- Are Indian valuations still attractive?
- China Plus One strategy: Opportunity for India
Niraj Shah in conversation with Bernstein's Venugopal Garre on 'Talking Point'.
- China Plus One strategy: Opportunity for India
Niraj Shah in conversation with Bernstein's Venugopal Garre on 'Talking Point'.
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TVTranscript
00:00 (upbeat music)
00:02 - Thanks for tuning into today's Talking Point.
00:13 I'm your host, Neeraj Shah.
00:15 The case for a chat today is centered around
00:19 what could happen to equity markets, of course,
00:21 but are Indian valuations still attractive?
00:24 And one could look at global valuations
00:26 and try and argue that maybe they aren't,
00:28 but look at historical valuations and argue,
00:30 maybe, just maybe, there could be some more room as well.
00:33 Would DI inflows further offset the impact of FPI outflows?
00:38 And what are the expectations
00:42 out of general elections 2024?
00:44 Is it a done deal or does the result
00:46 still evoke some response from risk assets?
00:50 All of this and more with our guest today,
00:52 Venugopal Garre.
00:54 He's managing director at Stanford Buzz,
00:55 Bernstein, joins us right now on the show.
00:57 Venugopal, good having you.
00:58 Thanks for taking the time out.
01:01 Just trying to understand from where you are perched,
01:04 how do you look at India relative
01:07 to the rest of the comparable region?
01:09 And what do you think 2024 holds in store
01:12 from where we are right now?
01:13 - Thanks Neeraj for having me on the show.
01:16 I think this realize is the first time
01:18 I'm actually on air with you guys.
01:19 So thanks a lot.
01:21 So, you know, I think India is now pretty unique situation.
01:25 There is a global excitement growing towards India
01:28 for a lot of right reasons.
01:30 Part of that is the fact that macro has,
01:32 you know, it's been seen a pretty good recovery
01:35 of the lows in India stacks up pretty much
01:37 as amongst the best performing emerging markets globally
01:40 in terms of overall GDP growth as well.
01:43 But the reality is that if you were to just look outside
01:46 of India, normal comparables usually happen with China,
01:50 which has been the one dominating a lot
01:52 of these emerging market funds.
01:54 And also in terms of global allocations as well,
01:57 valuations there have compressed of course,
02:00 quite a bit in the recent years
02:03 and has been an ongoing process for last year as well.
02:06 So the gap has expanded fairly widely.
02:07 Now, normally valuation calls itself are usually not taken
02:11 as a gesture in terms of how to approach investing
02:14 in a particular country, because you do tend to look
02:16 at the structural and cyclical practices as well,
02:19 which is where India is still favored.
02:21 But I would probably argue that compared
02:24 to where we were 12 months back and where we are right now,
02:27 and even in relative sense,
02:29 valuations very clearly look excessive.
02:31 They might be still pockets of opportunity,
02:33 but across the board, it is becoming a bit more tougher
02:37 to argue even the growth angle.
02:39 You have to really discount a lot of things into future,
02:42 expect and be a bit more imaginative with which,
02:45 you know, in terms of how to look at price
02:47 to earning multiples or build probably
02:50 an earnings growth which might last much longer
02:53 into the future.
02:54 So these are the challenges that I see,
02:56 you know, one characteristic way I sort of represent
02:58 that is that over the next 15 to 20 years,
03:02 I guess at the top line, top down index level,
03:04 the large cap index has to deliver anywhere
03:06 from 12 to 13% earnings growth, you know,
03:09 in a sustained basis.
03:10 That's a pretty large compounding that one has to expect.
03:13 And for Smith caps around 17, 18% over the long run.
03:17 Now, these are not very easy to achieve
03:19 when you look at from a long periods of time,
03:21 of course, you could achieve that over a shorter period.
03:24 So this is where I guess is a challenge
03:26 that somewhere down the line,
03:27 we have to see some form of a flat lining of the markets,
03:30 which is what we believe should happen this year.
03:33 - In some sense, Venugopal, you could argue that
03:38 relative to some of the other very attractive markets
03:40 or high performing markets we have, right?
03:42 We were looking at statistic while 2023,
03:45 India also did well,
03:47 but relative to Nikkei, hardly anything.
03:49 This calendar year, I mean,
03:51 a market like Nikkei is up 18%,
03:53 India for all the fanfare is meandering around a 2% gain.
03:57 So in some sense, the large caps of the nifty headline
04:00 has kind of flat line to marginally higher
04:03 relative to maybe other markets
04:04 or relative to some of the stock specific action
04:06 that we've seen already.
04:07 - Yeah, but you know, the very simplest way I look at it
04:12 is that India end of the day is an emerging market.
04:15 It is always better to compare ourselves
04:18 with how emerging market constructs work.
04:21 The funds are very different as well.
04:23 You can't have an emerging market fund
04:24 investing into Japan, for example.
04:26 And Japan has its own story,
04:27 but look at the currency as well.
04:29 So if you weren't really well hedged,
04:30 of course you would have lost a lot in currency as well.
04:33 But the reality is that if you compare with Latin America,
04:37 for example, where growth rates are still very meager
04:41 for a lot of these countries or outside of that,
04:44 even in ASEAN, which are a bit of them commodity driven
04:47 or even China, India might look up really well
04:49 in terms of overall macro construct,
04:52 not just for history for last year, but for today as well.
04:55 But the reality is that, you know,
04:57 the question simply is number one, is it priced in?
04:59 Number two is that, you know,
05:00 from an international funds flows perspective,
05:02 you know, if you're not gonna see
05:04 some of these larger countries do well,
05:06 which is let's say China,
05:08 you tend to see a lot of redemptions happen.
05:10 So it automatically restrains the ability
05:12 to sort of see a fairly large FII flow
05:16 happening into India from that perspective.
05:18 Now, India as an own asset class
05:21 is something they could talk about,
05:23 but we are still too early to be in that situation
05:25 where you can raise money,
05:27 let's say a billion dollar raise just for India alone.
05:30 I don't think we are in that situation right now.
05:32 I could argue that 10 years later that could happen.
05:35 So that's where the challenge is, right?
05:37 The constraints of FII flows
05:39 and how you approach investing,
05:41 maybe for a retail investor globally
05:42 has a choice of investing everywhere and anywhere,
05:45 but it is not the case for funds.
05:47 So you need to be cognizant of that.
05:48 - And that's such an important point.
05:50 Venugopal, could you just kind of talk about that
05:53 for a little moment,
05:54 because I have heard very divergent views
05:58 around the more popular opinion
06:00 that China's loss could be India's gain,
06:03 and the same and that emerging market X China mandates
06:08 are increasing by the dozens, if you will.
06:10 And at the same time, I see analysis which says
06:12 that while there is so much fanfare around it,
06:14 the absolute numbers are very underwhelming,
06:17 and it is some time away before we talk about this,
06:19 which is something that you alluded to too.
06:21 - Yeah, it's a fair point.
06:24 Believe me, all of us like telling stories
06:26 and you actually raise a lot of money through storytelling.
06:29 Of course, storytelling needs to have
06:30 a fundamental background in backing as well.
06:32 If you go wrong, you go wrong after a few years,
06:34 so that's the part and parcel of how investing works.
06:37 But if you were to think of it,
06:38 China, a lot of money did get pulled out over time.
06:41 I think some of it was an early call people took
06:45 on the cyclical aspects of China.
06:48 Some consider it as a structural challenge,
06:50 but I call it cyclical.
06:51 So whatever it's, some took an early call
06:52 and some capitulated later on.
06:54 This one performance is not good,
06:56 and you had to capitulate.
06:57 And then of course, funding was getting pulled out.
07:00 Now, these are large funds,
07:02 which are primarily funded to let's say endowment funds
07:04 and others, so these are asset allocators who take a call.
07:07 Now, when you pull out that money,
07:08 the simplistic thought process is that you are primarily
07:12 either investing and reallocating that to fixed income
07:16 or to the developed world or to something else.
07:19 It could be another asset class, maybe crypto, whatever.
07:21 So that's basically the way these things work.
07:24 Now, the reality is that a lot of this money,
07:27 which is allocated by these asset allocators,
07:30 also goes into private equity.
07:32 So it's not just public market,
07:34 it's only one phase that we see.
07:35 A lot of challenges are being seen in a private market,
07:39 or a VCP market, for example,
07:42 in some of the established countries like China.
07:44 It is very difficult to get your next round funding,
07:46 come closer to IPOs or raise money or list.
07:49 So when you get that opportunity,
07:51 you basically use public markets primarily
07:53 to create liquidity for yourself.
07:54 That's why that money, which is creating liquidity
07:56 for these asset allocators is not coming back to India.
07:59 I mean, if that was the case in the last two years,
08:01 if you were to accumulate FI outflow and inflow,
08:03 you're not really seeing any inflow.
08:05 If it's India's shining story,
08:07 why haven't we talked about $30 billion inflow
08:09 every year for the last two years?
08:10 It's actually 30 of outflow,
08:12 and we probably got some inflow,
08:13 which probably neutralized it, right?
08:14 So that is the reality right now.
08:16 - So I'll put, Venugopal, thanks for that.
08:19 Now, within this construct then,
08:22 what could mean,
08:28 or what could be the positive for an Indian market, water?
08:31 Because flows, even if they come,
08:35 can take valuations only as much higher.
08:37 In a world where in higher for longer rates,
08:40 or higher than the previous 15 years rates,
08:42 is a reality and therefore multiples,
08:44 likely ideally, should be compressed.
08:46 So what could turn the tide?
08:47 Because earnings growth, no matter how well we do,
08:50 will not be at a clip,
08:52 which could justify higher valuations, right?
08:54 So what do markets do then?
08:55 Do they flatline for the next 12 months?
08:57 - Yeah, so what comes to help normally at times is a cycle.
09:03 So cycle, what a cycle actually means?
09:05 Cycle means a string of EPSs,
09:07 so earnings growth of a certain level,
09:10 continuing for a longer period, right?
09:12 So this is not about 18% growth for two years,
09:15 and you go back to 6% growth, right?
09:17 So that's, of course, a very challenging situation,
09:20 but you have a slightly longer cycle,
09:22 where you have seven, eight years of,
09:24 let's say, a 15% growth, right?
09:26 So what does happen is, after some point of flatlining,
09:29 you tend to again, start to see that earnings growth,
09:33 give you the return.
09:34 So in a very simplistic way,
09:35 if price to earnings for an index or any stock
09:37 does not change from here, right?
09:39 And assume this is the new normal,
09:41 based on India's positioning in the world,
09:43 or the ROE perspective, asset-light companies, whatever,
09:46 let's assume this is the right multiple,
09:48 and thereafter, ideally,
09:49 you're gonna get your earnings growth as your returns.
09:51 If you're gonna get 14, 15% returns per year,
09:53 let's say, from the compounding aspect,
09:55 that's not a bad idea to be in equities in general, right?
09:58 The challenge for us has been that we have risen
10:00 very swiftly in terms of price to earnings,
10:03 and this level itself looks unsustainable, right?
10:06 So you do see flatlining as a broader concept
10:09 from a market level,
10:10 which is what we have been arguing for this year.
10:11 I'm expecting 8% returns for Nifty, for example.
10:14 And my argument is you get that much for fixed deposits,
10:17 in general, of course,
10:18 the taxation aspects might be different,
10:20 but then what's the fun of being, you know,
10:22 actively involved in equities?
10:24 But then you get bottom-up ideas.
10:25 Bottom-up ideas are relevant across every cycle,
10:27 so that doesn't matter.
10:28 That's not a unique aspect to it, right?
10:30 So that's like a situation today that I see,
10:32 but the only positive aspect, as you mentioned, for India,
10:35 is that we do believe that we are in a macro cycle,
10:38 which could last for a couple of years, right?
10:40 Maybe not the 2003 to '08 or 2003 to '10 super cycle.
10:45 You know, we've probably saw 25 to 30% earnings growth
10:47 on a Kigar perspective,
10:49 but can you deliver 15% growth over six, seven years?
10:52 The answer is yes.
10:53 - In which case, before we take that break,
10:57 one final question before the break, Venugopal,
11:00 which is that I heard you say that, you know,
11:03 bottom-up ideas might be par for the course,
11:05 and that's true, as you said, for any cycle.
11:07 My question, therefore, is,
11:08 SMIDs, very strong earnings growth potential
11:14 on a bottom-up basis,
11:15 maybe relative to large caps as well,
11:18 if you look at the overall universe,
11:20 even if you look at the investable universe
11:22 and not the 6,000 stocks.
11:23 So is there, even for global investors
11:27 that you guys might be catering to,
11:29 is there a tilt towards SMIDs,
11:32 or is there a preference for large caps
11:34 in a bottom-up world?
11:35 - Yeah, so, I mean, I would say that the importance of SMID
11:42 as a area to invest and look for opportunities
11:48 is increasing every year.
11:50 Last couple of years, it was primarily about
11:52 retail investors and domestic mutual funds,
11:54 which are, again, funded by retail.
11:56 Internationally, it used to be
11:58 sort of a very niche process.
12:00 Certain funds would probably look at alpha
12:03 by investing in some set of mid-caps, right?
12:06 We are actually starting to hear
12:08 pretty tremendous focus from a lot of funds globally
12:12 on seeking and trying to understand
12:13 the SMID cap opportunity.
12:15 But I have always been of the view
12:17 that it is very difficult to invest
12:19 at a broad-based basis in SMID
12:20 if you don't really have capability.
12:22 So first thing you need to build is hire people,
12:24 build capability, understand stocks,
12:26 and that is how bottom-up investing works.
12:28 Sitting somewhere in the US
12:30 and having somebody who's in China for 20 years,
12:32 you suddenly want to invest in SMIDs, it does not work.
12:34 You know, it's a recipe for disaster
12:36 because SMIDs can be very dangerous as well
12:38 when it comes to bottom-up picking.
12:39 You have to be very careful about
12:42 the business model and governance.
12:43 Maybe large caps you can scrape through
12:45 because what are large caps?
12:46 Large caps basically were SMIDs
12:47 which delivered over time,
12:48 and that's why they became large caps.
12:50 The risk element is usually lower, right?
12:52 So one thing I wanna highlight here
12:54 is we started our India SMID portfolio
12:55 for the first time ever this year
12:58 at a hefty SMID evaluation
13:00 because we really wanted to basically build
13:02 this portfolio over time
13:04 because I think this is the future of India.
13:07 - He believes SMIDs are the future of India.
13:09 Now I have five minutes on the segment,
13:11 so I'll have to do a bit of a rapid fire,
13:12 but Venugopal, I'm trying to understand,
13:14 you've constructed a SMID portfolio at these valuations.
13:19 Where is it that you've given
13:20 the highest weightage in the portfolio?
13:22 What team?
13:23 - Yeah, so I'll just tell you that it was a big struggle
13:27 to identify stocks.
13:28 I can assure you when you try doing bottom-up,
13:30 you realize how tough it is.
13:32 So what I did is that I realized firstly
13:34 that it is no point allocating everything to equity,
13:37 and it's a slightly long-term portfolio.
13:38 I wanna basically build it over the next 12 to 18 months
13:41 or 24 months, so I have 80% allocation basically
13:43 to somewhere down the line to non-SMID,
13:45 which is fixed income, which is almost 50% allocation
13:48 and 30% allocation to large caps
13:50 through a separate India portfolio, which I run.
13:52 So technically, 80% is not SMIDs.
13:55 The remaining 20%, we thought the first team
13:57 that we're gonna choose is where there's an opportunity
14:00 for non-linearity, as I say.
14:02 So this is basically manufacturing,
14:04 where I felt that while valuations are steep, 50, 60 XP,
14:08 but there is room for earnings growth
14:10 and certain surprises to come in,
14:11 because this is a phase where business is getting built
14:14 for those companies.
14:15 So there are four stocks out there,
14:16 which are primarily linked somewhere down the line
14:18 to manufacturing, or one is an EV-linked company
14:22 moving from a normal traditional to EV,
14:24 which is not a component company, two of them are.
14:26 One is an EMS player, the largest in India.
14:28 One is again an EMS component player, more towards PCBs.
14:31 And the fourth one is a logistics company,
14:33 which has in my view, also a linkage with manufacturing.
14:36 So there are four stocks allocated,
14:37 5% each right now on the SMID portfolio.
14:40 - Very interesting.
14:41 Not surprised that some EV plays a feature out there,
14:47 but it's interesting that you are playing
14:50 such a low weightage to SMIDs as well,
14:52 because as per the market cap too,
14:54 like 71% or 70% for large caps, 30% is still SMIDs.
14:57 So you are underweight that bucket,
14:59 but within that, EMS finds such a lion's share
15:03 in your portfolio.
15:04 Those valuations aren't exactly cheap, Venugopal.
15:06 So why this preference for EMS stocks?
15:10 - Yeah, so when I looked at the broader market,
15:13 I wanted to get certain things like certainty
15:16 of near-term earnings streams, right?
15:19 And how do you get a certainty of near-term earnings streams
15:21 is there are two approaches,
15:22 actually two sets of business models
15:24 which give you that certainty.
15:26 One primarily is let's say,
15:27 capital goods linked companies,
15:30 which have order backlogs.
15:31 So you have an idea of what revenue growth
15:32 and what margins they will deliver.
15:34 So they won't suddenly disappoint you meaningfully.
15:37 And the second one was emerging sectors,
15:38 such as primarily manufacturing,
15:41 where there are order backlogs
15:42 and you have a visibility of very high growth,
15:44 at least in the near term.
15:45 But then between this, manufacturing was critical for me
15:47 because I think this is at least a 10-year theme.
15:50 Number two was there are a handful of companies
15:52 like these which I have selected
15:54 who have access to production linked incentives,
15:57 which primarily means that they become a conduit
15:59 for any foreign company thinking of setting up
16:02 capacity in India.
16:03 These guys already have an advantage
16:05 of 10% plus on table for you, right?
16:07 So which is a reason why they become,
16:09 they tend to gain market share in that process.
16:11 So think of another laptop company coming to India, right?
16:14 Which is going to be the natural company
16:15 they would go to.
16:16 Somebody who has a PLI,
16:17 who has labor ability to gather labor,
16:19 has some skill sets.
16:21 So I felt that you could see non-linearity.
16:23 By non-linearity, just to highlight that I just,
16:25 at a 50, 60X company, which is trading at that level,
16:28 even a high growth is usually tends to be discounted, right?
16:32 But then the reality is that if you're,
16:34 let's say $100 of revenues that you are generating today,
16:39 and suddenly, let's say Apple comes into India,
16:42 incrementally, of course, in terms of new lines
16:44 and say, "Hey, you know what?
16:45 Let me just allocate some part of my volumes now to you."
16:49 It's suddenly what happens is 100 becomes 150.
16:51 So it's not about a specific case I'm saying,
16:52 but what I'm saying is that when opportunities are abound
16:55 in that area, you have a tendency
16:57 for a disproportionate scale up for some of the companies.
17:00 And that's the reason I decided to digest
17:02 extremely excessive valuations for that set
17:04 and still keep it in the portfolio.
17:06 - Got it.
17:07 Venugopal, we are out of time completely,
17:09 but I can't resist asking you a 30-second answer if you can.
17:12 Can election verdicts,
17:14 if it's pointing towards policy continuity,
17:18 still be a surprise or is it discounted now?
17:20 - I think policy continuity is already priced
17:24 in the markets.
17:25 And a much larger than expected mandate
17:30 might lead to some euphoria where you get even more excited
17:33 in terms of what all the existing government
17:36 can achieve in the next five-year term.
17:37 But that is the only element of surprise left, right?
17:40 We're not even thinking about a negative surprise right now.
17:42 It doesn't look like that's gonna be the case
17:44 in this election.
17:45 - Okay.
17:47 Venugopal, this was lovely talking to you.
17:48 Thanks for taking the time out and speaking to us
17:50 and look forward to have you more often on the channel.
17:53 - Thanks.
17:54 - All right, that's the view from Venugopal Garre
17:56 and that's all the time that we have
17:58 on this edition of Talking Point.
17:59 Thanks for tuning in.
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