cash Flows: Rate hike cycle an unknown, stick to cash flows: Kenneth Andrade
In a media interaction on Wednesday, Andrade, chief investment officer of Old Bridge Capital Management, said equities may not take a big hit as central banks prepare to increase the interest rate to combat inflation.
“None of us have seen what happens in a rate hike cycle, we have a couple of rate hikes that have happened in the last two decades but it is a very faint memory,” said Andrade.
“What will happen right now is if interest rates tend to tear up, price to earnings multiples will start coming down structurally. You are better off buying companies or businesses where you have got a very good handle on cash flows and you are very sensitive to the price you pay for it… so go back again, compute your price-earnings multiple. The cheaper it is the more you will secure yourself against volatility that will come through because of a rate hike,” he said.
Andrade added that he doesn’t expect too many earnings downgrades either in the March quarter earnings season. “Valuations are fair, they are not cheap. We are still susceptible to an event risk but earnings numbers are far more predictable right now and a lot of downgrades have already happened before the Q4 numbers. I don’t think there will be too many downgrades that will happen post that,” he said.
Andrade said the IT sector is seeing some kind of correction in terms of margins. It is not structural in nature but probably a cyclical change in the margin profile of these companies.
“You have to wait till the IT companies actually pass them on and that will demonstrate the ability of their pricing power. If they are able to pass it on they will be alright after the next six months,” said Andrade.
On financials, Andrade said, “I would rather be a beneficiary of the financials rather than participate in financials. We don’t like leveraged businesses. We like businesses with cash flows. Financials are neither of these two, that’s why we have stayed clear of it,” said Andrade. He advises looking for businesses that lend against assets, are into secured lending and stay away from businesses that have traditionally lent against income. “Asset prices are going up and incomes may not be as buoyant as it was in the last decade.”
Andrade said startups that have listed over the last year need to demonstrate longevity and profitability. “All of them have hit credible sizes on sales growth and investors will be watching how they convert that opportunity into cash flows and make a sustainable future without external capital,” he said. Very few of them will come through into the earnings cycle.”