Interest in Indian equities might have ramped up in recent years on the back of strong performance, but the structural growth story has a much longer history, FSSA says.
There has been a lot of interest in Indian equities in recent years, as the domestic stock market has performed very strongly. Looking at just the past 12 months, the broad-based BSE 500 Index gained almost 35 per cent.
But the economic success story of India is a much longer term development, tracing its roots back not just to the efforts of Prime Minister Narendra Modi since his inauguration in 2014, but even further to the 1990s, when the government started to open up the economy and denationalised its banking system.
Vinay Agarwal, Director at FSSA Investment Managers, has been investing in the country for more than 25 years and he doesn’t shy away from holding companies for the very long term, patiently waiting for the effects of the increasing wealth of consumers and a developing economy to play out at a corporate level.
“We think in terms of the long term; five to seven years at least. But if you look at my India portfolio, there are many companies which have been in there for over 10 years, some even for 15 years,” Agarwal says.
We think in terms of the long term; five to seven years at least. But if you look at my India portfolio, there are many companies which have been in there for over 10 years, some even for 15 years
Colgate-Palmolive India is a case in point.
“I’ve owned Colgate in India for over 15 years now, where 15 years ago you could make an argument that the per capita penetration of oral care was very low in India and it would rise with rising income levels.
“And if you looked at the competitive landscape, then P&G was not present, Unilever was sort of losing focus on oral care globally, and their franchises were becoming stagnant. So there was every chance for Colgate to keep gaining market share. Colgate is now the market leader with over 50 per cent market share,” he says.
And it is not just a matter of new consumers coming to the market. There is also a clear trend towards a so-called ‘premiumisation’ among consumers, driving further growth.
“The penetration levels over the last 15 years have risen, but there will also be premiumisation – as incomes rise, people start using more expensive toothpaste,” he says.
Agarwal significantly increased its position in Colgate two years ago, when the company went through a management change after a challenging period for the business.
Colgate had been facing strong competition from a local company Patanjali, which is owned by a popular TV yoga guru, Baba Ramdev. Patanjali focuses on ayurvedic medicine, a system of traditional Indian medicine, and other natural products, including a toothpaste made from natural ingredients.
The products caught on with the Indian public and the company was able to gain significant market share.
But in 2022, Colgate-Palmolive India appointed a new Chief Executive Officer, Prabha Narasimhan. Agarwal met with Narasimhan several times and believed she could implement real change at the company.
“The new CEO came from Hindustan Unilever and she started to change things here,” Agarwal says. “That convinced me that it should be a far bigger position in the portfolio, so I made it a top position in the portfolio, and she has delivered in the last few years.
“The market share has started going up again. The growth has started and premiumisation is also happening.”
Meanwhile, Patanjali has been facing legal action over misleading claims of the benefits of its products, including the claim that its product ‘Coronil’ would cure COVID-19 within seven days. The company’s struggle has caused its market share to fall from 15 per cent to about 8 per cent now.
Agarwal has also been invested in Nestle India for most of the last 15 years and has held a number of private banks, including HDFC Bank and Kotak Mahindra Bank, for at least 10 years or more.
And it is not just the large caps that he has held on to. He has also invested in smaller companies for significant periods. For example, Agarwal bought Blue Star, one of India’s leading air conditioner companies, 10 years ago.
“We’ve owned it for the last 10 years as people are buying more air conditioners with rising incomes. I think it is still a very small industry as compared to what it can become over the next 10-20 years,” he says.
“The valuation has become very expensive, so in the last 12 months I have trimmed the position significantly, but I still own a small bit in it.”
There have been some concerns about valuations getting a bit frothy, but Agarwal says the Indian market is quite deep and there are always new opportunities for deploying capital.
“We have been selling expensive names in our portfolio and wherever we thought that the valuations had become excessive. But that doesn’t mean there are not enough opportunities to redeploy that,” he says.
“We have redeployed the sale proceeds into companies that we think will be defensive over the next period, which are still generating high return on capital. And there is sufficient returns to be had from those companies,” he says.
The Modi Effect
Part of India’s economic success in the past decade has been attributed to Narendra Modi, who was sworn in as Prime Minister in 2014.
Modi’s government implemented a series of reforms, including efforts to improve India’s transportation infrastructure, as well as reforms of tax laws in the country that greatly improved the efficiency of cross-state trading in the country.
Agarwal singles out the introduction of a nationwide goods and services tax in 2017 as one of the key reforms that enabled businesses to operate much more efficiently.
“Looking back, we can see that that was very important for Indian corporates. Before this, for 70 years, India did not have a central tax system. Every state had a different tax system, which made it very complicated to do business and tax evasion was a common practice.
People ask: ‘What if Modi is not there, or what if there is a political change?’ But it won't matter; nobody goes back on positive reforms because people vote for growth, and that fact is not lost on politicians
“If your truck was going from your factory in one state to sell to a market in another state, then at the state border, you would have to pay octroi. And it was all physical, so there would be a mile long queue of trucks, and your product would not be transported for days.
“Since it has been implemented, these companies no longer need to have factories in every state they operate, they don’t need to have warehouses in every state, and they can consolidate it and centralise it, which creates economies of scale,” he says.
Although Modi’s reforms have been instrumental in the recent growth of the Indian economy, Agarwal also points out that the development of the country doesn’t depend on the efforts of one person.
“People ask: ‘What if Modi is not there, or what if there is a political change?’ But it won’t matter; nobody goes back on positive reforms because people vote for growth, and that fact is not lost on politicians,” he says.
Financials & Premiumisation
Financials, including banks and insurance companies, in India have also benefited from reforms, but these reforms predate the tenure of Modi by almost 25 years.
Before 1991, most banks in India were state-owned, following two rounds of nationalisation of private sector banks, first in 1969 and again in 1983. The government nationalised the banks in an effort to exert greater control over the development of the country and extend banking services into rural areas.
But inadequate prudential regulations, weak oversight and opaque accounting practices caused these banks to become inefficient. Therefore, the government denationalised the banks in the early 1990s.
“In 1991, when India liberalised its economy and opened up, it started giving out licences to private banks. HDFC Bank, for example, was born in 1994, and ICICI Bank around the time when new licences were given to private banks,” he says.
“These private banks are more consumer-focused in terms of deposits, mortgages, car loans and credit cards, and started to take away market share. And the best talent was also going to these banks.
“In the last 25-30 years, state-owned banks’ market share has fallen to around 65 per cent. I think over the next 20 years it will keep going down to, say, 40-45 per cent,” he says.
Partly this is because the banks offer better services, but Agarwal also expects these banks to grow further as consumers will look for premium services.
“The premiumisation that you can see in the trend from consumer staples to discretionary spending, where people go from buying soaps and shampoo to air conditioners, the same thing is happening in financials,” he says.
“It is not just about simple banking needs, such as a deposit or getting loans for basic things, but as wealth is rising, people will buy home insurance, health insurance and life insurance products, and they’ll need wealth management services, asset managers, and affiliated services.”
The premiumisation that you can see in the trend from consumer staples to discretionary spending, where people go from buying soaps and shampoo to air conditioners, the same thing is happening in financials. It is not just about simple banking needs, such as a deposit or getting loans for basic things, but as wealth is rising, people will buy home insurance, health insurance and life insurance products
Agarwal owns ICICI Lombard General Insurance, life insurer ICICI Prudential and mutual funds services company CAMS. ICICI Bank is one of Agarwal current favourite investments, although for years he wouldn’t go near it.
“I did not own ICICI Bank because I had question marks over their risk appetite and the governance. But then what changed was in 2017 the former CEO was fired, after corruption allegations, and the board was changed. Sandeep Bakhshi, who ran ICICI’s insurance and general insurance businesses, was made the new CEO.
“After he was appointed as CEO, I must have met him, or had calls with him, 10 times. We wrote letters on things that we were not happy about in ICICI Bank’s past. In our first couple of meetings, we realised that this bank was going to change dramatically. Bakhshi was going to change the culture of the business and get out of the loss-making businesses.
“They will focus on the right incentives, get the culture right, get the risk appetite right. And it took us some time to get over the line because we were thinking how can one person change this bank, which has been run in a particular way for such a long time?
“But he has completely turned around the bank in the last six years: the return on equity has gone from low single digit to high teens, the profit is up more than many multiple times and the share price is up four or five times.
“It is still one of the top positions in the portfolio,” he says.
This article was sponsored by FSSA Investment Management. As such, the sponsor may suggest topics for consideration, but the Investment Innovation Institute [i3] will have final control over the content.
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