Most evidence from research on financial markets suggests a lack of correlation between economic growth and equity returns. Indian markets supported this hypothesis well in calendar 2012. While most emerging economic data pointed to a continuous deterioration, equity markets continued to rise. This was accentuated after September 2012 when the government began to demonstrate political will and re-initiated the stalled reforms process. In December 2011, most people would have forecast a negative return for the coming year. Instead, we are looking at 25% gains for CY12, driven by FII inflows, even as domestic investors have been cashing out. Corporate profitability through 2012 has been substantially low with a stubborn, high interest rate regime. But the markets seem to ignoring all the facts. Stock markets tend to discount the future and FII behaviour seems to be reflecting that.
Going into 2013, a favourable macro compared to 2012 with a receding interest rate environment could help India Inc. This will especially help infrastructure and power companies. If earning growth returns, a re-rating of price-earning multiples from current levels could well be in the offing in 2013. Also, if earning growth does return, India will become a more compelling investment destination for foreigner investors compared with other emerging markets.
Financial markets, however, tend to dislike uncertainty and if there is turmoil on the political front due to the longevity of the government being put to risk or a populist Budget, there could be significant risks to the above stated positives.
Our approach is to invest in quality companies that have consistent profitability and are available at an attractive valuation. We tend to buy companies that are in the highest quintiles and sell those in the lowest quintiles on a price-to-book versus return on equity scatter plot. A consistent application of this approach, almost like any approach, we believe, will result in dependable, process-driven outcomes.
In this context, we like names such as Torrent Pharmaceutical and Balkrishna Industries; both are leading companies in their respective areas with reasonable return on equity history and trading at attractive valuations.
Torrent Pharma is a leading pharmaceutical player, part of the Torrent group with a strong balance sheet and strong cash generation. The company has a good focus on the domestic business and is an early mover in Brazil, a large, important LatAm market. It has also expanded its footprint in other key markets in Latin America such as Mexico and other emerging markets including Thailand and the Philippines in branded generic products. Torrent’s products cater to most therapeutic areas and saddle both acute and chronic therapies in domestic and emerging markets. A key risk is its late entry into the US market or a slowdown in the domestic pharma market.
Balkrishna Industries caters to the off-highway tyre markets in the US and Europe. Off-highway tyres is a niche market with growing demand and few players, thus making it a compelling investment case. Global mining and infrastructure investments tend to drive growth in off-highway tyre sales. However, for Balkrishna, agriculture is a key driver for growth. The company has a presence in the replacement market, which is not exposed to the price pressures of OEMs and enjoys better margins. The key entry barriers are a large number of SKUs and distribution system, both of which the company has established. The company derives over 90% of its revenues from supplies to over 100 countries including the US and in Europe.
As the famous investor Arnold Van de Berg said, “If you feel good about buying stocks, you may not be buying bargains. If you have sweaty palms then you have bargains and that’s the time to buy.” Some names may perhaps qualify for inclusion in the sweaty palm category today but could well be winners in 2013.