A Genuine Growth Story
By Yiannis G. Mostrous
MCLEAN, Va.–Initial results indicate that US corporate earnings haven’t fallen off: 30 percent of the S&P 500 companies have reported, and the majority has beaten estimates (though excessive pessimism had led analysts to lower third quarter estimates). The current market rally now seems to be supported by fundamentals.
Although many more companies have yet to report, the sample is large enough to justify some optimism that profit growth will remain strong into the end of the year, an assessment I’ve advanced for some time now.
My views on the global economy and financial markets remain benign–the markets can stay strong for the foreseeable future (see SRI, 11 October 2006, Testing#Testing).
Corporate reporting is underway in Asia, too, and the numbers have been positive to this point. India, in particular, is off to a flying start as more and more companies are earning consensus earnings per share upgrades.
Long-term readers will recall that India has been one of my favorite investment themes for many years. Because an increasing number of investors are showing interest in the India story, a review of the basics seems to be in order.
India remains by far the most-exciting growth story among global emerging markets (GEMs) in general and Asia in particular. It’s home to the most-diverse group of quality companies across a range of sectors.
Although India never exhibited strong growth characteristics like the rest of Asia and can’t match China’s reported growth rates, it’s avoided the boom-and-bust cycles so prevalent in the region’s developing economies. For an investor interested in achieving serious long-term returns, this fact is of paramount importance. And because India still represents only 2 percent of global GDP and 1 percent of world trade, it’s been less important to investors, even after accounting for the strong interest shown by investors since 2004.
Many investors, although they’ve begun to appreciate the country’s potential, aren’t yet convinced that India can deliver on par with China for the long term. This is a positive development because seasoned investors with knowledge of India’s economy and politics are ahead of the game.
That said, foreign direct investment (FDI) is steadily increasing. And as India tackles the problems that slow its growth, FDI will only grow (see the chart below of India’s monthly FDI in US dollars).
Source: Bloomberg
Two of the main problems India faces are rigid labor laws (specifically the inability of an employer to dismiss a worker without the permission from the state government) and poor infrastructure. The latter is probably the most-important problem; as things stand, it would be impossible for India to achieve double-digit growth because infrastructure at almost every level of the economy remains weak. Indian industrial production has been growing (as the chart below depicts), but much more needs to be done.
Source: Bloomberg
The Indian government is aware of such problems, and efforts are being made to offer solutions. One of them is the creation of Special Economic Zones (SEZs).
Since the new SEZ law was approved in February, there’s been a huge rush from private-sector companies to capitalize on it. The new legislation provides a uniform SEZ policy and covers all aspects of establishment, operation and fiscal oversight. There are currently 13 SEZs in operation in India and 150 more have been approved.
SEZs have long been seen as a means for India to establish inroads into small- and medium-scale manufacturing. The SEZ legislation helps the government in two ways. It quickly helps create high-quality infrastructure in small areas, thus helping manufacturing exports, and it allows experimentation with the liberalization of labor laws. SEZs also attract foreign capital and technology. Recently approved projects expect to command at least USD22 billion in investment capital.
But above all, the Indian story remains a domestic one, in the sense that domestic investment and consumption drive expansion, leaving the country less vulnerable to violent moves in the global economy. History has shown that relatively independent growing economies fair much better during global slowdowns.
India’s exports are at around 30 percent, a very small portion of GDP, especially when compared to the rest of the emerging-market universe. For example, the ratio for China is closer to 50 percent, Malaysia’s is more than 100 percent and Singapore’s is close to 250 percent. As a result, India’s eventual cyclical economic slowdown should be of a lesser magnitude than those of other GEMs.
The emergence of new industries in India (e.g., technology and pharmaceuticals), along with lower interest rates, has helped stimulate the country’s domestic economic growth. And given that India’s starting from a low base, it’s still too early to start thinking in terms of an overheating economic environment. While strong credit growth (the following chart shows loans are growing at a strong 30 percent rate) has alarmed many market observers, the virtuous cycle of job and income growth, and the consequent strong domestic economy, should continue.
Source: Bloomberg
Although there will undoubtedly be quite a few ups and downs along the way, the concept to understand is the potential upside; from a long-term perspective, the trend is still in its early stages and should become stronger as an increasing number of financial services are gradually made available to a growing number of Indians. As the following chart shows, consumer loans in India as a percentage of GDP are still quite low, while the population is quite young now and is entering its best consumption years.
Source: The World Bank
Although consumption trends remain strong, in India lower inflation and interest rates have helped tremendously in its development. As the following chart depicts, prime lending rates have been in a steady decline during the past decade; as long as they remain under control, domestic demand should remain strong, cyclical considerations notwithstanding.
Source: Bloomberg
The situation described above doesn’t mean the Indian market would be immune in the event of a global selloff. During the May downturn, the market lost 33 percent (in dollar terms) in little more than a month, bottoming on 14 June. Nevertheless, the Indian market is up 33 percent (in dollar terms) since the beginning of the year.
It’s not surprising that investors were quick to sell India during that time, as the good performance of the market made it a perfect target for profit-taking. Furthermore, investors can’t be accused of overreacting as India remains the high-beta market in Asia. It trades at 20 times earnings and 4.5 times book value, while its dividend yield is 1.28 percent–hardly a value proposition.
These numbers should come as no surprise to readers because they indicate both the strength of the Indian growth story and that investors are willing to devote their capital to this prime investment theme. As such, India will remain a high-growth but expensive story for some time.
The SRI Portfolio currently has exposure to India through ICICI Bank and Dr. Reddy’s Labs.
ICICI is a solid play on India’s financial sector, one of the fastest-growing segments of the domestic economy. Aside from banking, mortgage operations and other related functions, life insurance is particularly promising as Indians have welcomed services now offered by private companies.
The Indian market was first opened to foreign insurance investment in 2000. Since then, about 25 players have entered. Entry to the domestic market is accomplished via joint ventures (JVs) with domestic providers. The two largest foreign/JV players are Prudential ICICI Life Insurance and Allianz Bajaj Life Insurance.
ICICI Bank has been capitalizing on the increase in domestic consumption and credit growth. Once not very well run but now a franchise in turnaround, ICICI is a good way to get exposure to India’s banking sector as well as the life insurance boom.
Prudential ICICI is the second-largest player and the largest private player in India’s life insurance industry, which is still dominated by the state-run Life Insurance Corporation of India (LIC). Prudential ICICI has grown its new business annualized premium equivalent (APE) at 104 percent during the last three years and has improved its market share from 2 percent to 10 percent in the same period. Low penetration of life insurance in India (3 percent of GDP) and market share acquisition from LIC have been the key growth drivers.
Dr. Reddy’s is a fairly safe company and should be one of the survivors of the Indian generic pharmaceutical companies, either on its own or through a merger and acquisition (M&A) scenario.
Both ICICI and Dr. Reddy’s remain buys.
I’ve been following the Indian economy and markets since the late 1990s, and I must admit that making money there isn’t as easy as it used to be. As more people have discovered India’s potential, the market has become a little more volatile. But the story is still in the early chapters and, therefore, remains very interesting. India’s quality growth story–as long as it remains intact–makes its market a strong buy after any hard selloff.
Source: Bloomberg
MCLEAN, Va.–Initial results indicate that US corporate earnings haven’t fallen off: 30 percent of the S&P 500 companies have reported, and the majority has beaten estimates (though excessive pessimism had led analysts to lower third quarter estimates). The current market rally now seems to be supported by fundamentals.
Although many more companies have yet to report, the sample is large enough to justify some optimism that profit growth will remain strong into the end of the year, an assessment I’ve advanced for some time now.
My views on the global economy and financial markets remain benign–the markets can stay strong for the foreseeable future (see SRI, 11 October 2006, Testing#Testing).
Corporate reporting is underway in Asia, too, and the numbers have been positive to this point. India, in particular, is off to a flying start as more and more companies are earning consensus earnings per share upgrades.
Long-term readers will recall that India has been one of my favorite investment themes for many years. Because an increasing number of investors are showing interest in the India story, a review of the basics seems to be in order.
India remains by far the most-exciting growth story among global emerging markets (GEMs) in general and Asia in particular. It’s home to the most-diverse group of quality companies across a range of sectors.
Although India never exhibited strong growth characteristics like the rest of Asia and can’t match China’s reported growth rates, it’s avoided the boom-and-bust cycles so prevalent in the region’s developing economies. For an investor interested in achieving serious long-term returns, this fact is of paramount importance. And because India still represents only 2 percent of global GDP and 1 percent of world trade, it’s been less important to investors, even after accounting for the strong interest shown by investors since 2004.
Many investors, although they’ve begun to appreciate the country’s potential, aren’t yet convinced that India can deliver on par with China for the long term. This is a positive development because seasoned investors with knowledge of India’s economy and politics are ahead of the game.
That said, foreign direct investment (FDI) is steadily increasing. And as India tackles the problems that slow its growth, FDI will only grow (see the chart below of India’s monthly FDI in US dollars).
Source: Bloomberg
Two of the main problems India faces are rigid labor laws (specifically the inability of an employer to dismiss a worker without the permission from the state government) and poor infrastructure. The latter is probably the most-important problem; as things stand, it would be impossible for India to achieve double-digit growth because infrastructure at almost every level of the economy remains weak. Indian industrial production has been growing (as the chart below depicts), but much more needs to be done.
Source: Bloomberg
The Indian government is aware of such problems, and efforts are being made to offer solutions. One of them is the creation of Special Economic Zones (SEZs).
Since the new SEZ law was approved in February, there’s been a huge rush from private-sector companies to capitalize on it. The new legislation provides a uniform SEZ policy and covers all aspects of establishment, operation and fiscal oversight. There are currently 13 SEZs in operation in India and 150 more have been approved.
SEZs have long been seen as a means for India to establish inroads into small- and medium-scale manufacturing. The SEZ legislation helps the government in two ways. It quickly helps create high-quality infrastructure in small areas, thus helping manufacturing exports, and it allows experimentation with the liberalization of labor laws. SEZs also attract foreign capital and technology. Recently approved projects expect to command at least USD22 billion in investment capital.
But above all, the Indian story remains a domestic one, in the sense that domestic investment and consumption drive expansion, leaving the country less vulnerable to violent moves in the global economy. History has shown that relatively independent growing economies fair much better during global slowdowns.
India’s exports are at around 30 percent, a very small portion of GDP, especially when compared to the rest of the emerging-market universe. For example, the ratio for China is closer to 50 percent, Malaysia’s is more than 100 percent and Singapore’s is close to 250 percent. As a result, India’s eventual cyclical economic slowdown should be of a lesser magnitude than those of other GEMs.
The emergence of new industries in India (e.g., technology and pharmaceuticals), along with lower interest rates, has helped stimulate the country’s domestic economic growth. And given that India’s starting from a low base, it’s still too early to start thinking in terms of an overheating economic environment. While strong credit growth (the following chart shows loans are growing at a strong 30 percent rate) has alarmed many market observers, the virtuous cycle of job and income growth, and the consequent strong domestic economy, should continue.
Source: Bloomberg
Although there will undoubtedly be quite a few ups and downs along the way, the concept to understand is the potential upside; from a long-term perspective, the trend is still in its early stages and should become stronger as an increasing number of financial services are gradually made available to a growing number of Indians. As the following chart shows, consumer loans in India as a percentage of GDP are still quite low, while the population is quite young now and is entering its best consumption years.
Source: The World Bank
Although consumption trends remain strong, in India lower inflation and interest rates have helped tremendously in its development. As the following chart depicts, prime lending rates have been in a steady decline during the past decade; as long as they remain under control, domestic demand should remain strong, cyclical considerations notwithstanding.
Source: Bloomberg
The situation described above doesn’t mean the Indian market would be immune in the event of a global selloff. During the May downturn, the market lost 33 percent (in dollar terms) in little more than a month, bottoming on 14 June. Nevertheless, the Indian market is up 33 percent (in dollar terms) since the beginning of the year.
It’s not surprising that investors were quick to sell India during that time, as the good performance of the market made it a perfect target for profit-taking. Furthermore, investors can’t be accused of overreacting as India remains the high-beta market in Asia. It trades at 20 times earnings and 4.5 times book value, while its dividend yield is 1.28 percent–hardly a value proposition.
These numbers should come as no surprise to readers because they indicate both the strength of the Indian growth story and that investors are willing to devote their capital to this prime investment theme. As such, India will remain a high-growth but expensive story for some time.
The SRI Portfolio currently has exposure to India through ICICI Bank and Dr. Reddy’s Labs.
ICICI is a solid play on India’s financial sector, one of the fastest-growing segments of the domestic economy. Aside from banking, mortgage operations and other related functions, life insurance is particularly promising as Indians have welcomed services now offered by private companies.
The Indian market was first opened to foreign insurance investment in 2000. Since then, about 25 players have entered. Entry to the domestic market is accomplished via joint ventures (JVs) with domestic providers. The two largest foreign/JV players are Prudential ICICI Life Insurance and Allianz Bajaj Life Insurance.
ICICI Bank has been capitalizing on the increase in domestic consumption and credit growth. Once not very well run but now a franchise in turnaround, ICICI is a good way to get exposure to India’s banking sector as well as the life insurance boom.
Prudential ICICI is the second-largest player and the largest private player in India’s life insurance industry, which is still dominated by the state-run Life Insurance Corporation of India (LIC). Prudential ICICI has grown its new business annualized premium equivalent (APE) at 104 percent during the last three years and has improved its market share from 2 percent to 10 percent in the same period. Low penetration of life insurance in India (3 percent of GDP) and market share acquisition from LIC have been the key growth drivers.
Dr. Reddy’s is a fairly safe company and should be one of the survivors of the Indian generic pharmaceutical companies, either on its own or through a merger and acquisition (M&A) scenario.
Both ICICI and Dr. Reddy’s remain buys.
I’ve been following the Indian economy and markets since the late 1990s, and I must admit that making money there isn’t as easy as it used to be. As more people have discovered India’s potential, the market has become a little more volatile. But the story is still in the early chapters and, therefore, remains very interesting. India’s quality growth story–as long as it remains intact–makes its market a strong buy after any hard selloff.
Source: Bloomberg