a Cardio Hospital but shifted to a multispecialty model in 2013.

Narayana Hrudayalaya’s business model is asset-heavy. In the last 10 years, the company increased its gross block at a 17.2% CAGR, and during the same period, revenue also grew by 17%. The company operates on negative working capital, and over the last five years, EBITDA margins have improved from 12% to 20%, and PAT margins have improved from 4% to 12%. With a net debt of INR 214 Cr, the company maintains a healthy balance sheet. The company owns the logo and brand NH and has not diluted equity since its IPO in January 2016. The promoters continue to own 63.9%.

The company is planning an INR 2000 Cr capex over the next two years, which will be funded through a combination of internal accruals and debt. Even if we exclude maintenance capex, the new capex is estimated to be around INR 1450 Cr.

*Source: NH Q3FY22 Investors Presentation

Currently trading at 26 times FY24E, Narayana Hrudayalaya has high growth potential over the next 3-5 years.

However, one major risk is the company’s plan to leverage its balance sheet in the coming years. Assuming they raise INR 800 Cr in debt at 9%, it will double the finance costs (15% of operating profits). Nevertheless, if the management can deliver, it is an interesting long-term investment opportunity. Therefore, we are initiating an initial portfolio position of 3%.

Data Patterns: A Pure Play on the Defence Sector

Data Patterns is a pure play on the defence sector, having started with one product (a fire control system for Brahmos Aerospace) in 2001. The company currently has 20 product portfolios, of which 10 are key products. They specialize in the manufacturing of defence products like COTS, avionics, radars, electronic warfare, and more, catering to clients such as the Ministry of Defence, ISRO, DRDO, HAL, and others. Only 12% of their revenue comes from exports.

The company’s TTM sales are at INR 439 Cr, and the order book currently stands at INR 880 Cr. As per management guidance, the order book may go up to INR 2000 Cr in the next four years. The company has a debt-free balance sheet with cash reserves of INR 117 Cr, and a strong margin profile with EBITDA margins above 35% and PAT margins above 25%.

However, the company is highly dependent on the Government of India, with four clients (MoD, ISRO, DRDO, HAL) making up around 45% of the company’s revenue. Additionally, the cash conversion cycle is high at 215 days.

As of now, Data Patterns is trading at an EV/EBITDA of 38 times and an FY24E PE of 60 times. While the valuations may be stretched, given the growth visibility, we are initiating a portfolio position of 3%. If the company continues to deliver, we may increase our allocation over time.

We are also increasing our allocation (averaging up) to our existing names like APLAPOLLO, ICICIBANK, VBL & SIRCA which are delivering consistently on all fronts.

Post the rebalance, we will be holding 20 stocks + approx 10.6% cash.

Frequently Asked Questions about Capitalmind Focused Portfolio

**Q: I am a new investor in Capitalmind Focused portfolio. What should I buy now? **

A: If you would like to follow this portfolio, you can purchase all the stocks in the model portfolio as per the recommended allocation for each stock. However, for experienced investors, custom stock picking is also an option, but we cannot track the performance of custom selections. We do not have “hold” positions, and all our positions are tracked as if they are buys.

**Q: Can I skip investing in LiquidBees and park the cash in a savings account? **

A: Yes, you can keep your cash in a savings account or any liquid fund of your choice. We park our cash in LiquidBees to keep track of NAV calculations. However, the decision to invest in LiquidBees or any other liquid fund is entirely up to you.

**Q: How frequently is Capitalmind Focused portfolio rebalanced? **

A: We closely monitor our portfolio companies and regularly review our portfolios. Whenever there is a significant change in any of our companies, we rebalance the portfolio and communicate this to Capitalmind premium subscribers via email.

**Q: Do you follow technicals? **

A: We consider both fundamentals and technicals to support entries, exits, or position sizing in the portfolio. However, the portfolio involves risk, and we may exit a position even in the short term if either price action or fundamentals dictate.

**Q: What is the lot size of the portfolio? **

A: We suggest a lot size of approximately INR 3.5 Lac (including the cash component) for Capitalmind Focused. The idea is to get exposure to all the recommended stocks at the suggested position sizes. However, you are free to change the amounts as required, but this may result in different weightings.

Click here to read all previous Focused factsheets

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