Long-Term Investing Ideas in a Volatile Market
Simon recently spoke with a $35 billion global asset manager about how they're navigating the market volatility. The key takeaways are to think long term, tune out the noise...
Our 7investing team sets its sights on India! In Part 2, lead advisors Matt Cochrane and Simon Erickson speak with Ramneek Kundra and Saket Reddy about India's large conglomerates, its fastest-growing markets, and its major government initiatives. Ramneek and Saket share their favorite stock ideas in the country, and Matt and Simon share their overall key takeaways.
August 21, 2020 – By Simon Erickson
In Part 1 of our two-part series on investing in India, Dhaval Kotecha broke down India’s demographics, particularly its extraordinarily young population and growing middle class, and how they will drive India’s economy over the next decade. In this episode, 7investing founder Simon Erickson and lead advisor Matthew Cochrane talk to two more savvy investors with first-hand knowledge of India’s stock market, Ramneek Kundra and Saket Reddy.
Kundra explains that U.S. recessions have historically led to booms in India’s stock market. Kundra believes there are two explanations for this. First, a major recession leads to a drop in oil prices, which for a country like India that imports the vast majority of its oil can be a tailwind for the overall economy. Second, recessions lead to drops in interest rates. As rates fall fixed income assets look less attractive, causing U.S. investors to look elsewhere to park funds leading them to emerging markets.
After giving his overview of India’s economy, Kundra discusses his favorite current Indian investment, ITC Ltd ADR (ITCTY). ITC is deploying its free cash flow from tobacco sales into diversifying away into other sectors, particularly packaged food, personal hygiene products, and paper packaging, growing rapidly in the process. ITC is now a diversified packaged good conglomerate in a growing market with an ascendant middle class.
After speaking to Kundra, Reddy explains that finding companies with positive free cash flow in India is harder than you would expect, explaining that only a select few make that cut. In the Nifty 50 index, for instance, Reddy points out that only a handful of companies generate positive free cash flow and have grown earnings over the last few years, severely limiting the field of quality companies for investors.
Reddy then discusses Abbott India, a subsidiary of Abbott Laboratories (NYSE: ABT). Abbott India, Reddy explains, has a high return on equity and is growing earnings in mid-teens. The company’s top ten products are either the market leader or second in each of their sectors, giving its products strong brand recognition.
With India’s large population, young demographics, and growing middle class, India appears to be an attractive place for U.S. investors to look for new investment ideas. Both Kundra and Reddy shine light on where to begin looking for these opportunities in their exclusive interviews with 7investing in this episode!
0:00 – Ramneek Kundra introduction
2:41 – India’s macroeconomic outlook
4:54 – Corporate governance, shady accounting tricks, and investing frameworks for India
7:44 – 20 companies generate 70%+ of the country’s corporate profits
9:59 – ITC Ltd as an investment opportunity
11:16 – ITC is diversifying away from tobacco products
12:41 – ITC’s profitability and valuation
23:39 – India’s attitude towards smoking
29:20 – Saket Reddy introduction
30:46 – Challenges to investing in India
32:07 – Investment opportunities in India
34:37 – Why Indian investors prefer fixed income accounts
37:28 – Indian government regulations that can affect investors
40:13 – Abbott India as an investment opportunity
42:39 – Healthcare policies in India
43:53 – Concluding thoughts and key takeaways from Simon and Matt
Simon Erickson 00:00
Hi everyone, I’m 7investing founder and CEO Simon Erickson, joined by my 7investing lead advisor colleague Matthew Cochrane. You’re tuning in to Part Two of our deep dive of “Investing in India”.
Simon Erickson 00:13
In Part One, we just dug in to India’s growing e-commerce and digital banking model with our special guest Dhaval Kotecha. On today’s show, we’re going to hear the perspective of two more Indian investors, Ramneek Kundra and Saket Reddy, as they share what they believe are some of the greatest opportunities, the greatest risks, and the single equities that they’re looking at in the Indian market. Let’s tune in to see what they have to say.
Simon Erickson 00:41
Our first guest is Ramneek Kundra. He’s based in New Delhi, India, he has a very diversified background. Ramneek, it’d be great if you could start us with your background and also kind of how you think about your own personal investing style.
Ramneek Kundra 00:55
Yeah, so I basically started investing in 2015, when I was working for a SaaS startup in New York. It was called Decisive. It was an RTB [real-time bidding] platform, demand side platform. And I worked there as a customer success manager. And after that, after coming back home, I used to read investing books and just got into it. I made my first investment in Under Armour, which was a momentum stock back then. And it just went off and I was like, “Hey, I can do this stuff. It’s easy.”
Ramneek Kundra 01:41
And then I ended up investing in a few oil companies based on Ben Graham’s Intelligent Investor. I was like, “Oh!” And then I got really creamed in the market and lost like 90% of my investment in Chesapeake Energy. So that was a good lesson: to invest in great companies. And the third investment I made was in Charter Communications, which just went up and never looked back since then. So I’ve been learning since then, and really enjoy investing as an intellectual experience. And, of course, making money from it.
Matt Cochrane 02:27
That’s a great intro Ramneek. So let’s just back up for our listeners. And tell us how you view the bigger picture in India and its macro-economic outlook?
Ramneek Kundra 02:41
Yeah, so if you think about India’s macro-economic outlook. I’m not a macro expert. But what I would say is, before every four major booms in India, we have had a US recession. And why is that important? That is important because there are two or three things that a US recession does to a poor country like India.
Ramneek Kundra 03:08
So first, you have oil demand that just goes down in a US recession, because people are not spending as much as they would. And after that, that’s a 3% GDP tailwind for a country like India, which imports a lot of oil. And then after that, you have bond yields collapsing in the US. So that naturally prompts big investors to look outside the US. And so they go for emerging markets and they go for India. And the dollar usually is stable or going sideways during these times. So the currency risk is fairly lower to these investors. Because in the long run, over the long term; over the past 50 years, if you look at the Dollar and the INR Indian Rupee’s track record, it’s about like 3%. It’s grown at 3.5% CAGR since India’s independence.
Ramneek Kundra 04:13
So the dollar is always a tailwind for foreign investors. So it’s always a good time to look at India when the US is slowing down. And probably, I think one of the reasons Facebook invested in Jio is not only because India has a geographical fiber footprint that is growing or broadband penetration is growing. It is also about the timing to invest in India. So that’s how I think about the macro picture.
Matt Cochrane 04:47
So what would you say are the opportunities and challenges for investors looking to invest in India?
Ramneek Kundra 04:54
The first challenge that you have as a foreign investor is that you get no control of the management. In Indian companies, you have absolutely no say as a minority shareholder because most businesses are majorly owned by notorious promoters. They would have about 50% ownership in the businesses.
Ramneek Kundra 05:19
And then a second challenge is about fraudulent accounting. Because if you have such control, you have basically auditors in your pockets, right? So if you run forensics on the books of a majority of companies in India, you will find out that more than 50% of the businesses’ books are cooked. So that renders them completely non-investable for someone like a Carlyle or KKR or Brookfield. So you can [look for] a few hats. So you can quickly look at their auditor fee growth versus their revenue growth. Basically, if the revenue growth is like 5% and the auditors’ fee growth is like 7%, that’s a red flag, right?
Ramneek Kundra 06:08
And operating cash flow as a percentage of EBITDA receivables. Related-party transactions, where the promoter is basically lending money to the business at higher rates than what they can get from bond or permission bonds or just from the bank. And there are billions of dollars and they are busy with their own hobbies of playing golf and flying over the air in jets and interested in philanthropy.
Ramneek Kundra 06:43
So do you have all these agency and governance issues? And that’s why people are always wary of “Oh, you’re not going to invest in emerging markets? Well, you suck at investing and you are not looking at all these things right.” So you are going into an uncharted territory. And you are applying the same investing framework that you would apply in the US or in any developed economy. But that won’t fly over here. So it’s just your problem rather than a country’s. Or it’s a competence issue, I would say.
Ramneek Kundra 07:18
If you can figure all these things out; if you come to India and you think you’re going to invest in inherently cheap and obscure stocks and make money, the chances are you will get creamed. So these are the challenges that I see.
Simon Erickson 07:35
Ramneek, based on your background and your understanding of the Indian market, is there a stock or two stocks that’s really on your radar and that you’re really interested in right now?
Ramneek Kundra 07:44
Yeah. India is the only country in the world that has 20 listed companies generating 70% of the country’s corporate profits. Just 20 companies.
Simon Erickson 08:05
Ramneek Kundra 08:06
And because our public markets are still lagging behind what’s happening in the real economy. If you look at the listed space in India, you would look at companies which are like “old economy” companies. But at the same time, the real revolution is happening in tech.
Ramneek Kundra 08:30
So SEBI, which is the Securities Exchange Board of India, has these absurd hurdles of making like accounting profits and all those things before you list. So if you do that, then you are going to list on the on the stock exchange. So that’s the problem. You are not able to list all these great tech companies which are generating massive profits and growing like crazy. So there are old economies. There is a disconnect between what’s happening in real corporate India and what’s happening in the public markets.
Ramneek Kundra 09:09
So that’s why I like to segregate these top 20 companies. So, this is the data that comes from one of the Indian firms of Marcellus Investment Managers. They said like 20 listed companies in India 30 years ago in 1990 generated about 14% of the total profit. And now, it’s 70%. So you can see the mass consolidation that’s happening as a long term investor. I feel my job is to participate in the success of these companies, rather than just “go against the tide” and find out my own obscure companies which will be the big companies of tomorrow. Because out of these 20 companies, I figured 10 years from now, even at least 10 companies are alive, my portfolio will be alive and kicking.
Ramneek Kundra 09:59
One of the companies I identified, which I feel is undervalued currently, is ITC. And ITC is Imperial Tobacco Company, how it was called, now it’s just ITC. Because we are no more an imperialist in this world. So it was established by the British during the British Raj in India. And it’s a 100 year old conglomerate. It basically owns 80% of the legal cigarette market in India. So it’s basically like Altria of India. Altria owns 50% and ITC owns 80%. But what really differs from Altria is, it doesn’t have bad capital allocation [Simon laughs]. It doesn’t have any debt. And it is so diversified away from the tobacco business that you cannot even now call it primarily a tobacco company. Because more than 50% of its revenue comes from non-tobacco businesses. And it was like 65% 10 years ago.
Matt Cochrane 11:12
But what are some of those other businesses it’s involved in? If not tobacco?
Ramneek Kundra 11:16
That’s what I was getting into. They are investing majorly into CPG. They are the second-largest brand – I’ll give you an example – in instant noodles. And they are the second fastest-growing CPG company in India at the moment. And their non-cigarette business is growing at more than 50%.
Ramneek Kundra 11:47
So in the last 10 years, what they have done is they have given back 60% of their cash flow back to shareholders in the form of dividends. But 40% of that cash flow has been reinvested. So the narrative has been “Oh, ITC is investing in all these hotels, businesses, and everything like that.” But only 4% of the total cash flow went into the hotels, which is a low return on invested capital kind of business. But that also helps them sell their CPG products. There are lots of synergies. And even there, their average return on invested capital is 40%. Right throughout their business. 40%!
Ramneek Kundra 12:41
And the business right now sells for about like 14x, ex-cash. And they’re growing their CPG business at about a 30% clip on average. And their cigarette business is growing. 88% of India’s cigarette market is still illegal. The reason being, in India the government asked companies to put major warnings – where you have a man in the picture and you have like big cancer in the mouth – where they show it and so the people asked for foreign cigarettes, the smuggled ones. So ITC still has a long growth rate ahead of it, even in the cigarette business, because you have the youngest demographic in the world. Where the average age is in the 20s.
Ramneek Kundra 13:45
So even their cigarette businesses is pretty good. Pretty healthy. And 80% of their profits come from the cigarette businesses, in terms of free cash flow. So the lowest return on invested capital they have is in their paper business. And that’s 25%.
Simon Erickson 14:02
Still incredibly high.
Ramneek Kundra 14:04
Yeah, and it’s a commodity business, mind you. So it’s a paper business. I don’t know any paper business in the world that generates 25%. Probably I’m ignorant, I don’t know. But 25% sounds like a real good return to me in a commoditized business. And their CPG business is growing fast. So they are coming out of a capex cycle. For the last 15 years, they had some challenges. Where they had a distribution challenge. One of the insights I found was in 2015, ITC was delivering their biscuits and cookies through the same supply distribution channel which they use for cigarettes. And usually when cigarettes are unloaded from the trucks, they usually throw the cigarettes very fast. So like, throw the cigarettes and the boxes and everything. But you cannot do that with biscuits, right? Because biscuits will break and cookies will break. So they had this problem. They fixed that problem by completely changing their supply chain. And no one talks about it. No one knows about this stuff.
Ramneek Kundra 15:22
So the narrative going forward, I think, is going to completely change as their margin could expand because they are coming out of a capex cycle. And their return on invested capital would jump up to about 60-65% easily over time. And I think the stock will get, basically, a narrative change premium as well. And then you get a discovery premium, in terms of the insights I’m sharing with you. So I think the stock could easily trade at like a 30x multiple on the forward earnings, which will keep on growing at 10%-11%-12%. And you get a 5% dividend yield. So you easily get like 18-19% return for probably like seven or eight years. So you get like 7-8x in 10 years, I think.
Matt Cochrane 16:18
I mean, really you have the tobacco business. But you have the consumer staples covered, with the food brands it has, personal care brands like the paper products and the stationary. You have some consumer discretionary exposure there with some hotels. You know, it’s really one of those consumer…it reminds me a lot of a Procter & Gamble or something. Like when the American middle class was growing decades ago. I definitely see the potential here.
Ramneek Kundra 16:51
Right and the thing is, with ITC, the narrative change would also make a big difference over here. Because it’s not only a company with just cigarettes or focused on just making money. It’s a very progressive company. And, you know, when Microsoft is talking about going carbon positive in the next 10 years by 2030, ITC has been carbon positive, despite their cigarette emissions and all that, for the past 11 years. It’s the only company that’s been carbon positive for the past 11 years in the world. And it has these mammoth hotels, which are like the greenest hotels in the world. They have the maximum plants and maximum green footprint throughout there. So it’s a very progressive, professionally run organization, which I think no one is paying attention to right now.
Matt Cochrane 17:54
Is that as important in India as it is in the US right now? Like that carbon-neutral footprint and the green movement? Is that as big and important to the Indian consumer as it is to American consumers?
Ramneek Kundra 18:10
So right now, with my generation – I’m 30 right now – so with my generation, it’s very popular. We would invest in something sustainable, ESG kind of thing. I don’t think specifically like ESG, because ESG funds I’ve seen owning British Petroleum [laughs]. So if you step back, at the same time you think about sustainable stuff. You think about it. Young people definitely think about it. It’s not as big as in the US, but it’s growing fast. And you can see why ITC is ahead of where it is located. So that’s the point.
Simon Erickson 18:57
Yeah, just to recap a few of the things that you said that I thought were really interesting. It seems like there is a lot of risk and a lot of difficulty in finding smaller companies in India. One, because of the accounting. Two, you’re up against really huge companies. But what’s really interesting, like you also mentioned, is that those huge companies are nowhere near completely saturated or mature yet. I mean, 25% ROIC for paper processing still has plenty of growth. That’s just accompanying that Indian macro growth of the whole country and the consumer. And then the dividends. It sounded also like dividends are very important for investors for those large companies to pay out 60% for dividends.
Simon Erickson 19:45
Any final thoughts about India or ITC that investors here in the United States should be thinking about?
Ramneek Kundra 19:55
Yeah, just don’t look for obscure, small companies because you will have real problems in that area. But once you get going with the large business landscape and large conglomerates, once you have a grip of understanding all the large companies in India and how they generate their returns, then you can venture into some of the mid cap companies or smaller cap companies where you would have pattern recognition kicking in. You will be like “Okay, this is a monopoly, essential product, high ROCE [return on capital employed], the management is of this pedigree” and then you are good to go.
Ramneek Kundra 20:42
But don’t start with small cap and mid cap investing. That’s not the way to do it. It’s just strong advice, but even to someone in private equity who has like great experience or something like that, do a lot of legwork on the ground. That’s my advice. It’s really hard, I think.
Matt Cochrane 21:10
What’s ITC’s market cap, in US dollars?
Ramneek Kundra 21:14
In US dollars. Let me check. I guess ITC also has an ADR.
Simon Erickson 21:22
That’s what I was going to ask. If they were actually available for American investors.
Matt Cochrane 21:26
And they are. I meant to point that out too.
Ramneek Kundra 21:26
It’s “ITCTY.” Yeah. So I don’t look at ADRs as much. But it’s a 2 trillion…so it’s somewhere around like $33 billion in ITC’s market cap. So that’s not too much. If you were to have been five years ago, that would have been a $41 or $42 billion market cap, because the dollar appreciated.
Ramneek Kundra 21:29
Wow, that’s really interesting Ramneek.
Simon Erickson 22:12
It’s crazy. This blows my mind; I still can’t get over it. It’s like the expression of “having your cake and eating it too”, where you can have a company that can put 40% of its money back into its business that it’s getting at least 25% ROIC, which is crazy to me. I don’t know of any conglomerate in America that gets anywhere close to that. But then in addition to that, it’s still paying out 60% as dividends. I mean, and 20% return per year. Matt, we’ve got to start looking at some Indian companies.
Matt Cochrane 22:45
I know. I was thinking the exact same thing. Yeah, like an India basket here.
Ramneek Kundra 22:51
And whenever I talk to people in the US about Indian stocks and everything, they are always excited. They’re like “Oh, dollars would just appreciate like 2.5% to 3%.” You are going to make 20%. You’re not going to find a company that makes 17% easily in the US.
Simon Erickson 23:15
You’ve got to take a lot of risk for that in the US. Yeah, you’re not investing in conglomerates if you want that return here.
Ramneek Kundra 23:20
Yeah and also like these are like the FAANGs [Facebook, Apple, Amazon, Netflix, and Googles] of India. So you are investing in real large, monopolistic companies. It’s not like you’re investing in a small US company.
Matt Cochrane 23:39
Is the smoking population in India declining, like it is in the US? Or is it holding steady? Is it growing? How does the smoking population look?
Ramneek Kundra 23:50
Well Matt, if you look at our population, it is totally growing. So we are 1.3 billion people. So 1.3 billion people, growing at like 1% every year or something like that. You are looking at a flat smoking rate. And the population is young. So I think the average age in India is about…you can look it up…
Matt Cochrane 24:27
I saw that. No, I saw that in my research. Yes, like two thirds of the population is under the age of 35 or something. Right? Crazy. Very young population.
Ramneek Kundra 24:39
And in India, one of the things that people don’t realize is you don’t have to buy smoking packs. You can buy a loose cigarette. And that’s a big, big difference. Imagine, you see how many people you meet in New York, like “Hey man, can I buy a cigarette from you for $1 when you’re outside the club or something like that.” It’s surreal. So the mental hurdle just breaks down. So you’re paying like 50 cents for a cigarette stick. 50 cents or 60 cents, that’s nothing, even in India.
Simon Erickson 25:20
Huge margin. Like 99% margin.
Ramneek Kundra 25:23
It’s 100% ROIC. And regulatory hurdles; I don’t see any company penetrating ITC’s moat. Because the government keeps on increasing these duties on sin stocks like sin products. And from 2013 to 2016, in every budget that India presented in the parliament, they just increase the taxes on cigarettes by 10% to 12%. But ITC is still doing that price hike and is in the process of doing it. So in the next 10 years, you will also see like 10%-11% price hikes. And I’m fine with it. If you’re smoking; if you’re consuming a “sin product”, then pay high for it.
Simon Erickson 26:25
Well it’s the same thing like you mentioned when you’re talking about Altria earlier. I mean, that is the best-performing American stock in the last 50 years. Because it’s just the same “reinvest the dividends, limited competition, undervalued stock, put the money back in.” Just rinse and repeat.
Matt Cochrane 26:44
There was somebody on FinTwit the other day talking about how when you when you go for those best companies in “bad industries”, like with the smoking population declining, you actually can see better returns. Because you’re not attracting competition anymore. You just dominate that market. And even with a slow, steady decline, nobody’s coming in. So the market is all yours.
Simon Erickson 27:09
You nailed it when you said that they are actually a good capital allocator. Matt and I were looking at the ITC annual report before we chatted with you – I mean, all 365 pages of it or whatever it was, it’s huge – but it seems like they are getting a really good bang for their buck for investing in the CPG stuff, the agricultural stuff, paper. I mean, that’s what Altria wants to do. It’s just that it has not done a very good job with it in the last few years.
Ramneek Kundra 27:40
It doesn’t have good management. That’s the problem. ITC’s management is pretty spot on. Their culture is phenomenal. Altria doesn’t think forward, in terms of ESG and all of those things. But this company is really thinking hard about it. So this was all kind of the writing on the wall 10 years ago, when 65% of revenues were from cigarette. They’re like “we’ve got to change that.” Now they’re only 47% of their revenues are from cigarettes and 53% is from CPG business. So two months ago, they acquired a company for $400 million and put some cash to work. Like that’s just pocket change for ITC. For $400 million, they bought a spice company which is the largest spice company I think in West Bengal in India. And they bought it for like 2x sales and ITC itself sells for 4.5x sales.
Simon Erickson 28:45
Ramneek Kundra 28:46
So it’s immediately accretive. So you pay like $400 million or something and your own stock sells for 4x the sales. So you get a double by year-end, even if you don’t integrate very properly.
Simon Erickson 29:07
Great. Well once again, Ramneek Kundra, calling in from New Delhi, India. Our informed opinion of the Indian markets out there. We really appreciate you spending the time here with 7investing.
Ramneek Kundra 29:19
Yeah. Thanks for having me.
Simon Erickson 29:20
Our next guest is Saket Reddy. He is calling from Hyderabad, India. Saket, thanks very much for joining 7investing.
Saket Reddy 29:29
Thanks for the opportunity.
Simon Erickson 29:30
Before we jump into investing in India, could you tell us first a little bit about your background and kind of how you self-describe your own investing style?
Saket Reddy 29:40
Yeah. I’m just a college student right now. I work a lot on cash flows. I mean, a business can generate profits. But in the end, anyone who generates free cash flow is the real king in India. Because, out of the top five hundred companies – like the S&P 500 in the US – here we have the “Nifty 500”, which is called the CNX 500 as well. Here, we have only 50 companies that are able to generate positive free cash flow every year. So it’s very tough for an investor to invest in such companies because they’re either too expensive or they’re either too big to grow.
Saket Reddy 30:25
So I choose only those companies. I filter out every company, only those 50 companies stay. And then, allocate the reinvestment rate, I look at the profitability, and capital allocation is the main part. And I get almost 30 companies to invest in. That’s the proper filter. It’s called growth investing.
Matt Cochrane 30:46
Now Saket, with so few companies producing a positive free cash flow and things like that in India, is that a challenge for investors in India to find new investments?
Saket Reddy 30:58
Yes, it is a challenge. We have a benchmark index called “Nifty 50”. So in that index, only 5 to 10 companies generate free cash flow and earnings haven’t grown in six years. It’s only the top two to three companies that have grown at a CAGR of 10 to 15% in the last 10 years. So it becomes really tough for an investor to choose what to invest in.
Saket Reddy 31:22
So we have to go very deep into all the companies, then we have to select the best companies. Because if you’re an investor, you have to beat India’s deposit rates, because we have a pretty high deposit rate here. We have a deposit rate of 6% to 8% per annum. That is quite high compared to the interest rates in the US, which is almost at 1% or 2%. So we have to beat that. So equity investors always fight with the fixed income that is in India.
Matt Cochrane 31:51
Gotcha. So if that’s the challenge, but then on the other side, you also have a growing GDP. And the India’s overall economy. You also have a growing middle class. So what are some of the opportunities that India presents for investors?
Saket Reddy 32:07
You know, this concept that you’re talking about, it’s very under-penetrated. We have a lot of opportunities here. Insurance is a big opportunity for India. Health insurance and life insurance untapped. There’s only one big player; it is a government owned entity. It’s unlisted. It will be listed in the next two, three years, I guess. It has over 80% market share. But the private guys, as Matt talked about. HDB, the HDFC Bank, their group has HDFC Life Insurance Company. They are the best in the sector. And there are two three other private insurance companies. They’re growing at a brisk pace. Insurance is very under penetrated a lot of people are getting awareness really now in the last two or three years about insurance. That’s one sector.
Saket Reddy 32:52
Another sector is consumption discretionary. You know, ACs/air conditioners, televisions, these are big things. Other than that, one sector I’m focusing on for the next 10 years is asset management. As you see, we have everything on the fixed income side. Equity investment is 1/10th of fixed income investments in India, almost 130 lakh crores, that’s about 10 times the size of the largest listed company in India, the amount of money that’s in fixed income. And now, the deposit rates have fallen two-thirds from the last decade.
Saket Reddy 33:35
So passive index investments are coming now, like the US S&P 500 ETFs. You know: the normal ETFs, the factor ETFs, these are big things. With what BlackRock has done in the US. That’s what I’m eyeing for India. Any company that does it, that will be the biggest wealth creator in the next 10 years. India’s ETF industry has potential to grow 100 times. We are waiting to get it. There is no company that does it so far. We are waiting for interest rates to fall more, so that the fixed income may shift to equities or gold. That’s one sector.
Simon Erickson 34:14
Saket, could you elaborate just a bit more on what you were saying about how people were scared of their deposits getting lost with smaller banks? I know that everyone in India – in fact, probably the vast majority of people in India – are not investing their money. But for those that are able to save money, how are they traditionally doing that today? And how do they think about the stock market?
Saket Reddy 34:37
The stock market is a little inferior in India. People have more of a liking towards fixed income because they’ve got near double digit returns in fixed income. And deposit rates were very high. Also the interest rates were very high. So that’s one thing. Most people are saving into fixed income. They go to bank the deposit and they come off. For anyone who wants to take more risk, they’ll come into mutual funds. mutual funds is a big industry. It’s growing at a very brisk pace, moreso in the high teens. I guess the mutual funds is a big sector but mutual fund managers, the AMC, they haven’t generated index beating returns as well. So mutual funds people are getting away now. They have checked their returns, it’s not satisfactory, they’re coming into direct equities, which is a good thing. But if they go into long stocks, it’s a bad thing.
Saket Reddy 35:34
Then coming to deposits. What happened was we had one big bank that collapsed in 2018. Because our central bank had a risk check done on that bank. And it had given notice to its CEO to resign and stay away from the bank. And the stock price fell 60% in the next few days. Then it was okay and it was stable for the next six to eight months. But then, just before the coronavirus lockdown hit us, the government decided that a government bank would be taking over more stake. And a resolution was done. That was the most of it. No deposit lost any money before. It was only that depositers were actually locked in with their money for some time. No one lost anything. So that was a big hit to the third largest bank, with this at its peak.
Saket Reddy 36:39
So something like what happened to Wirecard pretty recently. But that’s one thing. And we have, instead of these private banks, we have cooperative banks. Which is a pool of people benefiting of a bank. That had one case of a fraud, which happened in the 2010s, that came out in the last year. Their depositors didn’t lose any money, but the central bank had to cap their deposits. They cannot take the entire money back for some time. So it’s all resolved now. That’s the only thing that people are scared of. So they’re migrating into the bigger banks, the safer banks. That’s the thing on deposits.
Simon Erickson 37:22
And could you also speak a little bit more about the Housing for All program that you mentioned earlier? What is that?
Saket Reddy 37:28
Yeah. The Central Government has brought the Housing for All program. It’s divided into many things. It’s like, we give low interest rates to people who want to their own house, or we give capital to people who want to build their own house. Something like that. So a lot of real estate companies in 2014 went up – from 2014 to 2017 – we had a very big bull run in India. They went up. They became multi baggers. But people noticed about their cash flows again, the government was not paying them at the proper times. The same happened with infrastructure companies, the road builders, the factory builders. The government had set up some various policies, good policies for roads or for sea routes. A lot of companies were in contact with the government. Very good things happened. But again, the government failed to pay them on time. And that had an effect on the company’s earnings and the share prices crashed.
Saket Reddy 38:36
So the thing is, I’ll give an example of Netflix. I don’t hold Netflix directly, but I hold Okta. Because Netflix, the subscriber base watches videos or watches TV series. But Okta gives service to these subscription based apps every time the user opens it. That’s how it works for paint companies. Every time you buy a house, the real estate developer develops it only one time. But you paint your house every eight years. You change your furniture every four to five years. You change your tiles every 10 years. So that’s how things work here.
Saket Reddy 39:17
One more thing is that I look at sectors where there is minimal to no government intervention. Because wherever there is government intervention, it’s a little risky to invest in there. Like power. Like telecom. Telecom is a big cash cow. Telecom companies, there are two to three companies only. A big sector, they’ve got everything in favor of them. They’ve got huge cash flows, but the government policies are eating the cash flows. We’re having a Supreme Court case now. We’ll see what happens with that. That decides the fate of the telecom companies.
Matt Cochrane 39:53
Thanks for that great overview, Saket. So we asked all of our guests on this show if they had one stock to recommend in the Indian stock market, what would it be? So what is your pick for that? And what is your pitch to our listeners today?
Saket Reddy 40:13
You might feel bad about that, because I’m speaking about Abbott India, which is listed in the US market as Abbott Labs. Because I’m not giving you a direct overview into an Indian company. So I’m sorry about that. But Abbott is my largest holding in India. People might not be happy with my Abbott India because there’s one thing about India that I want to tell you; it’s a little bit of a risk here.
Saket Reddy 40:40
Abbott India is a subsidiary of Abbott Labs, which is listed in the US. Abbott Labs in the US has two subsidiaries in India, one is listed and one unlisted. The listed company is Abbott India Limited, which deals in pharmaceuticals; that is tablets and consumer health, like hygiene. The unlisted company in India, which is wholly owned by Abbott Labs in the US, deals with consumer health again, but more of multivitamins, more of baby milk powder and all. Now, if you calculate the size of Abbott India Limited listed entity and Abbott Healthcare, which is the unlisted entity, the size of the company is the same. But investors in India are not getting exposure to the unlisted company. That’s a big complaint from some of the investors. But no complaint from me, because I have invested almost 10 to 20% of my exposure in Abbott India to Abbott Labs in the US. So no complaints from my side.
Saket Reddy 41:35
Other than that, the company has high free cash flow. The company reinvests 60% of its profits back into its business every year. It has got a high return on equity. The company has a good return on invested capital of 150 percent. That’s huge. It’s an asset-light model. The company sells tablets, sells vaccines. It does not have its own. I think it has a contract with Novo Nordisk to sell its vaccines. And the top 10 brands of Abbott have a moat in India. The top 10 brands have more than 80% market share. They’re either the sector leader or the number two in that sector. That’s how Abbott India is placed. And it’s growing earnings at mid to high teens. It’s growing profits at almost double digit. And Abbott India, it’s a growing company. It’s got high owner stake holding. And the one thing is that it’s an illiquid stock here because it’s very high priced. And that’s it.
Simon Erickson 42:39
Is health care paid for by the government in India, Saket?
Saket Reddy 42:43
Health care. Yeah. It’s divided into central and state. The government has brought up a big scheme a couple of years ago. So the state looks after most of the people’s health care. But the center has brought up another health scheme as well. One year ago, I guess, that covers most of the healthcare. And today is the independence day for us. So our Prime Minister’s announced a “one nation one health card system” as well. So we have to see how that goes.
Simon Erickson 43:19
Independence Day, by the way. What a day! Well, we really appreciate your perspectives here. Thank you for giving us quite a bit to think about quite a few opportunities over there in India. And we’ll definitely be keeping an eye on Abbott India as well. Saket Reddy, thanks again for joining 7investing.
Saket Reddy 43:39
Yeah. Thank you. Thank you Simon. Thank you, Matt.
Simon Erickson 43:41
Okay, so Matt, this wraps up our two-part series of Investing in India. We heard a lot of great perspectives: from Dhaval, from Ramneek, from Saket. All of these great investors in the Indian market.
Simon Erickson 43:53
Let’s pull together a couple of key takeaways on what we think of everything that we heard. I’ll go first.
Simon Erickson 44:02
It’s very interesting to me, the first key takeaway, is that India’s got some really big bills to pay. You know, this is a country that’s got 1.4 billion people. And we heard from different perspectives of our guests, that they’ve got a federal and also state based health care plans, similar to a Medicare, where the government’s picking up the bill for healthcare spend. They’ve also got a Housing for All initiative, where they’re subsidizing the interest rates or making capital available for people to get into homes across the country. And then we also heard about the de-monetization of paper currencies over there.
Simon Erickson 44:39
So putting all these together, Matt, my first key takeaway is that India’s government is very involved and really looking out for the good of its people. But it’s also going to have to raise a lot of money in tax revenue to be able to pay for all of those bills that it has.
Matt Cochrane 44:52
Absolutely Simon. And I can’t say enough how impressed I was by all three presentations we had over the last two days. My biggest takeaway was not only how large India’s population is, about 1.3 billion people, but also how young it is. Almost half of that 1.3 billion number is under the age of 25. And two thirds are under the age of 35. India’s median age then is under both the US and China, for comparison’s sake. And young people can be a huge boon to an economy. And just to your point, Simon, about rising spending that India will have to do with a young population. They’re on the right side of entitlement spending, that they’ll have to pay for similar programs to Social Security and Medicare like we do in the US. So their young population should be a boon to that economy going forward.
Simon Erickson 45:50
Yeah, no doubt, Matt. Like you just mentioned about those digital initiatives. You’ve got a tech savvy, young population that’s going to bring a lot more revenue to pay for those bills like we said that India’s got.
Simon Erickson 45:59
And then, to wrap this up with a third key takeaway, we heard all of our guests kind of focusing on the larger companies, right? We heard about these Indian conglomerate companies that were founded by these visionary leaders decades ago: Reliance, Tata, ITC. I mean, these are multiple 10s of billions of dollars [in market cap]. HDFC Bank. These are not small companies in India. And the small companies that are publicly traded, a lot of hesitation in investing in those kinds of companies because of the risks that are involved about the numbers not being accounted for accurately or about them being against those really, really large companies in the first place.
Simon Erickson 46:36
I think that this is a market that you probably want to focus on investing in those larger corporations and letting this Indian economy that’s growing at 7% or 8% a year GDP be a rising tide that rises all of those boats.
Matt Cochrane 46:52
Well, that’s a wrap. Ladies and gentlemen, thank you so much for joining us over the past two days to listen to our discussion on Investing in India with us. Again. I’m Matthew Cochrane, lead advisor with 7investing. And we’re here to empower you to invest in your future. Have a great day.
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