The Road Ahead for Indian Equities
- Details
- Category: Global Perspectives
- Published on Tuesday, 21 February 2012 11:03
- Written by World Money Analyst
After many months of work, we're proud to announce the launch of a brand new IM service, The World Money Analyst.
It is our admittedly lofty goal to have it become the world's single best source of in-depth investor intelligence from a global perspective. To do that, we have assembled a geographically diverse team of exceptional individuals to share their expertise - whether it be India or Italy, global commodities or currency opportunities.
Below is an article by our on-the-ground Indian correspondent Shan Nagasundaram that was scheduled to appear in our first issue. It contains a specific recommendation for a jewelry company that is traded on the National Stock Exchange of India (accessible by any good international brokerage service, one of which we also cover in the inaugural issue and available to American clients).
Unfortunately, as sometimes can happen, the stock got away from us before release, jumping more than 18% in the past 3 weeks alone.
As we're not one to chase a good deal, Shan is hard at work identifying other opportunities in his area of expertise.
The Road Ahead for Indian Equities
By Shanmuganathan "Shan" Nagasundaram
[Courtesy of the World Money Analyst]
Like most global markets, the past 10-year performance of Indian equity markets shows two distinct phases: 2001-2007 when stock prices made spectacular gains of nearly 400% (from 4,000 to 20,000); and post-global financial crash, 2008-2011. After collapsing from over 20,000 to 9,500, the Sensex rebounded and since mid-2009 has fluctuated largely within a narrow band between 15,000 to 20,000. From a bigger picture perspective, when measuring the Sensex in gold grams we find that it traded for the equivalent of 11 gold grams in 2001, but today stands at just 6 grams, wiping out more than a decade of gains in rupee terms.
With that little bit of history, let's take a look at what the future may hold. Though the Reserve Bank of India (RBI; the Indian central bank) has embarked on a series of 9 rate hikes in the last 20 months, on a fundamental basis, the monetary policy continues to be loose with negative interest rates and M3 growth at substantially high levels.
For reasons that I will quickly explain, I believe it is this loose monetary policy that will drive Indian markets going forward.
In Jens O. Parsson's book, "Dying of Money," he observed,
Everyone loves an early inflation. The effects at the beginning of inflation are all good. There is steepened money expansion, rising government spending, increased government budget deficits, booming stock markets, and spectacular prosperity, all in the midst of temporary stable prices. Everyone benefits, and no one pays.
True to Parsson's observations, the Indian government had embarked on grandiose socialist programs and farm debt write-offs leading to massive fiscal deficits that necessitated an inflationary policy. A good example of a socialistic intervention would be the Mahatma Gandhi National Rural Employment Guarantee Act that obliged the government to provide 100 days of minimum wage work to every rural household that needed it. As a result, M3 grew at a 20% compounded annual growth rate (CAGR) for the period 2001-08, but as with all cycles of inflation, the effects in terms of consumer prices was benign in the initial period.
Though the Indian stock market retreat started with the global credit crisis of 2008, it continues to stumble well after the event. Consumer price increases, meanwhile, have reached double-digits, and the RBI has been forced to undertake tightening measures. However, despite a series of rate hikes, M3 growth rates at 16% could only mean continued inflationary pressures. The reckless fiscal profligacy of the central ("Right to Food", "Right to Work" programs, etc.) and state (the freebie culture) governments isn't exactly helping the RBI's cause either.
Whether the RBI continues its rate hikes or takes a pause is a matter of speculation. Given the rather dismal understanding of economics by our policymakers (attributing inflation to GDP growth), and the clamouring by industry at large, we shouldn't be surprised with an extended pause or even a cut. The dubious central banking practise of measuring inflation by the diffused effects (i.e., consumer prices) that are subject to seasonal and cyclical fluctuations, rather than by the objective causative factors (i.e., increase in money supply), can provide the RBI with the needed justification, however flawed it may be. But sooner rather than later, the effect of the high growth in money supply will lead to spiraling prices, and the hikes have to resume.
Forecasts
As with other cycles of inflation, it will take time before the RBI gets ahead of the curve -after all, they can always attribute the higher food prices to floods/droughts, and energy prices to greedy oil multinationals/speculators/middle-east politics. Given the RBI's continued loose monetary policies, there is every reason to believe that Parsson would be right about the subsequent stages of an inflation cycle. As he has said,
... the latter effects (of inflating the money supply) patiently wait. In the terminal inflation, there is faltering prosperity, tightness of money, falling stock prices, rising taxes, still larger government deficits, and still soaring money expansion, now accompanied by soaring prices and the ineffectiveness of all traditional remedies. Everyone pays and no one benefits.
The Indian economy faces years of payback. Yet in nominal terms, the RBI's continued inflationary policies should keep the Sensex hovering in the 15,000 to 20,000 range. Measured in gold grams, though, the Sensex would lose substantially in the next few years. The bright spot, if there is one, is that the problems faced by the Indian economy are nowhere close to the politically unsolvable ones faced by the US economy. So India might indeed attract a lot of capital that wants to flee inflation-threatened dollar-denominated assets. This could send the Sensex much higher than 20,000. Yet under that scenario, gold prices would skyrocket and the Sensex priced in gold has nowhere to go but down.
A Retail Play on Rising Gold Prices
Gold has played a central role in India's history, both in its cultural traditions as well as in finance, commerce and wealth preservation. As inflation pressures continue to press against the Indian consumer, we see no reason for gold's role to change. One way to play India's growing demand for gold is in a regional retail jewelry company.
Thangamayil Jewellery Ltd
www.thangamayil.com
Gold Jewellery Retailer
Exchange: National Stock Exchange of India
Symbol: THANGAMAYL
Price: Rs.145.00 (as of Jan 16, 2012)
MCap: Rs.2,100 Mn (US$44M)
P/E: 7 Dividend Yield: 3.3%
Thangamayil Jewellery Ltd (TJL) is a leading jewellery retailer that operates in Tamil Nadu, a high gold-consuming state that, together with the state of Kerala, accounts for nearly 30% of retail gold jewellery sales in India. TJL has targeted the underserved semi-urban and rural towns in Tamil Nadu to achieve scale and profitability.
In business since 1984, it operated as a single-location store for years. The company was taken public in 2010 and has expanded judiciously to 14 stores today, with plans to reach 18 stores by FY 13.
Sales and net income have recorded more than a 50% CAGR during FY08 to FY11 due to a combination of increasing gold prices (which made gold an attractive investment option), higher unit sales per store, and increased geographical reach. For the same reasons, we think TJL could grow its revenue and EPS at a 30% CAGR for the next 3-5 years.
Sales would also be driven by a greater preference towards the "branded jewellery" segment by the increasingly "gold purity" conscious consumers. A recent government ruling making "hallmarking" of gold mandatory by gold retailers would also accelerate this transition towards the organized sector of gold retailers, as it will render the smaller players uncompetitive.
Recommendation
TJL is a low-risk business with good returns on equity (> 30%) and substantial growth potential. Valuations are very attractive with a reasonable dividend yield (6.0% expected for 2012). Investors can consider purchasing shares of TJL at the market for a target share price of Rs.350 by April 2013 (assuming the current P/E of 7 for FY13 with an expected EPS of Rs.50).
The principal concern would arise from a situation of declining gold prices. The gold inventory maintained at branches as well as for manufacturing is exposed to a valuation risk in the event of a sustained fall in gold prices. This could affect the company's margins and its sales growth. While we do not view this as a very probable scenario, nevertheless, investors would need to watch out for any steep and protracted correction in gold prices.
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