When one door closes, another opens; but we often look so long and so regretfully upon the closed door that we do not see the one which has opened for us. - Alexander Graham Bell
If one reads into the recent widespread fall of Indian equity markets, it would appear as if all entry doors to markets are firmly shut while exit doors are flung wide open to accommodate stampede! Over the last six months, the market capitalization has fallen from USD 1.8tn to USD 0.95tn: the sharpest and swiftest over last two decades. True, an ocean of worries seems to be ruling horizons: rising crude and commodity prices, the sub-prime issue, apparent US recession, high inflation, higher interest rates, currency volatility, fiscal deficit, slower corporate earnings growth and so on. And in a matter of a few months, focus has moved from global concerns to domestic issues and macro issues have begun to impact micros. But the same issues have been counted and recounted several times over disproportionately such that “fear” rather than “caution” is deciding the course of the markets. Six months back, it was as if India could do no wrong, and now it is made to appear that India would get nothing right. In my view, the situation is somewhere in between, if one examines dispassionately the ground level evidence. But prices now clearly lag reality, and by a margin.
As you shift your gaze from the closed doors to the opening ones, the picture looks more balanced if not opportune. I can’t predict whether the worst is over. It probably has not. In the short run, it is entirely possible that prices (not reality) may get worse before they start to get better. But if one is looking for high quality at attractive prices, than the proverbial Mr Market is knocking at the door. While possible short term negativity cannot be ruled out, nor can long term opportunity be ignored. I believe that the picture ahead will be far better then what is being priced in by the markets today. These are no doubt challenging times, but India has faced far more daunting challenges in its post-independence history and yet has grown throughout.
Overall strength of broad macroeconomic fundamentals (notwithstanding recent challenges) and robustness of corporate sector micros has never been better in the past then today. In our opinion, these are more interruptions than disruptions in a much longer term phenomenon. India continues to be a large sized opportunity with durable and high growth supported by remarkable capital efficiency: all essential ingredients for good equity investing.
India’s growth – a structural phenomenon
The reforms initiated in India during early nineties started bearing fruit sometime in the beginning of this century when India moved up to a “structurally” higher GDP growth rate. The GDP growth “potential” of India in long-term is considered highest among all the emerging economies. However, at various stages India has hit the barrier of infrastructure. It remains, and will remain for a while, an important issue. But despite all obstacles, the infrastructure spend as a ratio to GDP has inched up from 3.5% (2004) to current 6% (exp 2008) and is expected to touch 9% of GDP by 2010-11. This on a GDP which itself has grown at a rapid clip of 9% over last few years.
Simultaneously, with the rise of service and manufacturing sectors, the per capita income has more then doubled over last seven years, domestic savings to GDP has increased to well over 35% and the disposable incomes are slated to double again by 2015. India’s growth is well founded on all the three vital pillars for a secular economic growth – robust Consumption, healthy Savings rate and a strong Investments rate. There are problems being faced today, and there are solutions. The recent world-scale natural gas discoveries, 39% growth in the tax collections for the quarter ended June’ 08, better then expected performance in food grain output are some of the positive developments that have probably been harshly shrugged off by the markets.
Estimates for GDP growth in the current year vary, but even the most conservative estimate puts the number at above 7.5%. True, it is not the same as 9% (over the last three years), but it would still be very robust and one of the highest globally. Better still, situation today suggests that outlook for the year ahead is even better.
Markets always tend to overshoot in either direction, and there is nothing new this time. At valuation of about 12X FY09 earnings for sensex / nifty, we seem to have come a full circle back to the 2003 levels: the last time when such valuations were reached, and that year actually marked the beginning of five-year secular rise in Indian markets. If one searches beyond the top 30-50 companies, then picture is even better: many top quality businesses can be had at single digit or bare double digit valuations. I am confident that many stocks have a potential to multiply in their prices over the next three years, if not sooner. From “macro” to “micro” Let me give some examples to illustrate the point. There are some of the names where we find strong compounding opportunities. All of them represent quality businesses of size, entry barriers, character and superior efficiency, and managements with desire to succeed. Some of the important concerns today are energy costs, high interest costs, rupee volatility etc. Many of our portfolio positions have a good way of addressing these issues.
Opto Circuits India Ltd is a global scale manufacture of cardiovascular stents and patient monitoring systems. Addressing the large and growing opportunity of over $10 billion, it has grown at over 30% per July 2008 annum over last five years and is expected to maintain that for the next three years at least. Its largely global business is now making rapid strides in domestic market as well. With a Return on Capital Employed (RoCE) of about 35%, Opto Circuits is available at 15X FY09 and 11X FY10, attractive for a unique, high quality business.
Everest Kanto cylinders (EKC) provides an ideal foil to the current high oil prices. With a dominant 65% domestic market share in a technology intensive and high entry barriers business of CNG and other seamless cylinders, EKC enjoys an enviable moat. Both domestic and international parts of business are growing with multi-location plants around the globe. With a RoCE over 25% and expected growth rate of 45% over the next three years, EKC is available currently at 11X FY 10.
Nava Bharat Ventures Ltd (NBVL) is principally in a large and growing energy supply business along with presently highly profitable but volatile Ferro Alloys business. With steady and clear long term expansion of both the businesses, even after neutralizing the volatility of Ferro Alloys business, the core “annuity” character of energy business makes it a compelling opportunity at less then 6X FY09 for a business enjoying RoCE in excess of 40%.
Divi’s Laboratories, though not as cheap as some of the above, is a world-class, research-driven global CRAM (Contract Research and Manufacturing Services) business addressing an annual USD 40 billion (and growing) opportunity of pharmaceutical research and development. This is one business where I would assume over 20% earnings growth for may be a decade, if not more, with an outstanding RoCE of above 35%.
Even for a Fortune 500 company like Reliance Industries Ltd (RIL), with global size mature petrochemicals business, rapidly expanding refining business and new global sized gas business, which despite its large base has a major growth engine of over 30% for next two years, cash yield of over 12%, current price represents a valuation of 11X FY10.
Conclusion
The biggest positive in the current situation is the extreme sentiment negativity; that flushes out the possibility of shocks from a stretched market. All bear markets are born out of unbounded optimism, just the way all the bull markets have to raise the walls of worry. At this juncture, it is important to realize that what can be counted by everyone is usually not what decides the eventual course of markets. It will be prudent to bear a perspective that differentiates between secular long-term growth engine from the intermittent shortterm bouts (of optimism or pessimism). Former is intact, the latter is transitory. India, in our opinion, remains an attractive and almost indispensable investment choice for any serious long-term investor. This has not changed over the last six months, though prices have. That is a fresh opportunity all over again, rather than a threat.
Over last few months, our portfolios have broadly maintained healthy level of cash. The businesses that are included in our portfolios have to pass a few critical tests: strong and durable earnings growth, robust capital efficiency, large size of opportunity and reasonable value. Other things being equal, we have favored stocks that have adequate liquidity. Currently, sensex trades at rather modest 12X FY09 earnings, with many quality businesses being much cheaper. This valuation needs to be assessed in the backdrop of the globally benchmark able corporate sector (RoCE over 20%), earnings growth of 15% for current year and better going ahead, durability of growth and large size of opportunity. Given this, our stance will be to progressively deploy cash at current prices. Without ignoring near-term concerns in the environment, we believe it is the time to step out in the open and engage into opportunities with an eclectic mix of patience and conviction. Results will be healthy.
By Mr. Bharat Shah.
If one reads into the recent widespread fall of Indian equity markets, it would appear as if all entry doors to markets are firmly shut while exit doors are flung wide open to accommodate stampede! Over the last six months, the market capitalization has fallen from USD 1.8tn to USD 0.95tn: the sharpest and swiftest over last two decades. True, an ocean of worries seems to be ruling horizons: rising crude and commodity prices, the sub-prime issue, apparent US recession, high inflation, higher interest rates, currency volatility, fiscal deficit, slower corporate earnings growth and so on. And in a matter of a few months, focus has moved from global concerns to domestic issues and macro issues have begun to impact micros. But the same issues have been counted and recounted several times over disproportionately such that “fear” rather than “caution” is deciding the course of the markets. Six months back, it was as if India could do no wrong, and now it is made to appear that India would get nothing right. In my view, the situation is somewhere in between, if one examines dispassionately the ground level evidence. But prices now clearly lag reality, and by a margin.
As you shift your gaze from the closed doors to the opening ones, the picture looks more balanced if not opportune. I can’t predict whether the worst is over. It probably has not. In the short run, it is entirely possible that prices (not reality) may get worse before they start to get better. But if one is looking for high quality at attractive prices, than the proverbial Mr Market is knocking at the door. While possible short term negativity cannot be ruled out, nor can long term opportunity be ignored. I believe that the picture ahead will be far better then what is being priced in by the markets today. These are no doubt challenging times, but India has faced far more daunting challenges in its post-independence history and yet has grown throughout.
Overall strength of broad macroeconomic fundamentals (notwithstanding recent challenges) and robustness of corporate sector micros has never been better in the past then today. In our opinion, these are more interruptions than disruptions in a much longer term phenomenon. India continues to be a large sized opportunity with durable and high growth supported by remarkable capital efficiency: all essential ingredients for good equity investing.
India’s growth – a structural phenomenon
The reforms initiated in India during early nineties started bearing fruit sometime in the beginning of this century when India moved up to a “structurally” higher GDP growth rate. The GDP growth “potential” of India in long-term is considered highest among all the emerging economies. However, at various stages India has hit the barrier of infrastructure. It remains, and will remain for a while, an important issue. But despite all obstacles, the infrastructure spend as a ratio to GDP has inched up from 3.5% (2004) to current 6% (exp 2008) and is expected to touch 9% of GDP by 2010-11. This on a GDP which itself has grown at a rapid clip of 9% over last few years.
Simultaneously, with the rise of service and manufacturing sectors, the per capita income has more then doubled over last seven years, domestic savings to GDP has increased to well over 35% and the disposable incomes are slated to double again by 2015. India’s growth is well founded on all the three vital pillars for a secular economic growth – robust Consumption, healthy Savings rate and a strong Investments rate. There are problems being faced today, and there are solutions. The recent world-scale natural gas discoveries, 39% growth in the tax collections for the quarter ended June’ 08, better then expected performance in food grain output are some of the positive developments that have probably been harshly shrugged off by the markets.
Estimates for GDP growth in the current year vary, but even the most conservative estimate puts the number at above 7.5%. True, it is not the same as 9% (over the last three years), but it would still be very robust and one of the highest globally. Better still, situation today suggests that outlook for the year ahead is even better.
Markets always tend to overshoot in either direction, and there is nothing new this time. At valuation of about 12X FY09 earnings for sensex / nifty, we seem to have come a full circle back to the 2003 levels: the last time when such valuations were reached, and that year actually marked the beginning of five-year secular rise in Indian markets. If one searches beyond the top 30-50 companies, then picture is even better: many top quality businesses can be had at single digit or bare double digit valuations. I am confident that many stocks have a potential to multiply in their prices over the next three years, if not sooner. From “macro” to “micro” Let me give some examples to illustrate the point. There are some of the names where we find strong compounding opportunities. All of them represent quality businesses of size, entry barriers, character and superior efficiency, and managements with desire to succeed. Some of the important concerns today are energy costs, high interest costs, rupee volatility etc. Many of our portfolio positions have a good way of addressing these issues.
Opto Circuits India Ltd is a global scale manufacture of cardiovascular stents and patient monitoring systems. Addressing the large and growing opportunity of over $10 billion, it has grown at over 30% per July 2008 annum over last five years and is expected to maintain that for the next three years at least. Its largely global business is now making rapid strides in domestic market as well. With a Return on Capital Employed (RoCE) of about 35%, Opto Circuits is available at 15X FY09 and 11X FY10, attractive for a unique, high quality business.
Everest Kanto cylinders (EKC) provides an ideal foil to the current high oil prices. With a dominant 65% domestic market share in a technology intensive and high entry barriers business of CNG and other seamless cylinders, EKC enjoys an enviable moat. Both domestic and international parts of business are growing with multi-location plants around the globe. With a RoCE over 25% and expected growth rate of 45% over the next three years, EKC is available currently at 11X FY 10.
Nava Bharat Ventures Ltd (NBVL) is principally in a large and growing energy supply business along with presently highly profitable but volatile Ferro Alloys business. With steady and clear long term expansion of both the businesses, even after neutralizing the volatility of Ferro Alloys business, the core “annuity” character of energy business makes it a compelling opportunity at less then 6X FY09 for a business enjoying RoCE in excess of 40%.
Divi’s Laboratories, though not as cheap as some of the above, is a world-class, research-driven global CRAM (Contract Research and Manufacturing Services) business addressing an annual USD 40 billion (and growing) opportunity of pharmaceutical research and development. This is one business where I would assume over 20% earnings growth for may be a decade, if not more, with an outstanding RoCE of above 35%.
Even for a Fortune 500 company like Reliance Industries Ltd (RIL), with global size mature petrochemicals business, rapidly expanding refining business and new global sized gas business, which despite its large base has a major growth engine of over 30% for next two years, cash yield of over 12%, current price represents a valuation of 11X FY10.
Conclusion
The biggest positive in the current situation is the extreme sentiment negativity; that flushes out the possibility of shocks from a stretched market. All bear markets are born out of unbounded optimism, just the way all the bull markets have to raise the walls of worry. At this juncture, it is important to realize that what can be counted by everyone is usually not what decides the eventual course of markets. It will be prudent to bear a perspective that differentiates between secular long-term growth engine from the intermittent shortterm bouts (of optimism or pessimism). Former is intact, the latter is transitory. India, in our opinion, remains an attractive and almost indispensable investment choice for any serious long-term investor. This has not changed over the last six months, though prices have. That is a fresh opportunity all over again, rather than a threat.
Over last few months, our portfolios have broadly maintained healthy level of cash. The businesses that are included in our portfolios have to pass a few critical tests: strong and durable earnings growth, robust capital efficiency, large size of opportunity and reasonable value. Other things being equal, we have favored stocks that have adequate liquidity. Currently, sensex trades at rather modest 12X FY09 earnings, with many quality businesses being much cheaper. This valuation needs to be assessed in the backdrop of the globally benchmark able corporate sector (RoCE over 20%), earnings growth of 15% for current year and better going ahead, durability of growth and large size of opportunity. Given this, our stance will be to progressively deploy cash at current prices. Without ignoring near-term concerns in the environment, we believe it is the time to step out in the open and engage into opportunities with an eclectic mix of patience and conviction. Results will be healthy.
By Mr. Bharat Shah.
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