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The 'India story': Fundamentals intact!

Jun 15, 2006

The Indian stock markets are in the midst of a correction. The BSE-Sensex has lost as much as 30% from its all-time high of 12,671 hit in May, just one month ago. A combination of factors, ranging from concerns over inflation, rising global interest rates leading to FII outflows, higher crude oil prices and slower economic growth, have led to this correction, which has, in fact, hit emerging markets globally. Morgan Stanley has estimated that as much as US$ 2 trillion of investor wealth has been lost. Suddenly, emerging markets are not that attractive anymore, and global fund managers have seemingly started shifting money to safer US treasuries.However, just because markets have corrected, does it mean that the 'India story' is over? Our view is a resounding 'NO!' We do not believe that just because a bull market is in place, one should upgrade earnings estimates and pay higher prices for stocks, or that in a bear market, earnings estimates must be downgraded and one should become bearish.

In fact, we are of the firm belief that this fall is a healthy one, and that it corrects market excesses seen recently. For example, engineering companies were trading at obscenely high valuations of as much as 70 times earnings! Even though we are positive on the engineering sector, such high valuations are way outside our comfort zone. Even real estate stocks saw obscenely high valuations, such as Mahindra Gesco, which, at its peak, had a market capitalisation higher than BPCL and HPCL combined! These 'excesses' have now corrected to more reasonable levels.

Nonetheless, we mention a few points here that reflect the fact that, despite this outflow of Foreign Institutional Investors (FIIs) money of late, leading to this correction, fundamentally, the 'India story' remains intact.

  1. India's GDP is expected to clock a significant 7.5% to 8% YoY growth over the medium-term. If the UPA government focuses its energies on building up the country's infrastructure more speedily, then this figure can even go up to 10%.

  2. The expected earnings growth for the Sensex companies over the next 2 to 3 years is in the range of 12% to 15%. This is around 2x the overall GDP growth.

  3. Engineering companies' order books are overflowing, with most of them having order books ranging from 1 to 4 times their sales, thus lending them strong topline visibility. This is a good sign, as it shows the government's dedication to building the infrastructure of the country.

  4. The domestic consumption story is well and truly on. Higher incomes, powered by buoyant economic activity, have led to increased purchasing power. Pricing pressures seem to have tapered off, there is a move towards higher-priced products (up-trading). The untapped rural market is expected to drive growth, and organised retail (4% of the retail sector) is expected to grow to higher levels, which should help the FMCG sector as well. The growth shown by the sector in recent times has been amongst the strongest, and this is expected to sustain.

  5. Mobile subscriber additions continue at a scorching pace, with May showing an addition of as many as 4.25 m, CDMA and GSM included. The total mobile subscriber base in the country is now over 101 m, taking the gross teledensity (including fixed line subscribers) to 13.5% (Source: TRAI Website). Therefore, there is still tremendous scope for growth.

  6. The offshoring story continues unabated, with increasing acceptance of the 'Global Delivery Model' resulting in strong growth prospects for software majors. In fact, a top-tier software company has said that it is seeing stronger growth now than last year.

  7. Leveraging India's intellectual capital and low-cost manufacturing capabilities, apart from software, industries such as pharma, auto ancillaries and textiles have significant growth potential, as the world looks to make India a manufacturing, sourcing and design hub.

  8. Cement despatches remain strong, with cement majors selling anywhere between 13 m and 14 m tonnes of cement each month, driving the infrastructure boom.

  9. Foreign tourist arrivals continue to show impressive growth, at nearly 20% YoY in April 2006 (Source: Ministry of Tourism).

Therefore, we believe that, given the above factors, there is still plenty of room for growth. The BSE Sensex, at its current level of 8,929, trades at price-to-earnings multiple of 16.3 times trailing 12-month earnings. In fact, on a forward-looking basis, this becomes quite attractive. We have always said that it is very difficult to time the market, and that one should make staggered investments in order to average out the cost price.

At these levels, rather than trying to predict as to when the 'bear phase' will stop, it would be better to buy at each dip, and have a longer-term (2 to 3 year) time horizon in mind. Risks always abound, such as rising crude oil prices, rising interest rates, a global economic slowdown, unforeseen events, such as 9/11, geopolitical issues (Iran) and political risks. But then, equity investing by its very nature is risky. It is just a question of managing the risks, and we believe that the best way of doing this is to do one's own research, and have a long-term view.


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