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Matthews Asia Sees Indian Opportunities Amid Headwinds

Tom Burroughes, Group Editor , 23 May 2018

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The asset management firm sees opportunities in select areas of the country's market, while it ponders the growth outlook and recent equities setbacks.

Matthews Asia, the investment house, sees opportunities to be picked up in India’s equity market despite some expensive valuations, while the country’s economy faces a few headwinds.

India has moved some way since a package of changes by the government of Najendra Modi, such as the demonetisation measures and Goods and Services Tax. 

Indian equities have sagged: since January, they slumped by of 9.25 per cent, in dollar terms, according to the MSCI India index. By comparison, MSCI Emerging Markets (ex-China) is down just shy of 4 per cent. The MSCI World Index of developed countries’ equities shows returns since January of just 2.21 per cent. 

“Stock valuations appear inflated despite the fact that earnings have been depressed for almost four to five years.  Valuations are currently around 18 times one-year forward consensus earnings, compared with average historical valuations of 15 to 16 times earnings,” Sriyan Pietersz, ASEAN and frontier markets investment strategist at the firm, said. 

“We see heightened volatility in India's equity market over the next couple of quarters as the national elections approach in 2019. Earnings growth expectations for this year (currently at 24 per cent), also appear high, particularly in light of higher provisioning costs for banks in line with new RBI standards,” he said. 

Even so, growth forecasts from the central bank point to a robust economy, but the investment firm said the outlook looked credible. 

“GDP growth expectations for fiscal year 2019 (the year ending March 2019) currently range from 7 per cent to 7.5 per cent. This sounds ambitious, but it can be supported as recent reforms pull informal activity into the formal sector. This year, private consumption is likely to be the main driver, though it will be funded partly by debt, as incomes in urban areas were hit by demonetization and the Goods and Services Tax (GST) while agricultural incomes still remain weak. Minimum support prices for both winter and summer crops should, however, provide some support for private spending,” Pietersz said. 

“Recovery in private investment will be slow. This is because some slack remains in the economy with capacity utilization at 74.1 per cent, well below the threshold that is required to induce substantial fresh investment, and significant nonperforming assets still have to work through the banking system. With the national elections pending in 2019, many expect a meaningful recovery in investment to be visible only in fiscal year 2020. Public investment, meanwhile, is ramping up as the government expedites its priority infrastructure program on highways, railways, and affordable housing,” he continued. 

One risk to such a growth outlook comes from how India pays for its current account deficit, which at present is paid for via foreign direct investment and long-term portfolio flows. Rising external interest rates and higher oil prices could increase reliance on volatile short-term capital, making the domestic economy more vulnerable to global shocks, he continued. 

The firm said that with a relatively slow recovery under way and low credit growth, a rate rise is unlikely until the second half of this year. 

Favoured areas
“As active managers, we seek to buy stocks of companies that we believe have pricing power, which is not limited just to the consumer sector. Consider India's banking sector: If a bank is making small retail loans, it may achieve pricing power because small borrowers cannot dictate terms. Accordingly, we see opportunities in carefully researched retail-focused banks in this sector that concentrate on profitable growth. In contrast, if a bank is doing bulk lending, then borrowers have pricing power as they can shop around to find the best deals. We avoid investing in such banks,” Sunil Asnani, portfolio manager at Matthews Asia, said. 

“By and large, we are looking for an edge either in terms of business model or management focus. Given the kinds of investment risks - macroeconomics, reforms, politics, currency, inflation, deficit, corruption, corporate governance - we believe that active management can help investors avoid a lot of these risks and find stocks that will do well over the long term,” he continued. 

He added: “Relatively depressed sectors such as health care look attractive right now. In addition, companies that exhibit pricing power and are better-governed can be found across diverse sectors such as consumer, pharmaceuticals, financial services and even materials. We are looking for quality companies that have a sustainable economic moat and are run by productive and upright management teams.”

 

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