With cash levels in the portfolio having fallen sharply from 29% to 7% in the Q India composite, the near-term uncertainty of earnings should not take away from the long term economic opportunities in India.
While we have deployed capital recently, we will be happy to suggest a further allocation to India – if valuations support it. For that to happen, either prices have to decline – or a series of reforms creates a strong case for a serious step-up in the long term earnings potential of companies in India.
From being the wand-waving Prime Minister hopeful, Modi now has to prove that the BJP can deliver on the high expectations: that is the challenge. After 12 months, the honey moon is clearly over. Earnings have not grown as anticipated and the surge in share prices has resulted in a higher PER.
After crossing the 30,000 level on March 4, 2015 the S&P BSE-30 Index looks a little tired and may need to rest till the visibility of earnings is more realistic.
Another opportunity for a value investor?
And therein lies the potential opportunity.
On August 28, 2013 the Index marked an intra-day low of 17,500. The USD was at INR 68.36.
We were excited and sent out an email that evening stating that we were waiting for a further slip before we ask clients to load up on a lot of India exposure.
Sadly, the market took a U-turn for the Modi bull run.
Assuming that a 20,000 Index level was “fair value” in September 2013 – and assuming that companies have grown earnings on average at 8% per annum, that would translate to (all else being equal) to an Index level of 23,328 to make us believe that India is at “fair value” again resulting in lower cash levels. Anything below that is a large “overweight”. In mid-June 2015 the Index slipped below the 26,000 levels: 10% away from that level. The USD is in the INR 63.5 range.
At current valuations, India deserves about “75% to 100%” of your long term allocation – a notch up from the “50% to 75%” range. Valuations - and the expectations of growth in earnings within India - drive our “underweight”, “neutral”, or “overweight” views. Flows and “relative” choices in the global sphere do not drive our “allocation calls”.
Why we love India
Within this overall hype, there is a real economy with real growth and great investment opportunities.
If Prime Minister Modi sends the correct signals he will unlock the potential that India so wishes for. If he does not, be content with a 6.5% rate of growth in annual GDP. Even that is great for picking the winners with a long term view – as it has been for the past 34 years.
There are serious businessmen building serious businesses within the confines of a bad bureaucracy, illogical regulators, and a misguided political class. (No, we are not referring to the US or France!) The challenges we face is to identify these managements, understand the risks they are taking and assess the valuations at which we are willing to use client capital to fund these long term business plans by being investors and shareholders.
With a solid domestic savings rate of over 30%, India has the capital to achieve a 6% plus rate of growth in GDP (as shown in Chart 1) even in a troubled global environment. Though, if GDP needs to be kick-started, India needs a transparent mechanism to transfer national and natural resources from the government to the private sector. Everything else is a “quick fix” that will fail.
India’s policy makers continue to look for a quick fix, sticky-glue operation but there is the need for a tedious, methodical repair that needs to reverse decades of bad choices. And during this repair there will be waves of optimism (note the small cap and mid cap stocks zooming ahead) and currents of irrational fear (anyone remember May 2004, September 2008, January 2009, August 2013?).
With the macro noise around us, we remain bottom-up stock pickers. And we are keenly eyeing the potential additions to the portfolio. As managers with the mandate to look after your capital, we remain disciplined value managers. Our challenges remain: to understand and analyze the businesses; to decipher the valuations ascribed to these businesses in the stock market; and to understand the ability of the management to guide these businesses in uncertain times - the unflinching question of leadership is crucial. And share the returns fairly with minorities.