• Team Carnelian

Carnelian Update - Chartering in unprecedented times

Dear Carnelian family,

We hope that you and your family are safe and staying home.

We are in unprecedented times, thus thought of doing our monthly letter a bit differently, while still trying to address most questions you may have.

We firmly believe that our Indian scriptures offer a perspective on every problem. Supporting our belief, we would like to share a beautiful story from the Puranas, which seems pertinent to current times and can help us navigate through these times better.

Faith versus Fear:

Once Krishna and Balram were walking through the forests to reach some place, when night fell. The silver moon filtered through the leaves and the wind blew with all its might. They decided it was best to rest till the crack of dawn. While one would sleep, the other would watch over for wild beasts and they would take turns. Balram insisted that Krishna rest and he would play guard. Balram was smiling to himself as he watched Krishna sleep when he suddenly heard a sound, “Aaaaaah”.

Startled, he looked around and saw a demon about his height watching him with hungry eyes. Balram was scared and with a quiver in his voice, he asked, “Whhhooo aaarree yooou?” The demon laughed and said, “I am the size of your fear!” As he was saying this, he started growing bigger and bigger. Indeed, Balram was petrified. The more afraid he was, the more the demon grew. The more the demon grew, the more panicked Balram became! The demon was now towering – almost three times the size of Balram and he couldn’t take it anymore. Screaming, “Krishna!” he fainted.

Krishna woke up and saw Balram lying next to him. Assuming he was asleep, and it was now his time to watch out, Krishna reached out for his flute and was about to start playing it, when he saw the demon. The demon watched him with hungry eyes. Krishna watched him without much interest. Unable to take such apathy, the demon said, “Don’t you know who I am?” Krishna said, nonchalantly, “Looks like you are going to tell me, in any case!” The demon said, “I am the size of your fear!” Krishna laughed. And the demon started becoming small. The more Krishna chuckled to himself, the tinier and tinier the demon became, until it was the size of a miniature doll. Krishna picked him up and put him in the bag to show Balram.

The next morning when Balram woke up, he told Krishna, “Krishna, Krishna, thank God we are safe! You have no clue what happened to me last night while you were sleeping. A humongous demon came and told me he was the size of my fear!”

Krishna, with a smile on his lotus lips, removed the doll from his bag and asked, “Is this the demon?” Balram was confused and said, “Yes – it looks like him. But he was huge. How did he become so tiny??”

Krishna said, “He looked so huge because he was able to scare you. He was the size of your fear. I couldn’t help but laugh when he tried to scare me, and he kept shrinking. He would have disappeared, but I wanted to show him to you – hence I have kept him!”

This story rings a bell as it resonates well with today’s time. Given similar circumstances, most of us are behaving like Balram. Without doubt, COVID-19 is a colossal problem faced by humanity, but growing the fear of unknown bigger and bigger and getting petrified & paralysed is not going to make the problem small. Doing what we can do and having faith in positive outcomes is what we must focus on.


Where faith exists, fear cannot. Of course, faith is not easy to find and even once found, it will be tested several times. At times when things look completely impossible, you wonder if this five-letter word called faith can actually carry you! And yes, it can. In fact, often, it alone can - especially when you have done all that you could.

Just the way a room cannot be dark and lit at the same time, faith and fear cannot co-exist. Faith is time tested; it is validated. If we can stand strong, it carries us in the palms of its hands to the destiny that is awaiting us. Faith is not for the fainthearted. “The problem with some of us is that we have faith in our doubts and doubt in our faith.” However, things can be turned around.

Of late, most of us have been reading unnecessary and often fake news that create fear. As the fear grows, it can conceive, weave and believe in any story, sometimes the worst one. We must have faith in humanity’s ability to withstand every crisis like it always has done in the past; we must have faith in India’s potential and most importantly faith in our own ability and bright future. The best is yet to come!

With that, let us move on to our last month’s performance.

Risk means more things can happen than will happen. Nobody in January would have imagined a complete lock down of the world for an uncertain period of time along with such massive destruction of wealth. However, our January letter did mention about the uncertainty and volatility this could bring and we created ~15% cash but never did we imagine this scale of destruction!

Currently the world is grappling with 3 key questions:

1)How long and serious the COVID-19 spread can get; will it get worse before it gets better?

2)What will be the longevity of lock down?

3)How will the lock down impact businesses and economies structurally?

While answers to many of these questions are uncertain and will evolve with each passing day, one thing we believe is that the spread happened at a time when everyone was caught off guard. Now that it’s a full-blown crisis, Governments and organizations around the globe have come out with full might to curtail the spread and find a cure. And it will be a matter of limited time before which it will either get curtailed through a cure or a pause in spread of new cases or a combination of both. We must commend the Indian government for implementing a well-coordinated social isolation and fight against COVID 19.

We believe this will get controlled sooner than most people are expecting. We would assign a 60-70% probability to the world slowly opening up in May/June 2020 and India can even open earlier too. But never forget the balance probability, so one has to be watching & agile to the evolving situation.

How will the business and economies get impacted?

Currently, there are two risks that businesses are facing – productivity loss and liquidity crunch, with the later one being far more detrimental! The global economy will take a serious hit impacting the GDP, which might see a significant de-growth for a few quarters. We may not witness a sharp recovery.

We believe companies with good balance sheets and flexible cost structures will be able to navigate through. The RBI and Government will take counter cyclical measures to support either specific industries or general businesses to tide over the liquidity squeeze. But one can never be sure of the effectiveness of these measures, hence businesses with leverage and high fixed costs will be at high risk and will have to tread cautiously.


What are we doing at Carnelian?

We are broadly doing four things –

Stress test: We are stress testing our portfolio companies and many of our coverage stocks to assess structural damage to the earnings potential. Our stress test mainly focuses on cash flows, available liquidity in the Balance Sheet, management’s response to the situation, how they are taking care of their stake holders, etc. One simple rule we follow is any company not having up to one year of liquidity or wherein the earning power has got structurally impaired, will have to exit our portfolio. Fortunately, we have found none so far and the stress test has given us a lot more conviction on our portfolio companies which are a part of the magic/compounder baskets.

Companies with limited/no negative impact: There are businesses/companies which have negligible short-term impact due to Corona but price dislocations have been very sharp. It had always been a desire to buy some of these but valuations were beyond our comfort zone. These times are providing us the opportunity to buy into these using cash and/or by switching from existing portfolio names which might be good otherwise but the switch improves the long-term risk reward profile of our portfolio. Most of these companies fall into Compounder Basket and hence our desired ratio of compounder has gone up (40%), but we don’t mind that given the fact that it offers reward of magic but risk profile of compounder.

Companies with high short-term impact but strong business case and strong balance sheets: There is another set of businesses like retail, leisure, aviation, etc. which run on high fixed cost structures which will impact their businesses severely over the next two quarters. However, due to inherent demand and strong balance sheets they will turn around swiftly. Markets have punished these companies harshly. We believe businesses which have a demand and strong balance sheet will come back fast – thus we are buying and/or switching into some of these names.

Keeping team motivation high: In times like these, it is very natural for the team to feel depressed and bogged down by the gloom and doom. We have been keeping our and our team’s morale high. We have seen this before and believe this shall too pass.

What drives our faith in the business fundamentals in the current context?

When we do valuation of equities, large part of the value is attributed to the Terminal value. Then the obvious question is why are stocks down 40%-60% because of 1-2 quarters of disruption? The answer to that lies in the uncertainty around the longevity of this period and second is the structural impact on the business impacting terminal value. Many businesses run the risk of bankruptcy in this period, hence the correction is justified. If we can find out businesses (there are many), which will survive and emerge stronger during this period, there will be a huge value creation akin to the value destruction on account of uncertainty. This is the nature of the market.

We have seen many cycles to know that businesses will survive, we have to direct our effort in finding the ones which will survive. Someone rightly said: Virus will pass, so will the opportunity..

Our view on the markets - is it good time to invest?


Very often, we get this question about how much more downside is left? Truthfully, answer to this is known by none.

Howard Marks once said: “When everyone believes something is risky, their unwillingness to buy usually reduces its price to the point where it is not risky at all. Consensus negative opinion makes it the least risky thing since all optimism has been driven out of its price.”

We believe we are very close to the above situation. How close? We will be willing to hire anyone who can answer this question precisely with science. The one thing we are sure of is, once this unprecedented pandemic starts receding - businesses with strong Balance Sheets will flourish. Our hunt for such businesses is on – we now face the problem of plenty😊, plenty with favorable risk reward metrics. We continue to buy within our MCO framework and if our investors spare more cash, we will buy more.

Below is a summary of our past experiences of crisis and pointers which indicate market bottoming/favorable risk reward ratio.

MCap/GDP ratio – Current market cap to GDP ratio stand at 54%, last seen only in 2008 crisis. Usually through the cycles, it oscillates between 50% to 150%.

Earning yield vs G-sec spread (EY at 6.03% minus GY 6.07% is almost zero) – This ratio (EY-GY) is usually negative. A zero to positive ratio indicates either a significant & sharp drop in interest rates (like in the US/Europe post 2008 crisis) or significant correction in equities prices/valuation. Positive ratio in a growth economy is hugely value creative for equities, as equities will offer growth but bonds will not. Historically in such situations, Equities have offered good returns, once the immediate concerns settle down.


P/B Ratio (2.01) – at Nifty level, again is the lowest in the decade. Usually the range is between 2-3x. Several businesses are available at 0.3 - 0.5x book, just because the earning power of these assets are temporarily impacted. However, this does not mean they will be permanently impaired. They will come back once normalcy returns.

In a nutshell, the risk reward of investing in equities is surely favourable.

Our advice to the all our stake holders - Spend this time well with yourself & your family in addition to scouting for new opportunities to invest your capital.

Hopefully, 6 months later when we look back, we should cherish the quality time spent with our family and a healthy portfolio.

We are open and available for discussion on either the environment/ our portfolio/ or any other subject, should you want.

Stay healthy, happy and peaceful!


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