Prem's 2020 Letter to shareholders is out

[Parsad]

Somebody pointed this post out to me, and I had not seen it.  My responses in "red" after each point.

 

5. Believes, “India is the best country to invest in long term”. OK, but no explanation as to why. Not genuine.

 

He's given significant reasoning around this belief.  There are a ton of books out there that you can read on why this MAY be true.  I've seen the companies we've invested in, and what is happening in India, and it is eerily similar to China 15-20 years ago.  I think executing will be a bit more difficult than China, simply because the Communist government said we are going to do this and did it over 20 years.  India will have similar success, but I suspect it will come with more challenges.

 

6. Believes Modi re-election will turn around Indian economy. Again, no explanation as to why especially given that was the thought at time of Modi’s first election and it didn’t come to fruition. Again not genuine in his writing.

 

Again, plenty of comments by Prem in the past and present, and alot of books.  I agree with you, this is arguable though, as Modi's tenure is not guaranteed over the next 15 years...only for the next 5 years.

 

 

India story seems to be a mirage. Though we have heard many plausible explanations on why India is what China was 20 years ago, the ground reality seems to suggest a very different picture. In fact this is self-explanatory when one looks at the last 10 years, both in terms of the growth of the economy as well as the market returns. The S&P dollex 30 has given less than 20% total return in last 10 years and almost negative since the current government came to power 7 years ago. So much for the supposedly "world's fastest growing economy" !! This performance is with the fantastic global tailwind of low oil prices, low interest rates, flood of cheap money apart from the usual demographics, large market size etc that people talk about.

 

There is no change in the modus operandi of buying political votes by distributing free money at the cost of investment in infrastructure, health, education or other economical development. India continues to run twin deficit, have high unemployment, has trade deficit, saddled with bad loans in the banks/NBFCs, poor infrastructure, heavily dependant on imported oil/gas etc and we don't even want to discuss the poor corporate governance, weak judicial system, bureaucracy and red-tapism etc. I can give concrete examples of industry after industry that are getting killed due to bad policies.

 

Sorry to have side-tracked this post which was about Prem's letter and Fairfax.

 

You may be right, you may be wrong, or it may end up somewhere in the middle.  I'm guessing it will be one of those three!  :o

 

That being said, I cannot help but wonder what India will be like when true financial services become widely available to the populace, as it has been to most developed countries for the better part of the last century.  They have the youngest population in the world, a rapidly growing middle class, and mobile penetration is in the 94-95% range...including villages!  I see a company like Quess, IFIL or an airport like BIAL...I think, wow this young population is now getting access to the things generations in our country had.  The simple fact that Modi has registered all citizens, opened some 300M bank accounts, and expanded insurance/financial services/capital markets in a dramatic fashion...yes, miles and miles to go, but they are taking that step forward that only Gandhi and Nehru could have dreamed of.  Corruption will never disappear...it hasn't disappeared in the U.S., why would it disappear in India.  But it can be curtailed...the graft culture and thought process can be changed over a generation if the young people want and demand it.  It will be interesting to see how this experiment unfolds!  Cheers!

[Spekulatius]

Re India - GDP growth isn’t everything. India has substantial problems. For example inflation picked up from ~5% in 2019 to 7.35% lately. That’s a huge headwind as it causes a weakness in exchange rates relative to the dollar if purchase parity is kept. The valuations on India that I am seeing are just no attractive considering this backdrop.

 

You can buy bald for book value and with 20% ROE in Brazil right now if you care, but the country is run by a moron and the economy is probably going totally into the toilet as they can’t borrow for nothing like the US can.

 

You can make a lot of money when the situation improves and they rerate, but they also can do an Argentina and you are out of luck. For the time being, I‘d rather be in anything dollar or Euro denominated.

[PJM]

You may be right, you may be wrong, or it may end up somewhere in the middle.  I'm guessing it will be one of those three!  :o

 

That being said, I cannot help but wonder what India will be like when true financial services become widely available to the populace, as it has been to most developed countries for the better part of the last century.  They have the youngest population in the world, a rapidly growing middle class, and mobile penetration is in the 94-95% range...including villages!  I see a company like Quess, IFIL or an airport like BIAL...I think, wow this young population is now getting access to the things generations in our country had.  The simple fact that Modi has registered all citizens, opened some 300M bank accounts, and expanded insurance/financial services/capital markets in a dramatic fashion...yes, miles and miles to go, but they are taking that step forward that only Gandhi and Nehru could have dreamed of.  Corruption will never disappear...it hasn't disappeared in the U.S., why would it disappear in India.  But it can be curtailed...the graft culture and thought process can be changed over a generation if the young people want and demand it.  It will be interesting to see how this experiment unfolds!  Cheers!

 

I sincerely hope I'm wrong because I'll win more if i'm wrong :)

 

Some simple observations:

1. People always talk about the young population which can be great for the economy but only if you are able to create millions of jobs. Look at the employment rate as well as the quality of jobs created. The demographic advantage will not stay forever so if you don't leverage it you have missed the boat.

2. If you look at the history of any largish country that has grown strongly on per-capita basis (which is a more important metric than GDP) it has to be on the back of exporting the world its labour (manufacturing) or Tech (services) which eventually leads to high per-capita and middle class population, but Indian policy makers lack the desire or will power to do so.

3. The cost of risk capital in India is 60%+ for a country that needs massive capital to build its economy

4. A lot of the steps that you highlighted such as financial inclusion are great and theoretically should take the country forward but you are overseeing the numerous additional bad policies that has overridden the good.

5. Uday Kotak, one of the smartest guys in India summed it up well "Indian economy is like a white shirt that has gone dirty. Currently its undergoing washing but the fear is that it is washed so badly that it may end up tearing" (not exact phrase but something along those lines)

 

Sorry but I feel that a lot of people who look from outside are reading India like a great travel marketing brochure, especially when some political leaders are such marketing-savvy people.

 

Disclosure: I've been an investor in India since 2014 and have seen/spoken to hundreds of listed and unlisted companies, done scuttle-butting on many of these companies. So of course I'd love to see the country and the markets do well, but as a person of Indian origin it is extremely painful to see India constantly wasting an opportunity to really lift its people up. We are still hopeful but as any good investor one needs to avoid anchoring bias while assessing the investment.

[PJM]

Re InDia - GDP growth isn’t everything. India has substantial problems. For example inflation picked up from ~5% in 2019 to 7.35% lately. That’s a huge headwind as it causes a weakness in exchange rates relative to the dollar if purchase parity is kept. The valuations on India that I am seeing are just no attractive considering this backdrop.

 

You can buy bald for book value and with 20% ROE in Brazil right now if you care, but the country is run by a moron and the economy is probably going totally into the toilet as they can’t borrow for nothing like the US can.

 

You can make a lot of money when the situation improves and they rerate, but they also can do an Argentina and you are out of luck. For the time being, I‘d rather be in anything dollar or Euro denominated.

 

You are absolutely correct. With the twin deficits, high inflation and import oriented economy, there is a constant pressure on the INR. Historically INR has depreciated 5% annually, and then when you add up all the taxes and high cost of investment in India, you land up making 6-7% $ return if you can get 15% lNR return which is a tall ask.

 

Currently the top 15 companies in India has 40% market cap of all listed companies and pretty much all companies that have out performed in India has done that on the back of multiple expansion. Just look at the multiples of even simple consumer companies such like Nestle, Hind Unilever, Asian paints etc which would have been fine if they were growing at decent clip but none of these companies are growing at even 10%. So all the new money from local mutual funds are chasing these handful of 10-20 companies which has led to extreme polarisation. If you have put money outside these companies your portfolio has lost money. The funny bit is local regulation discourage investment outside the top 100 companies.

 

The other problem is that there is no bond market which makes it extremely difficult for corporates to raise debt money.

[TwoCitiesCapital]

Re InDia - GDP growth isn’t everything. India has substantial problems. For example inflation picked up from ~5% in 2019 to 7.35% lately. That’s a huge headwind as it causes a weakness in exchange rates relative to the dollar if purchase parity is kept. The valuations on India that I am seeing are just no attractive considering this backdrop.

 

You can buy bald for book value and with 20% ROE in Brazil right now if you care, but the country is run by a moron and the economy is probably going totally into the toilet as they can’t borrow for nothing like the US can.

 

You can make a lot of money when the situation improves and they rerate, but they also can do an Argentina and you are out of luck. For the time being, I‘d rather be in anything dollar or Euro denominated.

 

You are absolutely correct. With the twin deficits, high inflation and import oriented economy, there is a constant pressure on the INR. Historically INR has depreciated 5% annually, and then when you add up all the taxes and high cost of investment in India, you land up making 6-7% $ return if you can get 15% lNR return which is a tall ask.

 

Currently the top 15 companies in India has 40% market cap of all listed companies and pretty much all companies that have out performed in India has done that on the back of multiple expansion. Just look at the multiples of even simple consumer companies such like Nestle, Hind Unilever, Asian paints etc which would have been fine if they were growing at decent clip but none of these companies are growing at even 10%. So all the new money from local mutual funds are chasing these handful of 10-20 companies which has led to extreme polarisation. If you have put money outside these companies your portfolio has lost money. The funny bit is local regulation discourage investment outside the top 100 companies.

 

The other problem is that there is no bond market which makes it extremely difficult for corporates to raise debt money.

 

Weird. Sounds like the S&P 500 in 2020.

[Daphne]

India: a huge and skilled workforce ready and able to to take on so much more manufacturing as the Covid fallout lands squarely on China.  Geopolitics may very well drive the future here.

[Viking]

my guess is that they will continue to underperform as a function of relatively inferior investment results.

 

This is the problem. We can all speculate, but we simply cannot know whether the causes of poor investment performance are ongoing or whether the company can improve.

 

Lumpiness I can deal with. In fact I like it - the market pays a premium for predictability that (all else equal) I’d rather not pay. All I care about is whether Fairfax can adapt.

 

“The best predictor of future performance is past performance.” 10 years is a good amount of time. Much better than using the first 10 years, which an investor probably should throw out (given the company has changed immeasurably since then).

 

Well if you think that then for God’s sake don’t invest. But until recently you seemed quite positive on the portfolio they own; may I ask what changed?

 

Petec, sorry for the late reply to your question. I was just re-reading the thread and saw it :-)

 

What changed for me? The virus and its impact on the global economy. As i mentioned on the Coronovirus thread, on Feb 27 I went to 80% cash (and to 100% shortly after that).

 

Beginning last year and to start this year my read was Fairfax was slowly digging itself out of the hole they had put themselves in (with their investment portfolio). I liked the moves from the company that i had seen during 2019 and to start 2020. (Fairfax India was also a very large holding for me). But much work still needed to be done to get the company in a good place.

 

The virus changed everything overnight (for every company). Unfortunately for Fairfax, it put them deeper in the hole and may set them back years in terms of their recovery/transition. Their investing style is being exposed again as wanting, this time by the virus. Their low quality holdings are getting killed: Eurobank, Stelco, Blackberry, Resolute etc. (By low quality it might be country or industry or company.) At the same time, emerging markets/currencies have sold off so this has hit their substantial Indian holdings. Other large purchases like Recipe (collection of restaurant stocks) are turning into a disaster. Other recent investments like Toys R Us are likely severely stressed.

 

The bottom line is in 2019 Fairfax was moving in the right direction but much more work still needed to be done (more asset sales, repositioning etc). The virus has set them back ( yet again). Not fair. But you reap what you sow. Fairfax has to learn their style of investing puts them at risk to these sorts of events... hence the need to slowly, incrementally over time, shift the investment strategy. The reason i am so hard on Fairfax is i do like the company and i want them to succeed :-) i just can’t understand why they make things so difficult on themselves.

 

[petec]

 

You can buy bald for book value and with 20% ROE in Brazil right now if you care, but the country is run by a moron

 

 

Thank God the leader of the free world is an intellectual colossus, eh?

 

[petec]

@Viking - thanks.

 

On Emerging Markets, a couple of thoughts.

 

Currency will be a drag over the long run if local inflation is higher than dollar inflation. But currencies are very volatile around that long term purchase-parity trend. EM currencies are largely cheap today and more likely to be a positive than negative contributor on a medium term view.

 

Also, the inflation that drives EM currencies down over time also drives nominal GDP, revenues, and profits up over time. In the very long term it is likely a wash in that sense. The real impact of inflation a higher cost of capital. As a result of this, the best EM companies are some of the best stewards of capital I know of (but some of the others are awful).

 

Bottom line: for long term investors like Fairfax I don't worry about the impact of currency but I do worry about political risk and I always look at ROIC in real terms.

 

EMs certainly have their problems. A good way to think of this is that India's GDP/capita is $2,000. With all the technology, knowledge, and capital available in today's world it takes a really shit system to keep GDP/capita down that low. Even Brazil is 5x richer. But the positive side of this is that relatively small improvements in the system can have outsize effects. Progress is slow, but many emerging markets are moving forwards with better institutions, better regulations, better business conditions. And technology is turbocharging the process. The availability of technology to the man on the street, no matter how poor or poorly educated, is just incredible, and it is beginning to allow him to throw off the systemic shackles. A farmer who had to rely on the middleman to tell him the price of his crops can now check online. A family that can't access basic education can now get it on a phone. A bank that has not been able to address 50% of the population because the price of processing account and loan applications in branches is prohibitive for small amounts, can now address everyone via an app. This is transformative.

 

India and Africa may not reach our standards of living - possibly ever - but they will make enormous strides over the lifetime of Fairfax's investments, and lots of money will be made along the way.

 

As a related aside, one of the things that intrigues me about Fairfax is whether they will be able to share knowledge effectively across their sprawling empire. For example they have Digit in India. Can they export that approach to Fairfax Latin America, or Atlas Mara, or even Eurolife? Can CIB teach them how to operate UBN or CSB? There's a lot of cross-seeding in the portfolio - Richie Boucher (who led the turnaround of Allied Irish) is on the board and risk committee at Eurobank, and Hisham Ezz Al-Arab (the CEO of CIB) is on the board of Fairfax Africa. On paper there is enormous potential here and I almost feel Fairfax needs someone to coordinate this (as Carmilani is set to do on the insurance side).

 

 

 

[Spekulatius]

 

You can buy bald for book value and with 20% ROE in Brazil right now if you care, but the country is run by a moron

 

 

Thank God the leader of the free world is an intellectual colossus, eh?

 

Hardly so. However, the US can take a few punches while Brazil cannot. It’s mostly because theYS can print $ and borrow trillions for almost nothing. Brazil cannot do that, their currency tanked already and they have issues with inflation as is..

[petec]

 

You can buy bald for book value and with 20% ROE in Brazil right now if you care, but the country is run by a moron

 

 

Thank God the leader of the free world is an intellectual colossus, eh?

 

Hardly so. However, the US can take a few punches while Brazil cannot. It’s mostly because theYS can print $ and borrow trillions for almost nothing. Brazil cannot do that, their currency tanked already and they have issues with inflation as is..

 

Agreed.

 

That said, Brazil has been on a disinflationary trend for 30 years and pre-covid, inflation was well anchored in the low-mid single digits. The pension reform done last year was a big step towards controlling the deficit, which will help. And while the president is a moron the finance minister is superb and the administration has been doing a great job of improving business conditions.

 

Your point stands, but there are counterpoints, and the real question is: what's already priced in?