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Like India, Unlike China...

Oct 18, 2006

Unlike the South East Asian economies that largely depend on exports and international tourism for growth, unlike the Middle East that is largely dependent on oil to fuel their economies, unlike the South American economies that rely on natural resources and exports to US, unlike China where growth is not an issue but transparency is, India offers a much wider theme for investors that is leveraged on its strong domestic populace and growing relevance in the global arena.While this is not to say that India is insulated from global factors, in our view, the economy is likely to be relatively less affected by what happens in the US. In our view, there are three broader themes, which an investor could base his/her investment decision in Indian equities. We have listed the name of companies under each of the theme (the list is aimed at highlighting key players in the sector and is not aimed at recommending the stock to buy/sell).

Outsourcing theme...
Unlike in the early phases, outsourcing is not just about costs savings any more. Traditionally, business houses, globally, integrated backward/forward to optimize synergies, competitive factors has resulted in such companies getting back to what they are good at. For instance, the global auto manufacturers that owned a captive forging operations have shut such facilities and are looking to outsource the same from focused forging manufacturers that can deliver both quality and in the process save costs (similarly, the maintenance operations being outsourced to Indian software services companies). Over the last five years, Indian companies have leveraged this opportunity, have huge overseas operations and are in the process of mastering the global delivery model.

  1. Why Generics & Contract research and manufacturing? Because, there is a clear directional move by developing nations to cut healthcare costs. This can be achieved by supporting generic manufacturers of drugs (a disincentive for research) and/or manufacturing the drug in a cost competitive nation. In our view, it is not the case of either and or but a combination of both that will drive growth over the long term. Indian generics and contract manufacturing companies, in this context, have evolved a considerable degree over the last five years. Key companies to watch out for: Ranbaxy, Dr. Reddy's, Cipla, Sun Pharma, Wockhardt, Biocon, Nicholas Piramal and Glenmark Pharma.

  2. Why Software services? We like the story not because Indians speak English well, but the advantages of the global offshoring model far outweighs concerns. While we do have concerns with respect to the pace at which such companies may be forced to increase headcounts to meet demand, over the next five to ten years, we expect growth to be non-linear because of increased contribution from high-end value-add services. In our view, any slowdown in the US or other global economies will only strengthen the case for offshoring in the future. Despite immense challenges ahead, Indian software majors are indispensable and that we believe is the key reason why one should invest in Indian software services companies.

  3. Textiles: The fact that Indian labour is almost 30% to 40% as compared to developed nations and manufacturing units are shutting down because of increased competition from China and uneconomical costs, we believe that the case for Indian companies has further strengthen. However, we like those Indian companies that partner with global companies in an effort to focus on value-add segments, especially in areas like garments and home furnishings.

Manufacturing theme - Unlike China
It is a common belief that India's competence is in services and that of China's is in manufacturing. Amidst these common conceptions, there are pockets of excellence in India in the manufacturing sector. We promise you that many of these companies are not 'one-year wonders' but have global competence, which is not the case with many Chinese manufacturers. Unlike China that has flexible labour laws and superb infrastructure facilities, Indian manufacturing companies, despite various hurdles, have scaled higher.

  1. Commodities - Far ahead: It is a fact that some Indian manufacturers in cement, steel and aluminum are among the lowest cost producers in the world and it has been a case over the last five to six years. Take the case of Tisco. Despite the fact that it is was one of the worst year in terms of prices, the company's EBDITA margins was over 18% highlights the cost competence in a highly commoditised sector. There are many other examples like Gujarat Ambuja, Hindalco, Nalco and Sesa Goa. Given the country's dismal infrastructure, we believe that commodity companies will play a meaningful role in the domestic market as well as cater to the need of global markets through their overseas expansions.

  2. Auto ancillaries - The crown jewels: It is another crown jewel sector that highlights the fact that India is a good place to have a large-scale manufacturing setup, provided the fundamentals are well established. The likes of Bharat Forge, Sundaram Fasteners, MICO and Asahi India have the who's who of the global and domestic auto manufacturers as clients and it is expanding rapidly. The likes of Bharat Forge have not only proven that global OEMs can save upto 20% to 30% by outsourcing but also moved on to provide value-add servicing wherein entry-barriers are high.

Domestic consumption theme...
It is estimated that there are close to 200 middle class households that are consumers of various products and is clearly reflected in the fact private spending is almost 64% of GDP and is much higher than China. Despite infrastructure related bottlenecks and changes in the government, the Indian economy has managed to grow at a CAGR of over 6.5% over the last decade. Given the increased private-public sector partnerships on the infrastructure front, we believe that the economy should be able to grow at 6.5% to 7% per annum over the next five years. At this rate, GDP per capita should cross the critical US$ 1,000 benchmark in another four to five years, which in turn could alter the consumption pattern (As per KSA-Technopak's Consumer Outlook 2004, spending on grocery and personal care items combined accounted for 48% of total consumption expenditure). As income increases, the proportionate spending on food-related items will decrease paving way for higher growth in consumer discretionary products in the long-term.

  1. Retailing & consumer discretionary: The FMCG sector, the fourth largest in India, is estimated at US$ 13.1 bn (Rs 590 bn). In FY02, the total number of households in India was estimated at 188 m, of which 53 m were urban resident (28% share). More importantly, the rapid investment in road infrastructure in the last six years has opened up market opportunities for FMCG companies in the rural market as well. In fact, by 2015, the FMCG sector in India is expected to triple in value, which highlights the growth potential. Like in the international markets, organized retailing, which currently accounts for as little as 4% of the retailing sector, is expected to grow manifold. This, in turn, will fuel demand for discretionary products.

  2. Banking and investment: Consider the following facts. Fixed investment as a percentage of GDP has remained stagnant from FY99 to FY06 at 23% to 24%. India's consumer credit penetration as a percentage of GDP is just about 10% to 12%, which is significantly lower than some of the South East Asian economies. Mortgage credit penetration is just 6% of GDP. Penetration of passenger cars in India per thousand person is just 7. The annual spends on credit card by Indians in FY06 was US$ 380 (as compared to US$ 335 the previous year, Source: Economic Times). Based on our interaction with banks and in our view, retail advances should grow at 15% to 20% per annum over the next five years. As per Visa, there are around 140 m bankable consumers in India, which highlights the scope for cross-selling opportunities over the next five years. Not only at the retail level, but considering that fixed investment has been steady over the last five years despite faster GDP growth indicates that there is a need to step-up investment if GDP growth is to be accelerated. In our view, the banking sector will play a vital role in oiling the Indian economy over the next five to ten years.

  3. Infrastructure - Opportunity in disguise: Be it roads, power, telecom, ports, airports or even irrigation, India is under-invested. Recognizing the same, the government has announced various measures to boost investment in these sectors to smoothen economic activity and unlock efficiency. While the country has made significant strides on the telecommunication front, on all the other fronts, the country is lagging and going by the current trend, meaningful results are unlikely to be achieved over the next three years. But at the same time, the stronger companies in the engineering and power sectors have aggressive growth plans that can be achieved. While we have listed few companies in the graph, there are many more with niche focus, stronger balance sheets and a capable management at the helm.

In all, even as the prospects are promising, India, as a emerging and developing economy, is susceptible to global economic and geo-political developments. Apart from risks associated with the same, ironically, perhaps the other major risk that could slowdown India's economic growth is the availability of quality manpower. Many of the companies under our research coverage are facing huge attrition issues and in fact, some companies are unable to execute their business plan because of their inability to retail talent. Despite being the second largest populated economy in the world, little has been done at the ground level to improve educational standards in India, which has been subjected to political pressures. Perhaps, the fact that the political parties lack the broader vision will have a telling impact in the future. But as always, a strong democratic force, as always, will enable us to find solutions, though time consuming. And this is unlike China!

  • This article forms part of "NRI Investment Guide 2007" - a free-to-download online guide from Personalfn. To download the entire guide, please click here.


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