On the one hand, we are nervous…
Year to date, 34 companies have listed on the Indian exchanges raising a total of USD7.2 billion1, a figure which has been surpassed in India only twice before in the last 12 years on an annual basis. In our Monthly Manager Views in April 2021, we spoke about the initial public offering (IPO) rush that we had begun seeing in India early this year. Unsurprisingly, we have seen this frenzy continue, similar to what has been observed in many global markets.
Free capital has flooded financial markets with liquidity for more than a decade, fuelled by low interest rates and sustained quantitative easing by central banks. The result has been a meteoric rise in the availability of capital, as well as the valuations that companies are able to raise money at. In these cases, it is not unusual for a premium to be attached to disruptive “new-age” business models, where traditional valuation methods fail to apply given the lack of profitability. This year so far, the Indian start-up ecosystem has already added 22 new “unicorns”, which implies a valuation above USD1 billion. This compares to 11 new unicorns in all of 2020 and six in 2019.
The latest and largest of these in India to come to the public markets has been food delivery platform, Zomato, which listed in July 2021 with a market capitalisation of nearly USD8.5 billion. As a team, we did a lot of work on the company and had an encouraging meeting with the management team who we liked. Appreciating the long-term opportunity, we applied for this IPO, but withdrew eventually as we saw the euphoria around the issue. The company did their IPO at an eye-watering valuation of 14.9x Price-to-Sales (P/S), which is significantly above peers in other markets. Not only was this lapped up quickly by eager investors, but the share price then more than doubled upon listing. The demand for this IPO was also reflected in one of the longest anchor investor lists that we have seen in our years of experience.
On the one hand, there is a long runway for growth for such companies given that only 4% of India’s population actively consumes on internet-based platforms2; and, with rising purchasing power, such companies can see strong growth for many years to come. However, on the other hand, growth rarely happens in a straight line. We believe a large part of this potential opportunity seems built into Zomato’s current valuations, and despite making optimistic assumptions over the long term, we were unable to get any upside at all. Our investment approach focuses on capital preservation and thinking about risks is a big part of what we strive to do. This froth in the market makes us nervous.
…and on the other, we are very excited
The last decade has been a difficult period for Corporate India. After muddling through the stress of multiple scandals as well as severe asset quality issues in the banking industry, companies have faced a number of obstacles including demonetisation, the introduction of the Goods and Services Tax (GST), a liquidity crisis following the bankruptcy of a large infrastructure financier, and finally, a pandemic. Growth has been anaemic across sectors. Corporate profit fell to only 1.6% of GDP in 2020, compared to a peak of 7.8% in 20083, and was the lowest in 25 years.
The silver lining of this prolonged pain has been that certain reforms like GST and the Real Estate Regulation Act (RERA) have been introduced, which we believe will be positive for India’s development over the long term. Further, this period has helped market leaders in each category gain at the expense of weaker, unorganised4 competition. Our portfolio consists of many such dominant companies which have used this period as an opportunity to strengthen their market position in the categories they operate. As the country recovers from the pandemic, we believe these companies are positioned to capture the strong growth from the cyclical lows we are currently at.
Commentary from management teams is also more positive now than has been in the last few years. In a recent conversation with portfolio company Mahindra CIE Automotive, its CEO mentioned that during the sharp down-cycle in the automotive industry over the last two years, the company has won business from several new customers. They are running their factories 24/7 and are expanding capacity across divisions backed by customer orders. The management teams of Oberoi Realty and Mahindra Lifespaces have been witnessing customers move to organised sector real estate developers with strong balance sheets and a track record of delivering projects on time. They have received strong bookings for their new project launches. We have also seen that as disposable incomes rise, the share of customers’ wallets for discretionary products is increasing. This includes air-conditioners, property and financial products. The CEO of IIFL Wealth, the largest independent wealth manager in India, recently told us that over the last decade he has not felt this confident about the prospects of the business as he does now.
Our current portfolio is better quality than in the past. As per the table below, the Return on Capital Employed (ROCE) is 42% for the portfolio, which is attractive in absolute terms, and is higher than our own portfolios from three and five years ago. Growth is expected to pick up, with expected earnings per share (EPS) growth over the next two years estimated at 28% CAGR5 from a depressed base. Valuations for the portfolio are not significantly different from the past, with forward Price-to-Earnings (P/E) ratio of 27x.
|Portfolio metrics6||July 2021||July 2018||July 2016|
|Weighted average ROCE%||42.1%||34.9%||39.3%|
|Weighted average 2-year forward EPS CAGR||27.8%||12.6%||10.1%|
|Weighted average forward P/E||27.0x||26.3x||22.7x|
- July 2021
- July 2018
- July 2016
Weighted average ROCE%
Weighted average 2-year forward EPS CAGR
Weighted average forward P/E
With capital preservation at the heart of our investment philosophy, we believe the current portfolio is attractively positioned.
1 Source: NSE Prime Database, Kotak Securities; as of 10th August 2021.
2 Source: Bain & Company; The Ken newsletter.
3 Source: Statista
4 Organised vs. unorganised sector companies refers to those that are licensed and regulated by the Indian government and are subject to labour laws vs. those that are unlicensed or unregistered. Organised or formal companies include publicly traded companies, corporations and large businesses, while unorganised companies are typically smaller, owner-managed enterprises (“mom and pop” stores).
5 CAGR = Compound Annual Growth Rate.
6 Source: Bloomberg; as of 30th July for each corresponding year.
The information contained within this document is generic in nature and does not contain or constitute investment or investment product advice. The information has been obtained from sources that First Sentier Investors (“FSI”) believes to be reliable and accurate at the time of issue but no representation or warranty, expressed or implied, is made as to the fairness, accuracy, completeness or correctness of the information. Neither FSI, nor any of its associates, nor any director, officer or employee accepts any liability whatsoever for any loss arising directly or indirectly from any use of this document.
This document has been prepared for general information purpose. It does not purport to be comprehensive or to render special advice. The views expressed herein are the views of the writer at the time of issue and may change over time. This is not an offer document, and does not constitute an investment recommendation. No person should rely on the content and/or act on the basis of any matter contained in this document without obtaining specific professional advice. The information in this document may not be reproduced in whole or in part or circulated without the prior consent of FSI. This document shall only be used and/or received in accordance with the applicable laws in the relevant jurisdiction.
Reference to specific securities (if any) is included for the purpose of illustration only and should not be construed as a recommendation to buy or sell the same. All securities mentioned herein may or may not form part of the holdings of First Sentier Investors’ portfolios at a certain point in time, and the holdings may change over time.
In Hong Kong, this document is issued by First Sentier Investors (Hong Kong) Limited and has not been reviewed by the Securities & Futures Commission in Hong Kong. In Singapore, this document is issued by First Sentier Investors (Singapore) whose company registration number is 196900420D. This advertisement or publication has not been reviewed by the Monetary Authority of Singapore.
First Sentier Investors and FSSA Investment Managers are business names of First Sentier Investors (Hong Kong) Limited. First Sentier Investors (registration number 53236800B) and FSSA Investment Managers (registration number 53314080C) are business divisions of First Sentier Investors (Singapore). The FSSA Investment Managers logo is a trademark of the MUFG (as defined below) or an affiliate thereof.
First Sentier Investors (Hong Kong) Limited and First Sentier Investors (Singapore) are part of the investment management business of First Sentier Investors, which is ultimately owned by Mitsubishi UFJ Financial Group, Inc. (“MUFG”), a global financial group. First Sentier Investors includes a number of entities in different jurisdictions.
MUFG and its subsidiaries are not responsible for any statement or information contained in this document. Neither MUFG nor any of its subsidiaries guarantee the performance of any investment or entity referred to in this document or the repayment of capital. Any investments referred to are not deposits or other liabilities of MUFG or its subsidiaries, and are subject to investment risk, including loss of income and capital invested.