Portfolio Performance and Update on Fundamentals – December 2024

Note: For all strategies except GCP, Performance data shown is net of fixed fees and expenses charged till December 31st, 2024 and is net of annual performance fees (Except for Little Champs Portfolio) charged for client accounts whose account anniversary/performance calculation date falls upto the last date of this performance period. Since, for Little Champs Portfolio, performances fees are charged on cumulative gains at the third anniversary, of the respective client account, the effect of the same has been incorporated for client accounts whose third account anniversary falls upto the last date of this performance period. Performance data is not verified either by Securities and Exchange Board of India or U.S. Securities and Exchange Commission.
*For relative performance of particular Investment Approach to other Portfolio Managers within the selected strategy, please refer https://www.apmiindia.org/apmi/WSIAConsolidateReport.htm?action=showReportMenu Under PMS Provider Name please select Marcellus Investment Managers Private Limited and select your Investment Approach Name for viewing the stated disclosure.
Note: APMI provides performance data of Portfolio Managers managing domestic strategies only. Hence, GCP is excluded.
For GCP, performance data is shown gross of taxes and net of fees & expenses charged till end of last month on client account. . Performance fees are charged annually in December. Returns more than 1 year are annualized. GCP USD returns are converted into INR using exchange rate published by RBI.
Source: https://www.rbi.org.in/scripts/ReferenceRateArchive.aspx
The calculation or presentation of performance results in this publication has NOT been approved or reviewed by the IFSCA or US SEC. Performance is the combined performance of RI and NRI strategies.

CY2024 was a year of transition. On the one hand the external environment saw a transition in terms of the pace of economic growth, government spending,  leadership of the stock market etc. On the other hand, Marcellus’ CCP portfolio saw a transition in terms of sectoral exposure (addition of hospitals, domestic pharma, manufacturing, autos etc), a tilt towards enterprising compounders (i.e. companies with higher average rate of reinvestment of capital), and also an increase in the number of stocks in the portfolio (from 15 to 20 – reflecting the widening of our coverage universe in an environment where disruptions and changes in competitive intensity have become more frequent).

These changes to our portfolio constituents prepare us well as we enter 2025 with the co-existence of two polar opposite trends in the broader economy – healthy corporate balance sheets, but stressed household balance sheets. The width of the sectoral exposure that we have added to our quality universe over the last 12 months, gives us options to pick up high quality businesses in sectors which are not significantly exposed to the broader consumption slowdown e.g. healthcare (hospitals, pharma, diagnostics), private capex around manufacturing, exports, IT services etc. Moreover, several of our portfolio companies are implementing business initiatives that expand their target markets, add new revenue growth drivers and hence create resilience in their profits – for instance, Tube, Divis, Trent, Eicher etc. Several of our portfolio companies are also sitting on surplus cash piles which are likely to get utilised towards incremental organic and inorganic growth opportunities e.g. CMS, Escorts, Dr. Lal Pathlabs, Alkem etc. Hence, despite economic headwinds, in 2025 we expect healthy earnings growth of our portfolio companies, higher than that of the Nifty50 Index.

Global Compounders (GCP)

December proved to be challenging for the GCP portfolio, which underperformed its benchmark index by approximately 250–300 basis points at the gross level. This underperformance was driven largely by market polarization, with the “Magnificent 7” (plus Broadcom) – representing big tech – capturing favorable price action. These eight companies, now comprising 35% of the benchmark index, delivered returns of +2%, while the rest of the market declined by 6%. Our emphasis on mid-cap stocks weighed heavily on our relative performance.

For example, Tesla (TSLA), one of the index’s larger weights, has been on a remarkable rally, amplified by its perceived momentum since Mr. Trump’s resurgence as a political contender. While we deeply respect Elon Musk’s visionary leadership, it’s challenging to justify Tesla’s valuation at over 10x Price-to-Sales – multiples typically reserved for high-growth, high-margin businesses. While Tesla has the potential to evolve into a high-margin software services business, such transformations come with significant risks and leave little margin of safety.

Having said that, this divergence in performance has been a recurring theme for the year. The Equal-Weighted S&P 500 (which assigns equal weights to all constituents) has returned 13%, compared to the Market-Cap-Weighted S&P 500’s return of 25%.

The market’s concentration in a few stocks is not without reason – only a handful of companies, including those in our portfolio, have demonstrated forward EPS growth over the past two years. However, we expect this gap to narrow over time …

…particularly as valuation differentials between large- and mid-cap indices are currently near historical highs. S&P 500 is trading at a PE which is close to its all-time high. As earnings growth between these segments begins to converge, we anticipate a gradual rebalancing in market dynamics… 

Portfolio Commentary:

We made no changes to the portfolio in December. Two of our portfolio companies reported results during the month:

Heico:  Heico closed fiscal 2024 on a strong note, with 30% revenue growth and 27% net income growth. Organic growth contributed 6% to revenues, with the remainder coming from acquisitions. For FY25, organic growth is expected to accelerate, driven by improved defense outlays and continued strength in the aerospace aftermarket, as approximately 30% of aircraft fleets are expected to exit warranty. Heico’s balance sheet has significantly deleveraged, and its M&A engine is ready to reignite following the integration of its largest acquisition, Wencor. The recent selloff in Heico shares appears to be profit-taking rather than a reflection of fundamental concerns. Valuation-wise, Heico is trading at the lower end of its historical premium relative to the market. We anticipate 15%+ USD EPS and capital return compounding over the next 3–5 years.

Cintas: Cintas reported Q2 results with 8% revenue growth, 18% operating profit growth, and 20% net income growth. The resilience of Cintas’ uniform rental business is noteworthy, consistently compounding organic growth at 7–8%, supported by mid-single-digit pricing increases. While we have been cautious about Cintas’ valuation and have trimmed our position over the past year, the company’s fundamentals remain robust. Its strong balance sheet positions it well for potential acquisitions, which we are closely monitoring. The recent correction in Cintas shares, like Heico’s, was likely profit-taking after a strong rally. We remain positive on Cintas’ long-term setup.

Broadly, we continue to see opportunities in select subsectors where valuations remain attractive. A clear distinction has emerged, with the market rewarding companies that deliver on earnings while penalizing those that fall short. Among underperformers, we are identifying cases where challenges are transitory, presenting potential valuation arbitrage opportunities.

While this disciplined approach to relative valuation may mean sacrificing some near-term relative returns (the other way could have been churning the portfolio more, which would have tax implications for our investors) – which has been the case for last 6 months, we are confident in its long-term benefits. Our focus remains on maintaining a balanced and resilient portfolio, positioning us well for the year ahead.

Marcellus performance data is shown gross of taxes and net of fees and expenses charged until the end of last month. Performance fees are charged annually in December. Returns for periods longer than one year are annualized. Marcellus’ GCP USD returns are converted into INR using exchange rate published by RBI. Source: https://www.rbi.org.in/scripts/ReferenceRateArchive.aspx
Since Inception’ performance calculated from 31st Oct 2022. The inception date is 31st October 2022, being the next business day after the account got funded on 28th October 2022. S&P 500 net total return is calculated by considering both capital appreciation and dividend payouts.
The calculation or presentation of performance results in this publication has NOT been approved or reviewed by the IFSCA or SEC. Performance is the combined performance of RI and NRI strategies.

Kings of Capital Portfolio (KCP)

The broader market corrected in December with Nifty 50 and Nifty Bank declining 2% and 2.3% respectively, KCP (post fees) corrected lower by only 1.4% during the month. Over the past 6, 12 and 24 months, the Kings of Capital portfolio has outperformed the Bank Nifty Index as the euphoria and investor interest in public sector banks, tier-II private banks has subsided over the past couple of quarters.

One of the attributes of KCP’s outperformance has been the resilience in earnings delivered by portfolio companies. Consensus estimates print (from Bloomberg) for KCP (weighted average position size basis) suggests that KCP’s FY25E EPS estimates have been broadly upgraded by ~1% since the beginning of the financial year (1^st Apr’24) vs. decline of 2.3% for Nifty 50.

Whilst we continue to see EPS downgrades in the broader markets, large banks have bucked the trend, leading to reduced earnings growth gap between banks and the market. Meanwhile, large banks continue to trade at a discount to the benchmark, driving margin of safety. December month also marked another positive for banks driven the regulator’s action of 50 bps cut in CRR (cash reserve ratio – money which banks need to keep with RBI and get 0% return on the same). This policy action further builds on the change in stance by the RBI earlier in October from ‘withdrawal of accommodation’ to ‘neutral’.

With Nifty 50 and Nifty Bank declining ~9-10% from their peak and some stocks having corrected more has allowed us to buy them again at a cheaper price. One such instance of the same is HFFC (details below) – a company we sold earlier owing to valuation concerns.

Addition of Home First Finance

In the month of Dec’24, a large block by the promoters led to sharp cuts in the stock price of Home First leading to valuations correcting to ~2.7x 1-yr forward BVPS (incl. expected fund raise). We took this as an opportunity to buy into a great franchise, which continues to do well on all parameters (leading within the affordable housing finance space) and consistently posting RoEs of ~16-17%. In the current environment, asset quality risks are not visible in housing finance as of now (across players), this is perhaps the last segment to get hit in an asset quality downturn. Historically too, we have NOT seen asset quality risks play out in housing. We would expect the same to follow this time too. HFFC also has the lowest share of LAP book (~14%) within peers and has seen calibrated growth there, hence risks are low.