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INDIA MARKET OUTLOOK, ON THE CUSP OF ELECTIONS
CIO team, 24.03.2019
India will hold the world’s largest elections in April-May 2019, with over 900mn citizens casting their votes for the lower house of Parliament, the Lok Sabha. 29 states and 7 union territories, will elect 543 members, with the majority party or alliance forming a government to lead the world’s largest democracy for the next five years. Without attempting to predict the election outcome, we elucidate our expectations for India’s equity markets around this pivotal event. As we approach the elections, markets are turning agnostic to the outcome and reverting to fundamentals. The newly elected government will be assessed for its execution on improving infrastructure and ease of doing business as well as its budget discipline. These policies will take time to show results.
To quote from our Year Ahead 2019 investment strategy publication “Within Asia, India offers the highest earnings growth and the volatility in the run up to the May elections could generate attractive entry points. “ We reiterate our positive conviction not only for the short-term but also on the medium and long term, in line with our expectation for secular growth in corporate profitability. Our sectoral positioning for the coming years is built upon the megatrend of strong consumption growth.
The bull market in Indian equities, which began in March 2009, has just completed its 10th year, with a CAGR of 16% for large caps and 18% for mid-caps. So far in 2019, India has underperformed the broader emerging markets Index, but the gap has begun to narrow in March. Specific concerns for India, apart from political uncertainty, include the impact of rising oil prices. Our inhouse forecast is an average $65/ bbl for Brent in 2019, and we think the Indian economy can deal with oil at this level.
Growth momentum in 1H19 may slow but we expect stability in 2H19 as political uncertainty fades, and as fiscal stimulus boosts both consumption and public/private spending. The recent border skirmishes raise geopolitical concerns, which appear to be as of now contained.
Economic growth is likely to reaccelerate with PMIs in expansion mode and strong credit growth. Corporate revenue growth is strong, also supporting earnings. We expect further upside from Indian equities as the consumption cycle is still early to mid-stage.
Exhibit: Real GDP Growth (%)
Exhibit: Gross Fiscal Deficit (% of GDP)
Exhibit: Current Account Deficit (%)
Exhibit: CPI inflation (%)
Exhibit: FPI / FII - Net Equity flows
Inflation is expected to rise to 3.5-4.0% in the second half of FY20 but stay within the RBI’s target band of 4% -/+2%. Key drivers for inflation include oil prices, agricultural output and the monsoons. Since the RBI moved to an inflation-targeting framework three years back, price dynamics have changed significantly. India has transitioned from high, double-digit inflation, to below 4% last year and this year. Lower food inflation has helped in containing headline numbers, while higher oil prices are adding pressure. Services are at the 5-6% range.
Fair Value and Valuations
Our fair value of 1400 for the MSCI India Index implies another 5-6% return in 2019, plus dividends. This is based on a 19X price to earnings multiple and 16% EPS growth. Faster growth would generate additional upside potential. FY Q319 (Oct- Dec18) earnings season turned out to be a strong quarter. For the Sensex companies, revenue and net profit growth stood at 21% and 26% year on year. The Energy and Industrials sector surprised on the upside, both in revenue and net profit growth.
Emerging-market valuations remain deeply discounted to developed markets, even after a strong 2019. The exception remains India, which whilst expensive relative to EM peers (at 19X forward earnings for MSCI India), is widely held by international investors, including US$4.5 bn of inflows year to date. Indian markets are still underperforming so far in 2019, with the MSCI India Index +6.5% compared to the MSCI EM Index +10.9% (year to date total returns USD). We believe that India’s higher valuation multiples are justified by its fast earnings growth of 15-20% expected in 2019- 2021, as well as by the quality of the listed companies within the EM universe
Exhibit: India has outperformed EM in $ terms
Exhibit: India valuations (PE) are high but so is growth
Sustained demand for equities is supportive in keeping India's valuation premium to emerging markets. Domestic appetite for equity investing is growing, coinciding with India's growing young working population.
Demographics and Digitization supporting Ecommerce
India stands out with the largest millennial population in the world with 330 million. Millennials in India (47% share in the working age population) are digitally connected and are brand conscious
E-Commerce adoption (140 million online buyers) is increasing due to the rapid digitization of India, and with the maturation of usage among internet users (41% of the population). Global companies Walmart (through its investment in Flipkart) and Amazon have stepped up investments in India, as well as Alibaba and the Softbank Group. India is yet to catch up with the US or China – only 22% of internet users are shopping online vs 72% in the US and 74% in China.
Data consumption has increased to 8.3GB per user per month (3Q 2018) with a massive network roll-out by the telecom operators and with improved data speeds. The online shopping experience has benefited.
The average online shopper in India is still relatively a newbie and has been shopping online for 3.3 years with half having been online shoppers for less than two years. Per capita online spend is growing.
Exhibit: CAGR of various technology markets in India
India is on a path to using technology to provide structure to its economy with three main drivers. These moves will bring a large part of the population into the organized sectors and enable them to access cheaper financing.
Exhibit: Growing Internet Users in India (Millions)
Exhibit: Internet Penetration in Rural India
Growth in rural internet Penetration is a huge driving factor. By 2020, India is expected to become the second largest video-viewing audience globally
Exhibit: Online Video Audience (Millions)
Our preferred sectors:
To benefit from India’s growing consumption cycle and ecommerce adoption we like growth stocks in the consumer discretionary and industrial sectors and private sector banks. Shared mobility, electric vehicles and autonomous vehicles are important in lowering pollution levels and in line with new regulations on emissions. Companies that are investing in these new technologies should see exponential growth.
Consumer discretionary: Strong consumer loan growth and rising real incomes support consumption. Domestic auto sales in the two wheeler and four wheeler category are continuing to increase in contrast to the rest of the world supported by rising income levels, urbanization and credit penetration.
Financials: Sustained economic growth and borrowing from the growing middle class should support growing income for the private sector banks. The shift to digital payments is a game changer but not investable as many players are private (digital payments are led by Paytm or channels such as WhatsApp).
Industrials: Infrastructure build remains key to India’s economic growth backed by strong public capex. Some companies are growing above peers as they take advantage of India’s internet boom and advance in connectivity and adopt technology to be ahead of competition:
Reliance Industries: A well-diversified company moving away from its core petrochemical business to telecom (now 14% share of earnings) where its Jio franchise has already garnered 280 million subscribers (the largest incumbent Vodafone has 421 million subscribers) and Retail (9% share of earnings), where profits have trebled in the last one year. RIL is focused on online retail and trying to gain market share. Amazon and Flipkart dominate the market with 80%+ market share.
HDFC Bank: Well placed to keep gaining share in loan growth in India be it consumer, SME and corporate while digital will drive cost ratios down. 20% earning CAGR. The bank has been at the forefront of capitalizing on technology. Banks with strong ability to assess data will be the winners with HDFC Bank at the forefront.
Mahindra and Mahindra: The Company is a market leader in domestic utility vehicles and tractors. Treo, M&M's first electric three-wheeler, has been launched and the e-KUV will be launched by mid-2020. Focused on digital media as a sales channel and has received 55 million views for the XUV300 product and 60,000 inquiries.
Diversified solutions – investing through funds: Active managers are best able to catch the shifting demographic trends and offer diversification across the large cap and mid cap space. We reiterate buying growth at a reasonable price, reinforced by last year’s sell off as valuations were stretched and well above long term averages. The funds on our focus list:
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