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The Strong Shall Inherit The Post-Covid World

Marcellus’ Little Champs portfolio witnessed revenue growth of 10% YoY and PBT growth of 35% YoY in 3QFY21 (which compares favourably to 1% and 13% respectively seen in 2QFY21). This growth is driven not only by a recovery in the underlying industry demand but also by market share gains from weaker peers. Furthermore, thanks to the strong earnings recovery and healthy RoCE sustaining in 9MFY21, Little Champs’ strong balance sheet position (net cash position for most portfolio stocks) has actually improved through the crisis. This gives them the firepower to accelerate their market share gain efforts. Finally, the current favourable situation (market share gain opportunity, recovery in demand) together with Little Champs’ track record of sustaining healthy earnings growth & RoCEs with high – but sustainable – reinvestment rates gives us confidence about the prospects of these champion franchises.

Performance update of the live Little Champs Portfolio
At Marcellus, the key objective of our Little Champs Portfolio is to own a portfolio of about 15-20 sector leading franchises with a stellar track record of capital allocation, clean accounts & corporate governance and at the same time high growth potential. While we intend to fill our portfolio with winners, we want to be sure of staying away from dubious names where we are not convinced about the cleanliness of accounts or the integrity of the promoters (even though business potential may sound promising) as the fruits of company’s performance may not get shared with minority shareholders. We intend to keep the portfolio churn low (not more than 25-30% per annum) to reap the benefits of compounding as well as minimize trading costs.
The Little Champs Portfolio went live on August 29, 2019. The performance so far is shown in the below table.

Little Champs have emerged stronger out of the crisis, now set to accelerate market share gains

Healthy growth in revenues and earnings across most portfolio stocks in 3QFY21…

The recovery in revenues and earnings which begun for the Little Champs from 2QFY21 gained further momentum in 3QFY21 with most portfolio stocks reporting healthy growth in revenues and earnings. At the weighted average level for the portfolio, the revenue growth was 10% YoY (vs 1% in 2QFY21) while the PBT growth was significantly higher at 35% (vs 13% in 2QFY21). The growth in PBT across most stocks has significantly outpaced that of the top-line growth because of cost control measures initiated by these companies over the past few months and operating leverage benefits from top-line recovery.

For the first set of eight stocks in the below exhibit, the recovery in revenues were along expected lines given that these companies largely cater to resilient end-user industries like pharma, food, FMCG, etc. The second bucket – the auto ancillary companies – sprang a positive surprise due to strong recovery in automotive demand and production levels in 3QFY21. For the last set of stocks below comprising mainly retail, consumer discretionary and financial names, YoY revenue/disbursement growth is still negative; however we have seen much improved YoY trends in 3QFY21 vs 2QFY21 for this third bucket of stocks.

…with balance sheet position strengthening further through the crisis

Furthermore, contrary to our expectations of a net cash drain, the Little Champ portfolio on a weighted average basis, were able to sustain their net-cash equity position (0.1x) between March 2020-end to September 2020-end despite operating at sub-optimal levels for 1HFY21. This was on the back of recovery in earnings and a tight control on the working capital exercised by these companies (most Little Champs companies witnessed a reduction in working capital levels between March 2020-end and September 2020-end). We expect the net cash position to have strengthened further as at December 2020-end due to healthy earnings in 3QFY21 (the companies are not required to furnish quarterly balance sheet for the three and nine months ending reporting periods and hence the exact debt-equity position is not available as at December 2020-end for most portfolio stocks).

Little Champs have stepped on the pedal to accelerate market share gains

The net result of the crisis is that the Little Champs are placed on a relatively stronger wicket compared to their peers. This has enabled them to accelerate the market share gains by investing capital into strengthening their core business, expanding capacities or in some cases even buying out weaker peers. Some recent instances of the same are highlighted in the below table.

In some cases, we have also seen that some Little Champs companies which operate asset light businesses returning or planning to return excess capital to shareholders which is a positive move from corporate governance as well as capital allocation point of view. Even after returning the above amount back to shareholders, the net cash position would continue to remain healthy for these companies.

Reinvesting in core/adjacencies helped sustain earnings and RoCE  for Little Champs over the years

While the Covid-19 crisis, as discussed above, has provided Little Champs with an opportunity to accelerate market share gains, creating opportunity from crisis is actually a salient feature of these companies which have historically targeted market share gains by rationally and patiently investing in building long term competitive advantages. Furthermore, the Little Champs have also prudently used capital in targeting new growth drivers mostly either through expanding the wings of their core business (example – expanding from regional to local to global) or profitably deploying the cash flows from the core business into adjacencies (where they are able to leverage existing strengths surrounding product technology/manufacturing capability, distribution, customer relationships, etc). Thanks to these well thought through capital reinvestments, Little Champs are a rare set of companies which have been able to not only generate healthy earnings growth but also sustain healthy RoCEs.
Going forward, we continue to expect healthy earnings growth for the Little Champs driven by a continued recovery in demand across most end-user industries, sustained benefits of cost reduction measures initiated in the last few months and strong balance sheet/liquidity giving them the firepower to further consolidate their market shares.
Regards
Team Marcellus

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