While there is a tendency in investment circles to see India either as the land of milk and honey or as a country characterised by corruption and darkness, I find it useful to see India as a market with four fundamental tensions. These opposing forces not only help me moderate my own bullishness or bearishness, but also help our team generate investment ideas through market cycles.
The first tension is between the promoters and the political class. Over the past decade, the under-the-table model of doing business has kept this tension in check (by giving the politician his cut from the ‘India Story’), but now that it is difficult to move anything under the table, this business model has broken down. While the obvious casualties have been companies whose core competitive advantage was connect with the political class, the beneficiaries, when the capex cycle turns, will be the cleaner companies (many of which also happen to be better managed than ‘connected companies’). Ambit’s ‘good & clean’ portfolio has outperformed the market by a clean 15 per cent points over the past year and a lot of that outperformance is due to our avoidance of politically connected companies.
The second tension, and arguably the one which can generate the greatest amount of upside for investors, is between the relentless growth of 'aspirational consumption' in India (for example, watches, cars, bikes, designer undergarments, processed food – anything which signals to the society at large that the said consumer is upwardly mobile) versus corporate India’s limited ability to satiate this demand. This has created a massive opportunity for MNCs who are coming to the party with cheaper capital, better products and well-drilled marketing practices. While the casualties of this newfound MNC obsession with the Indian market will be India companies in head-to-head competition with MNCs (for example, Hero, Dabur, Maruti, Voltas), the beneficiaries will be the MNCs’ listed subsidiaries in India (for instance, GSK Consumer) and Indian companies who have entered sensibly structured partnerships with credible foreign partners (Eicher Motors, Amara Raja and Page Industries, for instance).
Investors looking to play the ‘aspirational consumption’ theme without getting disrupted by aggressive foreigners need to look for niche plays where the MNCs have little interest (pressure cookers and TTK Prestige, entry-level cigarettes and VST).
The third tension, and perhaps the one with greatest ‘clarifying’ power (that eliminates a range of seemingly worthy companies), is the demand for affordable capital in India and limited supply of the same. Since the cost of capital in India is the highest among major emerging markets, Indian investors should put a premium on cash-generative companies, rather than buying power, real estate and infra companies with little experience of complex project management, weak contract enforcement rights and almost no visibility on cash flow generation. The good news is that over the past five years, the India market has done just that – cash-generative companies have outperformed by wider and wider margins as we have moved from FY2008 to the present. I believe that even when we return to bull market conditions, this characteristic of the Indian market will not go away. Leaving aside a few exceptions like Torrent Power, Sadbhav Engineering and Oberoi Realty, Indian power, infra and real estate companies will struggle to find fans.
The fourth and final tension is a blast from the past – labour versus capital. As real wages of workers (especially contract workers) have fallen over the past year, troublesome agents, often with political connections, have found it easy to incite unrest on the shop floor. As always, both sides have a strong case here – contract workers can point to abysmal wages and an absence of provident fund provisions whereas promoters can point to the need for competing against China. Be that as it may, this tinderbox is primed to explode and we are trying to make sure our clients don’t invest in companies where the promoter does not have a clear contingency plan to deal with labour unrest.
I continue to believe that investors who deploy capital keeping these four tensions in mind will outperform even in the 6 per cent GDP growth climate that we are heading towards. In fact, the existence of these tensions imposes formidable barriers to entry of the sort that can’t be found in, say, China. Chinese companies structurally lower ROEs and ROAs vis-à-vis their Indian counterparts are proof of this.
(Saurabh Mukherjea is the Head of Equities at Ambit Capital. The views expressed here are his own and not Ambit Capital’s.)
