Ashmayu Quarterly Newsletter- Probabilistic vs. Deterministic
By Harini Dedhia
Dear Investor,
I recently came across an interesting excerpt from Anil Anantha swamy’s ‘Through Two Doors at Once’:
“Even if you have all the information about a single photon as it leaves the source
and goes towards the double slit, you can only calculate the probability of the photon
landing on a certain part of the photographic plate. There’s no way to tell where any
particular photon will go. Nature, at its deepest, seems inherently non-deterministic.”
At a micro (or quantum in physics parlance) level, everything is probabilistic. Only
when you zoom out to the macro (Newtonian level) does the world seem to get more
classical and deterministic in nature.
The same holds true for investing and in businesses as well. If you were to ask us,
which of our portfolio companies will give the highest returns at any given point of
time- the truth is we do not know. (If we did, we would run a one stock portfolio).
What we do know is that if our process is set right, our portfolio ends up delivering
the desired returns.
From the set of businesses we own in our portfolio, two managements have
exemplified this probabilistic way of thinking; Landmark Cars and Natco Pharma.
Landmark Cars
Landmark cars is possibly the best run car dealership company in the country
today. They are the largest dealers in India for most of the OEMs they work with-Mercedes, Jeep, BYD, and Honda.
A dealership business at its core is a retail business with greater cyclicality. Imagine
if a brand were to see sales volume drop in half- what would be the outcome of a
retail outlet of the brand? The operating deleverage, given most of its costs are fixed
in nature (rent, employees, electricity, etc.) would alone plunge the retail outlet into massive losses.
At the start of 2023, Jeep was one of the top 3 brands in their portfolio. The
highest selling car from the Jeep stable was the Jeep Compass of which 60% of
the sales came from its petrol variant. In April 2023, the petrol variants of the
Jeep Compass were discontinued as they were not compliant with the stricter
(phase 2 BS VI) emission norms.
The resilience in their operating numbers is an ode to their portfolio approach at
managing the business. A revival in Honda new sales (20%+ growth in FY24),
newly seeded used car business that crossed 120cr+ in revenue in year 1 along
with other portfolio bets holding steady helped Landmark tide over this crisis
period.
Additionally, they have bolstered this portfolio approach even more so in the last one year.
M&M and KIA have been added as new OEMs in their portfolio
MG Motors (post partnership with JSW) is now a great balancing item in the
portfolio as Landmark is no longer only reliant on BYD making it big in the EV space in India
BYD showroom count to increase post receipt of homologation certificate for
ATTO 3 (allows for higher volumes to be sold by removal of cap on import
volumes). These showrooms however are to be carved out partially from Jeep
showrooms in some locations (amortizing those fixed costs better)
Opened a Mercedes Workshop in Hyderabad, the second largest luxury car market in India
All of the above has been done in the last year itself. It is this basket approach
within their area of competence that has enabled them to do well when the
industry struggled (FY19-FY23 saw no growth in passenger car volumes in India)
and will continue to do so in the future as well. There is no way for Landmark to
know for sure which OEM shines in which year, and which launch is well
received by the customers. As long as they have a portfolio approach that covers
multiple OEMs, the odds of them doing well in any given year is far greater than
that of an individual OEM.
Natco Pharma
From all the companies in our portfolio, it is perhaps the management of Natco
Pharma that lays out their probabilistic thinking in the most direct, clear manner.
Natco Pharma is a complex generics manufacturer that has two skill sets in
abundance- frugal science and legal. They have the highest profit yield per dollar
spent in R&D amongst all pharma companies listed in India today. Yet, even with
their skill sets, there is a clear recognition of the fact that a lot of the factors that
determine the outcome of how a specific molecule pans out for them is beyond their
control.
Their claim to fame has been being the first to challenge patented blockbuster
molecules in the US, especially in the oncology space and wading through the legal
processes in order to launch the molecule as early as possible while being FTF-giving them a considerable lead over competitors. Accepting price erosion in generic medicines in the US as a fact of life, the management has been clear in
stating that they will have to take bets that take their profit pool to the next
orbit. They however do so in a risk adjusted manner.
Of the 10 bets they take in challenging a complex patented molecule in the US- 2 make it big, 2-3 fizzle out given competition or the drug itself faces challenges
from other molecules, and 5-6 give okay-ish results. However, everytime they
manage to hit it out of the park (and they don’t know which one will when the
bets are made), the orbit of the company changes. The risk adjusted nature of
their bets of this portfolio approach is highlighted in the fact that instead of
doing a single filing without any partners (therefore be entitled to 100% of profit
or any other outcome), they were willing to partner with large pharma
companies to do the filings but do multiple such filings.
With every orbit shift, the profit of the company seems to settle at 3x of
where the orbit move started
Given the 2000cr+ cash on books today and another 2000cr+ being generated
by the time Revlimid goes completely generic (and therefore faces steeper
price erosion), Natco has taken a lot many substantial bets in the 5-6 okayish
part of the portfolio, some of which are filed with no partners unlike all the orbit shifting launches done so far where Natco was entitled to only 30% of the
profits or lesser
Today, the portfolio approach at Natco has widened to not only include bets on
various molecules but also to include various geographies (Canada, Brazil, Saudi,
Philippines, Saudi Arabia, etc.) and a foray into agrochemicals based on the two
same skill sets (frugal science and legal expertise).
Probabilistic vs. Deterministic
A counter argument to having a probabilistic mindset and therefore a portfolio
approach to running a business can be one of the following:
Not having a Plan B, forces one to work harder/ sharper to ensure Plan A is a success
Being deterministic is akin to being focused
However, I disagree with both these assertions. In neither of the above two cases
have we seen an operator go beyond their circle of competence. Their portfolio
approach is simply a result of them realizing what they are good at (returns) and
accepting the fact that even in the businesses they know so well there are a lot of
small things that are beyond their control (risk-adjusted). They are therefore
showing humility in accepting what they know and what they can control
instead of hubris; a hallmark of great risk adjusted approach to generating
returns. In doing so, they have reduced the chances of making a permanent loss
of capital on the whole a close to zero probability event- these are the odds I like.
As always, we thank you for putting your faith in us and entrusting us to be
your partners in your wealth creation journey.
Best,
Harini Dedhia
Head of Research