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Investors are undervaluing India--and its next generation of stocks
04/05/2011 8:30 am EST
So it was no surprise that on my recent trip to India, conversations with U.S. or European travelers would take that turn.
What was surprising was the exact form of the question. What, they’d ask, is your favorite Chinese stock? And we’d be off on a discussion of dairy and food company Bright Food Group, or Internet search engine Baidu (BIDU) or China Railway Construction.
In Mumbai, Kochi, and Delhi, the question was always the same. Against a background of Mumbai’s construction cranes, the surprising new high-rise skyline of Kochi, and Delhi’s ubiquitous ads for new schools of English, engineering, and computer science, all that the Western travelers wanted to talk about was China.
After a while it got downright perplexing. In the midst of an economic boom that is projected to see India’s GDP grow by 9% in the fiscal year that ends in March 2012, no one wanted to talk Indian stocks?
And after a while it led me to wonder, if investor indifference was so pervasive, could India’s stocks be undervalued?
For the Indian stocks that everybody knows today and from a short-term perspective, I think the answer to that is No. The familiar names and the ones that it’s actually possible for investors from outside India to buy, aren’t especially cheap, even though the Indian stock market was down 3.9% for 2011 as of April 4 and down 6.2% from its November 2010 high. Despite that decline shares of Tata Motors still sells for 26 times trailing 12-month earnings per share. That compares to a trailing 12-month price to earnings ratio for Ford Motor (F) of 8.3. India’s Infosys (INFY) trades at a trailing P/E of 30. In the United States Oracle (ORCL) trades at a trailing P/E of 21.
From a long-term point of view, however, I think the answer is Yes. At least that’s the perspective that I came back with after a recent short visit to India. While the Indian stock market as it now exists isn’t a particular bargain, the emerging Indian stock market is. Let me try to explain.
It’s easy to understand why Western investors, especially Western investor who have actually been to India recently, should be so cool to the country as an investment option. The economy struggles to stay afloat in a tidal wave of bureaucracy. (I still don’t have a clue why my wife had to supply our marriage certificate in order to get a visa.) Hopes that Prime Minister Manmohan Singh would use his second term to reform the country’s rules on foreign investment, remove layers of subsidies that stifle efficiencies in sectors such as food production and transportation, and overhaul the country’s education system have been dashed by a wave of scandal that has left the government focused on little beyond its own survival.
And maybe most of all there’s just the sheer chaos of India’s day to day economy. Shops crowd upon shops. Market streets are constantly in motion with everyone selling something to someone. On the highways trucks co-exist with cars and tractors and auto-rickshaws and the occasional camel-drawn cart in a system that works-to the degree that it does work--only because everyone leans on their horn at every opportunity. Temples are wedged next to roadside restaurants next to factories next to recycling shacks. One day I saw two women treading mud into brick with their feet next to a factory that made backhoes.
Most of us have a bias for order and organization. And on that metric, the reality of India just doesn’t score as high as China, the big competitor.
That bias, however, can sell India short. Take this example.
Auto rickshaws, little three-wheeled, gold-cart-sized cars (you might also know them as tuk-tuks from Bangkok), fill the streets of Indian cities, providing cheap alternatives to taxis and faster and more convenient alternatives to buses. It’s tempting to think of them as primitive—they sure look ragged—and a sign of India’s under-development. (Especially after you’ve seen a tiny car loaded with eight college students clinging to every available handhold.)
But in Delhi, at least, the fleet to auto rickshaws runs on compressed natural gas to reduce air pollution in the city. And the government is now requiring drivers to install GPS instruments (they already have meters) so that passengers can be sure that they aren’t being taken out of their way to drive up a fare. (Auto rickshaw drivers staged a slowdown/strike in Delhi while I was there to protest the cost of these systems.)
Still seem quite as primitive?
Or take the chaos of India’s higher educational system. The road from Delhi to Agra was dotted with new schools, often sprouting up in the middle of an empty field or on the edge of a factory zone. Billboards tout everything from the English-language play schools for the pre-kindergarten set to English-language MBA programs. Some of these adds clearly offer more than any school can deliver—“Master English in 75 hours” read one. But some like the Blossom play schools—English-language medium, the billboard notes—reminded me of the flyers of pre-schools back in New York. While the national government is tottering toward some kind of grand national educational reform package (or not), the chaotic Indian economy is throwing alternatives up against the wall. Some will stick. Others? Well, the University of Michigan wasn’t built in a day.
The Indian stock market at the moment is dominated by the great family enterprises of Tata or Reliance and the stars of the last generation in India’s technology industry such as Infosys and Wipro. Look at the portfolio holdings of a fund such as the iShares S&P India Nifty 50 (INDY) to see what I mean. Add in the shares of a few big banks such as HFDC Bank (HDB), a cell-phone giant such as Biharti Airtel to those family enterprises and you’ve pretty much got the top 25 holdings of any India index.
What’s missing—and what I think is undervalued in India’s stock market—is the next generation of companies. There’s been a relative paucity of new issues from Indian companies tapping into New York or London markets—and thus available to non-Indian investors--since the Infosys-Wipro days. Those companies are percolating under the surface but these are exactly the companies and the offerings that have been the biggest victims of the national government’s failure to introduce financial market reforms.
So companies like Jain Irrigation Systems, probably the best pure play in the world on water efficient drip irrigation systems, or Sintex Industries, the maker of the plastic garbage cans and water collectors that I saw everywhere in India, or Suzlon Energy, a wind power company that has managed to grow market share even though it isn’t backed by the financial muscle of the Beijing government, or Asian Paints, a beneficiary (like Sintex) of India’s housing boom or a media company such as UTV Software Communications, or drug companies such as Sun Pharmaceutical Industries all trade in Mumbai but unlike the earlier generation of Indian companies don’t trade in New York or London.
I think that’s about to change—although perhaps only slowly. There are persistent rumors, for example, of an overseas offering from Jain Irrigation. Hungry investment banks are pressing the case to Indian companies, and the example of Chinese and Brazilian companies tapping international capital markets with offerings outside their home market has increased pressure on companies in all emerging markets to go global with their financial strategies.
I’d keep my eye out for a move by any of these companies to reach out to New York or London. This part of the Indian economy is where the next generation of growth lies. And where you might be able to find growth at a bargain price sometime in the next year or two.
Full disclosure: I don’t own shares of any of the companies mentioned in this post in my personal portfolio. The mutual fund I manage, Jubak Global Equity Fund, may or may not now own positions in any stock mentioned in this post. The fund did own shares of Baidu, Ford Motor, HDFC Bank, and Infosys as of the end of January. For a full list of the stocks in the fund as of the end of January see the fund’s portfolio at http://jubakfund.com/about-the-fund/holdings/
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