India is one of the world’s strongest economic growth opportunities today. With its young, growing and increasingly educated population; reformist government; strong financial institutions; developed capital markets and burgeoning middle-class, it offers the long-term investor a great opportunity to invest in some extremely high quality companies operating in a structurally attractive market.
India is often portrayed as a backward country that faces many political, economic and cultural challenges. However, if one steps back and takes a wider and long term view, the potential for economic growth and societal wealth creation is extremely high. GDP per capita (USD) has gone up by 3.5x in the last 15 years under different economic and political regimes. It is also abundantly clear that its people want and indeed strive for a better standard of living. There are multiple factors that we believe reflect this opportunity from a top-down perspective but also, and more importantly, from a bottom-up level. While we will not attempt to discuss all of these factors in this piece, we will focus on some of the big trends that should drive secular growth in the long-term and how some truly great companies are positioning themselves to benefit.
Secular growth drivers
The demographic dividend
When India achieved its independence in the late forties, the country had a population of around 360M. This number has swelled to a massive 1.33B (United Nations estimate, July 2016) accounting for nearly a fifth of the world’s total population. While these numbers are staggering, it is even more relevant when we consider the age profile, with around 70% of the population under the age of 35. This provides India with a massive labour force and, of course, a huge potential consumer base that is increasingly more skilled; better educated and whose demands are increasing. Demographic trends such as these are highly stable, predictable and generally feed positively into economic growth. With more people having the potential to be productive, to consume and contribute to growth of the economy, India should enjoy the benefits of the “demographic dividend” for some time.
Convergence – The S-Curve Effect
While India’s total economy is worth around $2.3 trillion (already the world’s sixth largest), per capita GDP is only around $1,700 annually, placing the country firmly to the left of exhibit 1. With expectations that India’s per capita GDP could potentially double in the next 10 years, this will have profound effects on consumption patterns. What we know is that when an economy begins to grow its GDP per capita over $2,500, consumption and demand patterns change, shifting from subsistence (bare minimum to live) to secular demand for goods and services (personal hygiene, convenience food, bank accounts etc.)—this is called the “S-Curve” effect. This is one of most powerful trends we believe exists in India today; one that is almost entirely domestically driven sector.
A reforming government
The most recent national elections were held in 2014, heralding into power the Bharatiya Janata Party (BJP) and Narendra Modi as Prime Minister with a strong majority on a manifesto of reform with a focus on overall economic growth. Mr. Modi came to office pledging to boost financial inclusion, regularise the black (or “parallel”) economy and to bring more people into the tax net. Modi’s reform campaign began with the “Jan-Dhan” program, which has brought more than 250M new account holders into the formal banking system. They then had a tax amnesty for undeclared financial assets as well as the new Goods and Services Tax (GST) legislation (which strives to bring in a single tax network across the country versus the current state level tax system). Then, of course, came November’s bombshell “demonetisation” where, the Prime Minister announced that the entire stock of Rs500 and Rs1000 bank notes (amounting to 86% of all cash in circulation) were no longer legal tender. While we cannot know the true impact of each initiative now, what is uplifting is that in a world dominated by populist politicians, India has a Prime Minister that is attempting to instigate genuine change and take the right steps for the prosperity of his nation.
Not without risks
While the topics discussed on the previous pages may invoke a view that all is well in India, this is certainly not the case and of course, there are major issues and challenges to be faced. Despite the present reform agenda, India continues to be plagued by corruption and tax avoidance which is something of a way of life in India. The country typically scores poorly on many measurements like the ease of doing business and corruption perception indices (as produced by World Bank Group and Transparency International, respectively). India is also a highly fragmented country and economy with poor infrastructure and significant cultural differences. Nothing can be easily implemented in a country with 1.3B people. It is also a significant importer of many natural resources (oil being the key one), that although this has been a tailwind in the past 18 months on account of the major price correction, could be an external risk should we see a major repricing.
The bottom-up perspective
For us, this is where India really gets exciting. India has a long tradition of capital markets and in fact has over 5,000 listed companies supported by a strong local ownership base. This is pretty impressive when you consider that another major emerging market, Mexico, currently only has 136 listed companies. While clearly this in itself will not allow you to benefit from the secular growth potential of the economy it does provide some level of comfort in terms of market depth and the ability to build a diversified portfolio.
While we have discussed some of the long-term secular growth trends that are occurring in India, it would be naïve to think it is “easy” to exploit and participate. History is littered with examples of secular and powerful trends that have ultimately led to little in terms real investment returns (airline and automotive industries to give an example).
We believe the complexity of operating in India with infrastructure that has a long way to develop creates opportunities as well as entry barriers for incumbent companies. Successful companies that have dominant franchises and which have created scalable and profitable businesses tend to have high profit persistence and the ability to deploy capital with high returns over a long period of time.
India case study: Emami Ltd
Emami is an Indian producer of fast-moving consumer goods (FMCG), engaged in the personal care/cosmetics and healthcare businesses.
It is one of the highest quality operators in the space, having a significant distribution reach, well known entrenched products; operating in an under- penetrated market; offering products that will increase in demand with rising incomes. As such, Emami is well positioned to benefit from the secular growth potential of India.
They are the dominant player in most of their key product segments (hair oil, cooling oil, antiseptic creams etc.) with very strong brands. They have consistently grown revenues nearly 17% since 2010 and driven operating efficiencies, growing profit after tax by approximately 23% since 2010. They operate an extensive distribution network across India with an indirect reach to upwards of 4m retail outlets and which they are aggressively growing.
While Emami commands a dominant market share, the potential to grow cash flows is significant given that the penetration rates for many of the product categories remains low at present. This, combined with the growing middle class population and expected increases in per capita GDP, offers significant scope for the company to expand its reach and grow their profit pools.
The company has developed significant “moats” around their business lines, particularly in terms of distribution (where poor and cumbersome infrastructure has raised the barrier of entry to competitors) and their strong brand recognition. Emami management also has a proven track record of innovation, new category launches, and disciplined capital allocation and acquisitions.
Emami is an example of a great company with a proven ability to generate cash flow, has a long runway of growth, and operates within some of the structurally attractive segments of the Indian market.
There are clear and powerful drivers of secular growth present in India. While the country faces several challenges, the opportunity for a longterm investor to participate is significant. We believe that investing in high quality business that supports sustainable cash flow generation is the best way to participate in these themes in the long-term.