Stock markets in India have been soaring as the economy enters a prolonged period of political and economic stability. At elevated valuations, near term returns seem uncertain but investors should focus on riding the megatrends.
India’s per capita income has grown by 300% in rupee terms in the last decade, creating an aspirational consumer of goods and services. This, coupled with government policies, has kickstarted megatrends that will drive India’s growth story over the next decade, creating massive investment opportunities.
1. Formalisation of the economy
The unorganised sector accounts for nearly 75% of trade and 90% of employment in India. With initiatives like GST, the tax arbitrage available to the smaller traders will slowly erode increasing addressable market for the organized companies. The opportunity for established players in the consumer, healthcare, textiles, and jewellery industries is immense.
Organised hospital and diagnostic companies control only 10% of the overall market which is growing at mid-teens every year. With only three to four large players in the country, they are expected to catapult five to six times in the next decade.
Dr. Lal Pathlabs is the second largest pathology service provider growing at an impressive 27% revenue growth in the last five years, 11% above the industry growth. It generates a healthy cash flow and has seen a PE contraction recently to 30x against 45x historically providing a good entry point to long term investors.
2. Housing boom
Low cost housing is the focus area of the government and the best way to play this is through housing finance companies (HFC). Mortgage to GDP is less than 10% in India versus an Asian average of 20%. Owning a house is still a dream for most Indians, hence most home buyers are end users, resulting in this sector delivering the best risk-adjusted returns. Consider this: HDFC, a blue chip industry leader, has delivered a compounded annual return of 23% in USD terms for the last 15 years.
Recently, my favourite has been Canfin Homes, the fastest growing mid-size HFC focused on lending to salaried class first time homeowners. Canfin’s USD 2 billon balance sheet has grown its loan book by 30% annually and stock price at 100% (USD terms) every year in the last five years with a NPA of just 0.2%!
3. Physical to financial savings
Demonetisation may not have achieved much on black money, but it did put money to work! Banks received USD 230 billion of new deposits and a major portion of the same has stayed in the banks. Falling currency holdings and low deposit rates are pushing more savings into capital markets chasing better returns. Household savings percentage in mutual funds and equity markets have increased fourfold since 2011. This is another megatrend which will reshape the financial services industry.
The direct plays on this theme would be capital market oriented companies like IIFL Holdings, and Edelweiss which have been doing well. Since their model is more cyclical in the long run, I prefer a pure play on this theme, the recently listed Central Depository Services Limited (CDSL).
CDSL is the only listed play on the depository services which is a duopoly market in India. It has been growing at an impressive 23% in the last three years with expanding margins of 54%. Its annuity revenues with operating leverage make it a cash generating machine. The stock trades at 35x earning, but expect it to be lapped up by institutional investors on every correction.
For those who feel markets are at the top, you risk missing the bus. India has one of the highest real rates since 2002 which provides room for last few rate cuts by RBI. The spread between the 10 year paper and nifty earning yields at just 60 bps, one of the lowest levels in history. This is the reason valuations of Indian equities will remain high compared to previous years and other emerging market peers.
The elevated PE levels or the recent IPO boom may signal revival of animal spirits in the economy or an over exuberant market. Historically, bull markets in India have never peaked with interest rates bottoming out, rather this happens mostly at the initial phase of a bull cycle.
“We always overestimate the change that will occur in the next two years and underestimate the change that will occur in the next ten.” This Bill Gates quote is apt for investors who focus too much on the short term noise and miss the megatrends.
