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Why valuations should not block India’s investment case

01 May 2024

Valuations in Indian large-caps do not appear stretched and are justified by the nation’s structural growth.

By Darius McDermott,

Chelsea Financial Services

The Indian elections are in full swing, with current prime minister Narendra Modi hoping he has done enough to stay in power for a third term.

With a process lasting more than six weeks and with more than 970 million registered voters, the country has been dubbed ‘the world’s largest democracy’. To put this into context, the entire population of Europe is 741 million.

Modi is widely expected to retain power, with recent estimates indicating his Bharatiya Janata Party (BJP) will win around 300-320 seats – with a few more going to its allies (543 Lower House seats are divided up, with a 272-seat majority needed).

Modi’s policies have transformed India in the past decade. They cover banking, manufacturing, inflation management and an increased focus on physical and digital infrastructure, all of which have boosted the long-term growth potential of the economy.

The numbers speak for themselves – at a time when growth has been challenging across the globe, GDP in India stood at 6.7% and 6.4% in 2022 and 2023 respectively, with estimates that it can grow at 6.7% consistently over the next decade.

This is aided by some significant tailwinds benefitting the economy. They include demographics (50% of the population will be comprised of Millennials and Gen Z’s by 2030) and a growing middle class (the percentage of high and upper middle-income households in India is expected to rise from 26% in 2021 to 45% in 2030). In short, the characteristics of India’s growth are very much structural rather than cyclical.


More changes to come

Dipojjal Saha, a macroeconomist and product specialist at Ashoka India Equity, cites the infrastructure story as a key element, with a compound annual growth rate (CAGR) on capital expenditure standing at circa 20% since Modi came to power.

Saha said: “90% of India’s railways are now electrified, compared with 30-40% previously. The number of airports has doubled, while the turnaround time at ports has improved rapidly. Previously, some 20 million rural homes had access to tap water, now almost all of them have access.”

The second area bearing fruit is manufacturing, with India having already made strides in both defence and technology. The ‘Make in India’ initiative has successfully reduced India’s reliance on imported goods. India’s government has cut corporate taxes for new manufacturing production and launched production-linked incentive schemes across multiple sectors.

Goldman Sachs India Equity portfolio manager Hiren Dasani said: “Progress has been made since Make in India was first introduced in areas like electronics given fast-growing domestic demand. Capex intensive industries, such as electric vehicles and semiconductors, may have to rely on global corporations as they develop due to a lack of raw materials domestically. Mobile phone supply chains have been shifting from China to Vietnam and India.”

But there are clearly far more societal strides to be made. For example, the minimum wage in India is lower than other Asian economies, while only one in five women are in the official workforce.

Lofty valuations are justified – and this is why

The trouble is that India’s success story is one of the worst kept secrets and this is reflected in valuations. Figures show the MSCI India price-to-earnings (P/E) premium over the MSCI Emerging Markets index is currently between 70% and 80%, whereas the average since 2007 has been closer to 40%.

But there is a strong argument to support those numbers. Not only has growth been justified, given the likes of urbanisation, attractive demographics and the rise of digitalisation, but the de-rating of China has shaken up the composition of the market.

Only a couple of years ago, India accounted for just 10% of the MSCI Emerging Markets index (with China accounting for 35%). India’s exposure has now almost doubled to 18%, while China has fallen to 25%, Saha pointed out.

When you compare India’s valuations versus its own history, it is a different story. “Valuations for the past 10 years in India have been 20.7x, it is currently around a P/E of 19.7x, so they are not stretched. It has also seen the highest earnings growth amongst its peers,” Saha argued.

This bring us back to the aforementioned structural – not cyclical – growth story. Alquity Indian Subcontinent manager Mike Sell said that while India’s P/E has re-rated over the past decade due to Modi’s reforms, valuations are not stretched.

“India has a high P/E because of strong earnings growth over a number of years. The earning per share stand at 17%, giving it a price/earnings-to-growth (PEG) ratio of 1.3x. On a PEG basis, India is cheaper than the likes of Korea, Japan, Mexico and the UK,” Sell said.

“Countries like Korea, Taiwan and Thailand may have a lower PEG, but they are cyclical, not structural stories. India has multi-years of growth, not pockets of opportunity.”

One area that does look more expensive is the small and mid-cap space. UTI India Dynamic Equity assistant manager Ravi Gupta said valuations are at a 25% premium for mid-caps and slightly higher for small. This follows two strong years when firstly, supply chains recovered as businesses started to re-open post-Covid, promptly followed by the fall in commodity prices.

Gupta’s exposure remains around the 35-40% mark in the small and mid-cap space, having taken profits in some areas and reoriented into other parts of this market. “One thing that has helped in the last few years has been the increase in IPOs. It has presented a number of opportunities to investors,” he added.

India’s growth is hard to ignore. The International Monetary Fund expects it to be the third-largest global economy by 2030 as its GDP continues to stand out from its peers. Valuations are a consideration – but experienced active managers should be able to cut through the noise to tap into the opportunities in the region.

The case for investing in India as a standalone allocation continues to grow. Those who may prefer exposure as part of a wider emerging markets portfolio may want to consider the likes of the GQG Partners Emerging Markets Equity or FSSA Global Emerging Markets Focus, which have 29.7% and 24% invested in the country, respectively.

The views expressed above should not be taken as financial advice. Darius McDermott is managing director of FundCalibre and Chelsea Financial Services.

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