• Team Carnelian

Carnelian Update – Some respite but continue to focus on risk

Dear Carnelian family,

We hope you and your loved ones are all doing well and safe at home.

Several weeks into the pandemic, I am sure you have read or heard a lot on Covid-19, its impact on the economy and businesses. Our view is nobody knows. The only thing that we know is, this is first time humanity has witnessed a global lockdown of this scale and its impact, specially the second and third order will be difficult to assess in the complex inter-connected system. Only time will tell us more about this. Oil price plunging into the negative, closure of corporate bond funds, are some of the examples of second/third order effects. We will see more of these in times to come, depending on which direction the current pandemic takes.

What do we do?

The only thing we can keep doing in these times is to manage risk and keep some dry powder available with a defined shooting range and fire as and when the target appears.

There is NO space for bravado in current times when it comes to risk. We believe two risks are far from over yet and we will watch them closely over the next couple of quarters:

1. Risk of second/third order impact on markets/economy (could be in the form of bankruptcies, systemic failures, policy failures or the many unknown unknowns)

2.Risk of rise in the spread of Covid-19 post relaxation of the lockdown. We think there is a good probability that numbers will go up and a small probability that it might even get dangerously large. We don’t know. Both scenarios will have an impact on the psyche of people and will hinder return to normalcy.


One thing is clear, in times like this, the companies with sound balance sheets and strong business models will survive. Big will become bigger. Many weaklings across industries may not survive and eventually will die or get sold.


What have we done?

1) The few things that we have done during the last couple of weeks of turmoil are

sitting on 18% cash

2) increased our holding in Pharma & Healthcare stocks where we see a positive impact of the crisis reduced the risk profile of our portfolio by adding large caps/replacing small caps with large caps.


Markets and Carnelian


It is in times like these, the value of our MCO (Magic-Compounder-Opportunistic) framework, Investing Principles and PIU scorecards (proprietary scorecards) gets tested. Based on the findings of this scorecard we invested into companies attributed by strong leadership positions in their segments, robust balance sheet and experienced, committed & passionate managements in our portfolio. This combination should help them come out of woods well.


We ran a stress test on all of our portfolio companies - few of the important parameters along with our analysis are highlighted below.


Important parameters:

-Reported leverage and off-balance sheet leverage

-Liquidity surplus (Cash and liquid investments)

-Contingent liabilities, commitments and guarantees

-Impact of currency movements

-Impairment/write-off risk on inventories, receivables etc.

-Decline in sales

-Fixed cost and impact of the same in times of shutdown


Our analysis and actions:


Our comments on few of the important parameters from our stress test:

Portfolio Companies (other than Credit BFSI Companies):

Pre-Covid-19, our portfolio companies had a debt equity ratio of ~0.2x. Stress testing the same assuming a worst-case scenario of revenue pain for the next two quarters, revealed this number will not change materially. Despite the expected revenue de-growth and profitability getting meaningfully impacted for a year, we believe that there will be no structural impact but continued intact long-term prospects attributed by robust Balance Sheets and strong company fundamentals.

Credit BFSI Companies:

Stress test in the credit space highlighted no drawdown from their Balance Sheet despite increasing credit costs, since most of our portfolio companies have a capital adequacy ratio well above the regulatory requirements


Rising credit costs will impact short term ROEs resulting in subdued valuations resulting in some of the portfolio stocks trading at or below book value.

Overall, our interactions with the management of our portfolio companies suggest that they are pro-actively undertaking various efficiency measures like digitization, work from home, rationalizing unproductive expenses etc. which will result in structural profitability improvement post the pandemic.

All of our portfolio companies have been in existence for more than a decade and have come out of the earlier crisis much stronger. This instills confidence and conviction in us that this time should be no different.

We will continue to keep a watch. We will be objective and unemotional if we get convinced of any material change in any of these facts or something else offers a better risk reward. For now, we believe that we are well positioned.

We will be very happy to engage and discuss, should you need to know anything about portfolio, markets or economy.



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