There is no other market with the RoE profile of India: Vikas Khemani
India may not have witnessed a broad-based earnings recovery, but several sectors are doing well, including finance (excluding public sector enterprises), automobiles, consumer durables, cement and commodities, Vikas Khemani, president and chief executive officer, Edelweiss Securities Ltd, said in an interview on the sidelines of the Edelweiss India Corporate Day 2017 conference in Singapore.
Among investors, the conviction around the long-term India story remains intact despite short-term disruptions such as demonetisation and the goods and services tax (GST), Khemani said.
Edited excerpts from the interview:
What is the investor community in Singapore asking you about India during your summit here? What has changed from last year and the year before?
The conviction around the long-term India story remains intact. But investors also have to see their returns on a medium-term basis and have to evaluate their investments on a quarter-on-quarter basis. In the last one year specifically, a lot has changed due to demonetisation, GST implementation and some disruptions... These changes are good from a long-term perspective, but definitely have caused short-term disruption, and every corporate has to deal with it. Investors are evaluating as to how long these disruptions will last, which industries are getting impacted positively and which ones negatively. And it is around this that a lot of deliberations are happening.
But the conviction in the India story is undoubtedly very strong. More so, because this government has been able to pull off these big-bang reforms, which we’ve awaited for decades. For instance, bankruptcy code implementation has been in the offing for a long time, and the government has been able to do it, and this will probably unleash a new chapter in the NPA (non-performing asset) resolution in the history of the Indian banking system. Investors are taking note of these big structural reforms, and they are factoring it in.
As regards to earnings recovery, while on the broad base, the earnings recovery has been a bit elusive, it has been fairly decent in segments. If you look at financials, if you take away the public sector enterprises or corporate lenders, where the bulk of the problem is, the growth has been fairly robust. You pick up any other sub-sector of financial; other than this bucket, it has been growing very well. We have also seen automobiles, consumer durables, cement growing very well. Commodities were not doing so well, but they have also come back.
Another important thing when we look at earnings growth, a factor that most people miss, is that top line is a combination of gross domestic product (GDP) growth and inflation. If GDP growth is about 7-8% and your inflation is about 7-8%, you can grow your top line by 15%, but we’ve not had that kind of growth. This is because in the absence of inflation, your top line growth cannot be more than 7-10%. Investors expect 15-20% growth, which cannot happen in this environment.
When you have low inflation, it reflects on the low multiple you are able to give because the interest rate has gone down. This reflects in high valuation even in an ostensibly low-growth environment.
Volume growth of 6-7% is coming through—this was the case earlier too, but 7-8% volume growth plus inflation growth was making it look very robust. I think soon you will see the disappointment around corporate earnings also dying down. Smart investors are taking note of this and playing their strategy accordingly.
Again in terms of sector-specific themes, what are their queries?
Investors always want to know which are the big themes which can give you sustainable, deliverable returns. They want to know which sectors offer sustainable growth without any hiccups, have least regulatory interferences… We have been very vocal in highlighting one sector—the financial one. India is going through a big financialisation wave. Financial savings are going up, and as a result of that, this intermediation of savings, the utilization of resources from savers of capital to users of capital will create a huge amount of opportunities for lots of financial services players like us.
Let us not forget that two-three years ago, 30-40% of the Indian population was not plugged into the financial system, which has changed. So, we believe that this is only the beginning of the whole trend.
Second is the unorganised-to-organised theme. In India, due to regulatory changes like demonetisation, GST and also underlying forces like increasing the per capita income and more technology, many industries have started seeing a market shift from unorganised small players to organised large players. This cuts across many industries like building materials, plastics, textiles and many other segments.
Their underlying theme is this—where the inefficient, unorganised players will be less viable, they will move towards organised side. In my mind, this is a decade-long theme. You will see a huge amount of value being created in this space, and we have many companies out here representing that.
Third, a huge amount of investment is happening in India especially in the infrastructure segment—the government is spending close to $1 trillion over the next five-six years across railways, metros, ports, roads, affordable housing and this will have a huge impact on job creation, steel and cement consumption. This is just beginning... and we think that the impact of this will start reflecting in the Indian economy’s fundamentals and volumes over the next couple of years.
Across these three themes, you cover a large part of the opportunities in India—you will see many other themes too coming about from time to time; manufacturing is another theme that the government is promoting through ‘Make in India’. Historically, there was a very low investment that happened in the likes of chemicals, fertilizers, and we are suddenly seeing a lot of investment, and that will also become very big over a period of time.
The way to look at India is that, if you can overlook a little bit of short-term noise, we are a great opportunity. Indian GDP will grow from $2 trillion now to $5 trillion now in 2025, and even if you keep the rule of thumb—the market cap-to-GDP to one—we will still create wealth of over $3 trillion over the next seven-eight years. So, you can’t ignore this kind of transformation and this kind of opportunity. I do believe that the risk can come from global factors. Complacency around risks is there in all global markets.
Are you then saying that the risks India faces are more global ones and not local?
For India, there are more global risks than local risks—you can never predict geopolitical factors. Also, right now we are dependent on one person’s visionary leadership and it’s very critical that the continuity of that remains, because Indian expectations have gone up, and any disappointment around that can be lethal. Other than that, I don’t see any local issues, to be frank. If the risks come, they will be induced by any disruption in the global markets, which could be due to scaling down of the balance sheet of global central banks.
India is seeing record initial public offerings (IPOs) this fiscal—do you see it as a case of everyone rushing to tap the market before the froth starts settling?
I don’t see this as a negative. It’s a positive because first, you can only list when the environment is good. If you understand the Indian market setup, around 55% of the Indian corporates are owned by Indian promoters and families and government, 22% are owned by foreigners, around 15% by mutual funds and 4-5% is GDR/ADR (global depository receipts/American depository receipts). So, there is only 5-6% of real floating stock.
If I take a $2 trillion market cap that is only $100-120 billion. If Indian markets are getting anywhere between $15-20 billion, retail investors will look to go out and buy. It is very important for the health of the market that we have supply of good paper.
Today, if HDFC Life, ICICI Lombard and others are going public, it is also an opportunity to participate in them over the next 10 years. Lots of companies went public in the 2004-06 period—today many of them are very large. As long as the quality of the company is good, management is good, long-term structural drivers are in place, I feel there are very good opportunities to participate in them.
When talking to potential investors in Singapore, what is the sense that you are getting when comparing India to other Asian players?
People say they like the profile that India offers and that there are not as many opportunities in other places. Someone was telling me that Vietnam and Philippines are the only two markets that offer a similar kind of profile, but they are smaller markets. So, if you have to deploy large capital and participate in a very big wealth creation opportunity, then India, which is moving from $2-5 trillion, is the only option.
Today China is not that option—yes, it is another large opportunity, but not an option like India. Other emerging markets like Brazil are not an option. I haven’t met any investor who says “I am not interested in India”, or who says, “I don’t want to increase my exposure towards India”. Everyone is looking to participate more in India, but I think they are waiting for their own timing. Compared to other emerging markets, I believe that the confidence around India is very high.
Overall in terms of valuations, is India still seen as expensive?
In isolation, yes. But you have to look at two things—one is the new interest rate regime. You can’t compare with historical valuations without looking at the new interest rate regime. We are in an environment where inflation is fairly contained, trajectory of inflation looks very benign and interest rate trajectory looks very soft. So, you can’t have the same valuation getting traded at when the interest rate was 8-9%.
Second, when we compare with other markets, you have to look at the RoE (return on equity) profile. There is no other market with the RoE profile of India. Third, you have to look at the growth profile. Over the next five-ten years, which market can promise you the growth profile that India can over the next seven-eight years?
If you look at all these things, I don’t think it is expensive. It is, in fact, cheap. Valuation is a function of growth, return ratios and alternative investments. If you look at all three things, then India is cheap.
But if I were to just compare with the PE (price-to-earnings) ratio, price-to-book ratio and take whichever other markets and historical, I will not get the right answer. And probably that is the perspective by and large that people have.
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