Investment thesis on Restaurant Brands Asia

We published our investment hypothesis on RBA which operates Burger King India (BK India) and Burger King and Popeyes franchises in Indonesia on Pg 7 of our Q1FY23 Letter. 

Over the last few months, we received some relevant questions on Quick Service Restaurants (QSRs) as well as RBA from partners and other colleagues in the Investment industry.  This note attempts to answer these questions. Please read the thesis above before reading further.

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The shadow of Private Equity ownership on our buying decisions

The purpose of our letters and occasional blogs is to provide transparency in how we are thinking with the goal of creating stronger alignment with partners who want to think and act long-term.

Two companies in our portfolio – STAR Health Insurance and Restaurants Brands Asia – have existing Private Equity (PE) shareholders looking to exit.   Everstone is looking for a buyer for its stake in RBA.  Similarly, there are a few PE investors in STAR who are looking to sell their stake. 

PE funds have a finite life and need to return capital.  The shadow of these exits often results in a weakness in stock prices till the exit is complete.  For example, one of the PE investors in STAR sold a large stake via a block deal last Friday at a discount to the prevailing market price which resulted in a 8% drop in price.

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Why have we continued to buy Star Health

The price of Star Health corrected significantly from our first purchase price.  We have continued to buy on the way down and are now at an 8% position weight.

Original investment thesis

The industry provides a rare combination of “win-win-win” business with growth longevity, a strong moat and healthy ROEs.

  • Consumers: It’s a must have product for consumers as Health issues can bankrupt families and should have priority in the Consumer wallet.
  • Regulator: Wants more insurance coverage and hence should not grudge the industry a ~15% accounting ROE.  There isn’t enough history in India for companies to model claim ratios over time (unlike Life Insurance where LIC has mortality tables).  So the regulator permits price increases when product claim ratios becomes adverse.   Star just announced an average 25% price increase in its flagship product.
  • Company:  Can grow premium at 15-18% CAGR for a decade (1.5%% natural increase in population growth, enhanced retail health insurance penetration (currently 4%), 6-7% medical inflation and 5-10% increase in covers with rise in Incomes) at 16-18% accounting ROEs. 

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Why do we never go down the risk curve in Financials to chase cheap valuations

Silicon Valley Bank in the US has collapsed.  SVB imploded as 3 risks collided

  1. Side effects of excessive money printing came to the fore –> steep increase in the US yield curve as long term interest rates rose from 1.5% to >5% in about 15 months
  2. Highly concentrated depositor base which withdrew large sums quickly
  3. Huge Asset Liability mismatch –> short term deposits were parked in long term Assets (akin to what happened with our Real Estate NBFCs).  Hence, SKB was forced to sell long term assets and book losses when faced with withdrawals at the wrong time, which eroded its Capital base and created momentum for a run on deposits (vicious cycle).

An article that explained what happened is enclosed.

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Investment thesis on Kama Holdings

Kama Holdings is the Holding company of SRF. Please read this important disclosure. 1

Summary thesis:

  • SRF will grow profits at 15%+ over the next decade riding market opportunity and leveraging its strong competitive position. However, we expect valuation multiples for SRF to correct over time as mean reversion takes place and when growth slows down.
  • The Holding company discount for Kama has expanded over the last 5 years.  This should narrow over-time as the mispricing vs peers gets corrected.
  • Hence, buying Kama is akin to buying SRF at a margin of safety.   If the discount on Kama does not narrow, we should earn similar returns as one would earn on owning SRF.  However, if we are right, we should earn a substantial kicker above returns earned by owning SRF.

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