SVN Capital Fund commentary for the fourth quarter ended December 31, 2024.
Dear Partner,
SVN Capital Fund’s portfolio returned +11.8% (net; subject to audit) for 2024. Depending upon when you invested, your return may be different.
Here is what I’d like to cover in this letter:
- measuring management teams;
- the portfolio and performance highlights; and
- India and Bajaj Finance Limited.
Measuring management teams
In October 2024, I was invited (via Zoom) to speak to a group of students from a small college in Northern Italy. As I went through the four-part investment objectives I employ, one of the students asked me, “How do you evaluate the Duke?” He was referring to the famous speech that Warren Buffett gave at the University of Florida in 2007, in which he said:
…I don’t want a business that is easy for competitors. I want a business with a moat around it. I want a very valuable castle in the middle. And then I want…the Duke in charge of that castle to be honest, hard-working, and able [emphasis mine]. And then I want a big moat around the castle, and that moat can be various things.
Since some of you have asked this question, and it keeps popping up in many of my conversations, I decided to write about it in this letter.
Evaluating “the Duke” (and the team) is a subjective process. It can sometimes be challenging, as it entails measuring some of the qualitative features of the doyens and doyennes.
As Beryl Markham, an aviatrix, said in her memoir, “If a man has any greatness in him, it comes to light, not in one flamboyant hour, but in the ledger of his daily work.” Fortunately, the ledgers of these long-serving CEOs (the average tenure of the CEOs of our portfolio companies is ~13+ years) contain enough debits and credits, allowing me to evaluate both their probity and perfidy.
Since identifying the negative qualities is more straightforward, I look for disqualifying features first. Criminal convictions or any integrity-impacting legal fracases would be disqualifying features. When I was conducting due diligence on a company, a former senior management team member described the CEO, sotto voce, as someone “who has great respect for the truth, and so uses it sparingly.” I ran, metaphorically, as fast as Forrest Gump. Integrity is a desideratum.
Often, corporate skullduggery is evident in the proxy documents. The proxy describes in detail the compensation and incentive programs, and it is one of the first few documents I review before diving into in-depth analysis. When the proxy displays low insider ownership interest, egregious compensation schemes, and shareholder-unfriendly incentive structures for the senior management teams, I put them into the unfavorable features bucket. For example, I have passed on many companies where the incentive payments to the senior management teams were based solely on sales growth, as this is a recipe for long-term disaster. The disqualifying and unfavorable features are somewhat more easily identified; what I look for is the absence of disqualifying and unfavorable attributes.
On the other hand, I look for an abundance of favorable and essential features in the management teams. Most of the time, these two features reveal their presence through the many effects they produce across the organization. For example:
- Good corporate culture is an aftereffect of these positive features. One such aftereffect is low employee turnover. Hermès, the French luxury company that we own, has one of the lowest employee turnover rates (~5%) in the world. This is a result of many decades of favorable decisions. Pierre-Alexis Dumas, a member of the founding family and artistic director at the company, made a few profound comments about the culture in a recent short CBS interview, which you can see here: Hermès and the success of the coveted Birkin bag | 60 Minutes.
- Reinvestment is a sine qua non for intrinsic value creation in business. Few businesses present the opportunity for the management teams to reinvest all the free cash flow generated. Fewer management teams make such an impactful decision even when they have such reinvestment opportunities. Dino Polska, the Polish grocery chain, is one where the founder has made such a favorable decision since the company’s founding.
More often, it is the owner-operators who have such favorable and essential features that lead to value creation. As such, nine of our 10 portfolio companies are owner-operated or family-controlled.
As Phil Fisher, the other father of investing, famously said, “Getting to know the management of a company is like getting married. You never really know the girl until you have lived with her. Until you’ve lived with management, you don’t really know them to that same degree.” C’est la vie. Studying the “ledgers of their daily work,” which reflect the fortes and foibles of the management teams, makes the craft of investing so much more enjoyable.
Before I leave this section, let me help jog your memory regarding my investment objectives. I look for an affirmative answer to the questions below.
- Is it a business that I can understand?
- Is it a high-quality business that generates a healthy return on incremental capital, and does it have good reinvestment opportunities?
- Is it run by honest, competent management teams with skin in the game?
- Is it available at a reasonable valuation?
While the sieve I employ continues to be very fine, you will be relieved that it is not impervious. During the second half of 2024, it allowed me to add four new businesses to the portfolio.
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Portfolio and performance highlights
We currently have investments in 10 businesses. Cash is approximately 1.0%. Here is a look at the portfolio composition.
Beginning in July, after the long-awaited imprimatur from India, I started buying the stocks of three Indian businesses and one in Canada. In the next section, I will describe India’s investment appeal and one of the investments in more detail.
I sold three stocks from the portfolio: Evolution AB (EVO) in Sweden, Old Dominion Freight Lines (ODFL) in the US, and Text SA (TXT) in Poland. All three are good businesses that I believe will do well over time, but as Stephen Sondheim, the renowned composer and lyricist, said, “Sometimes you have to throw out the good stuff to get the best stuff.”
Having studied the business models closely, met the management teams several times over the years, and spent enormous amounts of time thinking about them, these “sell” decisions were not easy. While there are company-specific reasons for exiting these investments, the common thread is how they have helped refine my personal investment philosophy. Most of the sale proceeds went towards buying more-attractive businesses in India.
Investing involves finding, owning, and holding on to a small number of outstanding businesses. These companies can deliver a significant multiple of our initial investment and drive returns. In my year-end 2022 letter I said, “I walked away convinced that being a willful sloth helps lay a genuine path to prosperity.” We now have a few examples from our portfolio—three of the top four contributors (KKR, CPRT, and HEI) have been in the portfolio for more than four years. On our average cost, we are up 3.5x in KKR, up 1.9x in CPRT, and up more than 1.8x in HEI. In the next section, I will tell you why my conviction level remains high for strong long-term performance.
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In the year-end letters, I like to show the following table comparing our portfolio to the market average.
Our businesses generate better margins and returns than the market, and our balance sheets are far superior, evidenced by the low debt levels and high interest coverage. We own a collection of high-quality businesses.
One important marker of such quality is consistently high return on capital; weighted average return on capital for our portfolio was 28%, almost 2x the market’s. Over the years, as the quality of the portfolio has improved, so has the return on capital. Not only do our companies generate healthy returns on capital, but they do so while growing at a healthy pace—free cash flow grew 19% during the year.
The weighted average free cash flow (FCF) yield of the portfolio was 2.4%, while it was 3% for the market. Since the quality of our portfolio is significantly better than the market average, it is no surprise that our portfolio is valued at a slight premium to the market.
History tells us that the stock price follows the fundamentals of the business. As such, my conviction in the long-term performance of our portfolio comes from these high-quality markers in our businesses.
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The top three contributors during the year were KKR which I will describe below, KNSL, and HEI. Combined, these three alone were ~18% for the year.
KKR
The stock is up ~78% for the year. We have owned the stock since the fund’s inception, and I continue to remain optimistic about the long term. Let me tell you why.
Scott Nuttall, co-CEO, recently said:
We have got multiple paths in asset management to surpass $1.0 trillion in the next five years.
So…our priority in 2025 is to monetize the environment that we see coming. And that means fundraising, deployment, and monetization.
The alternative asset management industry has been growing at a healthy pace. According to iCapital, an industry research platform, total assets under management (AUM) in the industry are expected to hit $25 trillion by 2028 from its current level of ~$18 trillion.
Fundraising
Since 2010, AUM at KKR, one of the largest in the industry, has grown at an even faster pace—CAGR of 18%—and is $624 billion as of September 30, 2024.
At the investor day in April 2024, the management team laid out its short-term goal of raising $300 billion (cumulative) by 2026. KKR is well on its way to achieving this goal; in the first nine months of 2024, they raised $87 billion of new capital.
Deployment
Investment opportunities are enormous for KKR. For example, Infrastructure is a segment that is expected to need $100 trillion of capital by 2040. The company currently has only ~$60 billion in AUM in this segment, with a lot of room to grow. Another segment that is a big investment opportunity for KKR is Credit, which overtook Private Equity as the largest segment in 2021. For example, asset-based finance (ABF) is a subsegment within Credit that is expected to reach ~$10.0 trillion by 2030. KKR currently has AUM of ~$66 billion in ABF.
During the year, KKR deployed $60 billion into new investments and continues to plant the seeds for future harvesting at a healthy pace.
Monetization
After a two-year drought beginning in 2022, exit opportunities both through the IPO and M&A markets have improved in 2024. KKR and other alternative managers expect the exit market to remain robust in 2025.
The collective efforts of fundraising, deployment, and monetization have led to a healthy total operating earnings (TOE), the primary measure of operating performance. TOE, which does not include the important but volatile income stream of “carried interest,” was $1.47/share in Q3 2024 and $4.76/share for the last 12 months. Separately, gross unrealized carried interest was ~$7.9 billion, or ~$9.00/share, as of September 30, 2024. During the investor day in April 2024, the company announced its goal of generating $7.00/share of TOE by 2026. The company is well on its way to achieving this goal.
At the current price, we own a company with significant room to grow, trading at a reasonable valuation.
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The bottom three detractors during the year were DNP (~-3.5%), the newly added Canadian company, and EVO (~-2.8%), which I sold during the year. Let me tell you why I continue to like DNP.
Dino Polska S.A. (WSE: DNP)
The stock is down ~15% for the year. Ever since the Russia-Ukraine war started in 2022, this grocery chain’s sine curve of operating metrics tightened in frequency and gained in amplitude. Inflation and interest rates continued to surge even as the refugees from war-torn Ukraine poured into Poland. Fearing a monumental shift in buyer behavior, the management team halted the company’s store growth, the effects of which are still reverberating through the company’s financial statements. See the table below for the turbulence.
Store growth is the lynchpin holding the valuation of this fast-growing retailer together. The average new store growth over the five years before the war in 2022 was ~24%. After the war, the number of new stores was only 250 in 2023 compared to 341 in 2022.
In the meantime, price competition between the two large grocery chains (Biedronka, a homegrown behemoth, and Lidl, a German giant), combined with an increase in minimum wage across Poland, piled pressure on DNP’s margins. This was a painful combination—the top line was crimped while the cost of doing business went up. The stock was down as much as 35% during the year. The wheels appeared to be coming off.
So, what now? In my discussion with the company after the Q3 2024 earnings release, the management team said that, in retrospect, applying the brakes on store growth was a mistake. The consumers, while tight-fisted, didn’t change their behavior as much as initially feared. Having realized this, the focus has been on opening new distribution centers and stores. Store growth is expected to return to its historical pace, if not better. As such, growth has picked up steam over the last few quarters (32 new stores in Q1, 66 in Q2, 69 in Q3, and 115 in Q4, which is the highest number of new stores in a quarter in the company’s history), and I expect DNP to return to its historical trend. Also, the price war between the two grocery giants of Poland has cooled off and is expected to normalize over time.
We own an owner-operated retailer in Poland, with room to at least double its store footprint (it currently has ~2,700) over the next few years, trading at an attractive valuation.
India
During my recent peregrinations through India in mid-2024, one of the most interesting people I met was Mr. Bharat Shah in Mumbai. He is the author of a fabulous investment book (Of Long-Term Value and Wealth Creation in the Stock Market) and is the head of research at a large Indian investment company (ASK Group). His writings, interviews, meetings, and Zoom calls have influenced my investment style enormously.
We discussed several topics, including his personal investment philosophy, Indian business models, and markets. When I asked about the stock market during the conversation, he suggested I examine the last 30 years of the local economies and stock markets in the US, China, and India. He said, “The market is a ruthless arbiter of underlying reality over the long run.”
Here is a look at the three markets.
The historical performance of China and India were startling…at least to me. So, just as I was wondering why the Chinese stock market did not keep pace with its rocket-ship of an economy, Jason Zweig, a renowned financial journalist, wrote about it in WSJ. You can read it here: China Shop by Jason Zweig in WSJ.
However, my focus in this section of the letter is on India. While the performance of the Indian economy and market has been impressive over the past 30 years, the more relevant and essential question is about the future.
One widely known factor is the country’s large population base, expected to have a fast-growing workforce larger than China’s by 2030. In addition to this long-term trend, three significant developments over the last decade have positioned India well for a repeat performance over the next 30 years.
- Physical and digital infrastructure improvements: The highway network doubled over the past decade and the number of airports has more than doubled. More than the physical infrastructure, the country has made enormous leaps in digital infrastructure.
- The first is the Aadhaar card (equivalent to Social Security), a biometric identification card that is the cornerstone of India’s digital infrastructure. This was quickly followed by bank accounts for everyone (1.4 billion bank accounts) and then the Unified Payments Interface, the world’s most extensive real-time payment interface, through which more than 40% of the Indian GDP is transacted.
- Goods and Services Tax, an indirect tax system for all goods and services: The blockchain-type technology makes tax evasion very difficult. The system reformed the existing tax structure and formalized a large part of the economy, increasing tax collections.
- Clean up of the banking system: Concurrent with improvements in digital infrastructure, the RBI (India’s central bank) undertook an aggressive asset quality review of all banks in 2015.
The administration implemented a new insolvency and bankruptcy code in 2016. This has led to a significant improvement in working capital cycles. These are mammoth forces unleashed within the last decade and will likely provide a significant tailwind to the economy. I will be writing about these in more detail over time.
So, how do these macro developments in India help our portfolio? Over the past two decades, these developments have unburdened the entrepreneurs and have freed them from their Svengali. In addition, these developments have helped elevate ~300 million Indians (the size of the US population) into lower- and middle-income groups. As such, the consumer accounts for over 2/3rd of the Indian GDP, with plenty of room to grow. This lower-and-middle income group is on a ravenous search for essential consumer durables like TVs, two-wheelers, washing machines, and such. And that is a good segue into Bajaj Finance, one of our holdings.
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Bajaj Finance
This INR 4,232.3 billion (~$50 billion) market cap company is India’s largest non-banking financial company (NBFC) or specialty lender.
What does the company do? In the Western context, Bajaj Finance is a specialty finance company or, in a more pejorative sense, a shadow bank. India’s credit market has experienced significant growth over the last decade. As of September 30, 2024, the size of the credit market hit an all-time high of $3.1 trillion. It has grown by 13.8% from 2000 to 2024. As of July 2024, ~1/4th of the country’s credit was provided by NBFCs (while most of the balance is supplied by the banks), growing from ~1/6th in 2014. Since there are limited barriers to entry, there are lots of NBFCs around the country. However, there are significant barriers to scale, and Bajaj Finance is the largest. With a loan book of $44 billion, the company makes one in every five loans made by NBFCs in India.
A brief history
Until the Great Financial Crisis in 2008, the company, founded in 1987, was solely focused on providing financing for two- and three-wheelers manufactured by Bajaj’s auto division. The credit crisis that delivered the coup de grâce to Lehman Brothers in New York almost dealt a death blow to Bajaj Finance, 8,000 miles away in Pune, India. Credit impairment was the primary reason. As such, the management team was forced to reevaluate its strategy.
So, in 2008, the founding family, which still owns more than 50% of the outstanding shares, friends with deep expertise in lending, and young-blood management with a penchant for execution, came together to set the company’s wheels in a different direction. They diversified the business from being just a captive lender to Bajaj vehicles to lending on consumer durables, housing, small business, and construction equipment, to name a few. One such offering was the zero-interest cost consumer durables loans, an incredibly successful and highly profitable type of loan. Today, Bajaj Finance is India’s largest and most diversified NBFC, with a presence in ~1,600 locations and 148,000 distribution points, serving a wide range of customers in both urban and rural areas.
Bajaj Finance now has a vastly expanded product suite (more than 40 product lines), including consumer lending, SME lending, commercial lending, rural lending, deposits, and wealth management. Each of these 40 lines is run as 40 mini-companies within Bajaj Finance with various leaders. Since 2010, the company has grown its loans by ~89x and book value by more than ~77x. The stock, in turn, has gone up by more than 200x.
Quality of the business: A typical quality business that I find attractive has two essential features: growth and predictability. I evaluate a company’s quality on both a qualitative and quantitative basis. First, here are some quantitative metrics.
Since 2010, the number of customers using the various product lines of Bajaj Finance has grown ~48x (from 1.9 million customers in 2010 to 92 million in 2024), which has helped its loan book (net) grow ~89x over that time. Bajaj Finance doubles its loan book every ~2.5 years! What is remarkable is that this growth has come with excellent credit quality metrics—average non-performing assets over the last 10 years was 50 bps. Also, the operating cost, measured as “Cost/Income,” is one of the lowest in the industry at ~30%. The business is run with a conservative balance sheet; for every INR 5.00 in assets, there is INR 1.00 of equity or capital of ~21%. I have attached a 17-year financial snapshot in Appendix I.
Bajaj Finance is more than an innovative specialty finance company. It is one of the largest recruiters of computer science graduates in India. The company maintains a large “data lake” of information on the rapidly increasing middle-income group of consumers. It collects more than the credit profile of borrowers. For example, it collects personal details, financial information, credit history, banking transactions, and demographics. The company can make lending decisions rapidly using enhanced data analytics capabilities. This IT infrastructure, which helps the company with underwriting and operations, has created a sustainable competitive advantage. Bajaj Finance is more of an innovative technology company than a pure specialty finance company.
This consistent growth, combined with a conservative balance sheet, allows the company to generate more than 20% return on equity.
Management team
Chairman Sanjiv Bajaj is the younger son of the late founder, Rahul Bajaj. Through Bajaj Finserv, he controls 51.3% of Bajaj Finance. Credit to him and Rajeev Jain, managing director, for diversifying the business model to its current form.
The simple mantra has been organic growth, focusing on increasing the number of customers and distribution points around the country while reinvesting in IT infrastructure and, increasingly, AI-enabled data analytics.
Valuation:
A few days ago, Rajeev Jain provided the five-year projection in which they expect the company to double in size. One key feature would be its reliance on AI. “…[W]e should aim to reduce our operating costs to NIM (net interest margin) by one percentage point every year over the next three to four years,” said Rajeev. He also expects customers to increase to ~200 million over the same period. Since the end of the pandemic in 2021, EPS has increased 3.4x, while the stock price has stayed flat. I expect the stock price to catch up and reflect the strong fundamentals.
We now own a high-quality specialty finance company in a fast-growing country trading at a reasonable valuation.
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There is a lot more I could have shared—particularly the new businesses I added during the second half of the year—and made this letter even longer. But I hope I have shared enough to get you excited about the potential of our portfolio.
Thank you for being a partner. It is a privilege to serve you.
Sincerely,
Shreekkanth (“Shree”) Viswanathan
