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Why India Is Undervalued
04/06/2011 7:00 am EST
True, blue chips from India are not cheap. But a host of emerging Indian companies offer growth at a bargain price—and I expect many of them to start trading in New York soon.
It comes with the territory: When people I meet on my travels discover that I manage money and write about the stock market, they always ask, “What’s your favorite stock?”
So it was no surprise that on my recent trip to India, conversations with US or European travelers would take that turn.
What was surprising was the exact form of the question. What they’d ask, specifically, was for me to name my 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 the 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.
Why Aren't Investors Excited About India?
It got downright perplexing. In the midst of an economic boom projected to see India’s GDP grow by 9% in the fiscal year ending March 2012, no one wanted to talk about 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 actually possible for investors outside India to buy, aren’t especially cheap—even though the Indian stock market was down 3.9% in 2011 as of April 4, and down 6.2% from its November 2010 high.
Despite that decline, shares of Tata Motors (TTM) still sell for 26 times trailing 12-month earnings per share. That compares with a trailing 12-month price/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 to whether Indian stocks are undervalued is "yes." At least that’s the perspective that I came back with after my recent visit there. 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 investors who actually have been to India recently, should be so cool to the country as an investment option. Its 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 were high 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 efficiency in sectors such as food production and transportation
- overhaul the country’s education system
But those hopes have been dashed by a wave of scandal that has left the government focused on little beyond its own survival.
NEXT: You May Not Like Chaos…|pagebreak|
You May Not Like Chaos…
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, 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 horns at every opportunity.
Temples are wedged next to roadside restaurants, next to factories and next to recycling shacks. One day I saw two women treading mud into brick next to a factory that made backhoes.
Most of us have a bias toward order and organization. And by that metric, the reality of India just doesn’t score as high as that of China, its big competitor.
That bias, however, can sell India short.
Take this example: Auto rickshaws—little three-wheeled, go-cart-sized cars (you might also know them as tuk-tuks in Bangkok)—fill the streets of Indian cities, providing cheaper alternatives to taxis, and faster, 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. But in Delhi, at least, the fleet of 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 passengers can be sure that they aren’t being taken out of their way to drive up a fare. (While I was in Delhi, auto rickshaw drivers staged a slowdown/strike there to protest the cost of these systems.)
Still seem quite so primitive?
...But Don't Be Fooled by It
Or take India’s higher education 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 English-language play schools for the pre-kindergarten set to English-language MBA programs. Some of these ads clearly offer more than any school can deliver—“Master English in 75 hours,” read one. But some, like those for the Blossom play schools, reminded me of the flyers from preschools back in New York.
While the national government is tottering toward some kind of grand, national education-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, such as Tata or Reliance, and the stars of the last generation in India’s technology industry, such as Infosys and Wipro (WIT). 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), and a cellphone giant like Bharti Airtel to those family enterprises, and you’ve pretty much got the Top 25 holdings of any India index.
NEXT: Finding the Next Indian Giants|pagebreak|
Finding the Next Indian Giants
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. 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.
Consider 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 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.
They all trade in Mumbai—but unlike the earlier generation of Indian companies, they don’t trade in New York or London.
I think that’s about to start changing, 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 abroad 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 column in my personal portfolio. The mutual fund I manage, Jubak Global Equity Fund (JUBAX ), may or may not now own positions in any stock mentioned in this column. 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 here.
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