18 February 2020 (pre-recorded 16 February 2020)
Below is a transcript of the episode, modified for your reading pleasure. Please check the corresponding audio before quoting in print, as it may contain small errors. Please remember we’ve been discussing individual companies to bring investing to life for you. It’s not a recommendation to buy or sell. The fund may or may not still hold these companies at your time of listening. For more information on the people and ideas in the episode, see the links at the bottom of the post.
[INTRODUCTION]
James Yardley (JY): Hello and welcome to the Investing on the go podcast. I’m James Yardley and today I’m joined by Mithran Sudhir, the Elite Rated manager of the Goldman Sachs India Equity Portfolio fund. Mithran, thank you very much for joining us today.
Mithran Sudhir (MS): Great to be here James, thanks for having me.
[INTERVIEW]
[0:20]
JY: Mithran, so you obviously manage a portfolio of Indian equities. So let’s talk a little bit about the Indian market. It’s been a roller coaster ride last year, India sold off very aggressively, as many markets did with the pandemic, but now it’s bounced back very strongly. Can you tell us a bit about what’s caused that and what you’re seeing on the ground?
MS: There are three key reasons why that rebound was that strong.
Firstly, I mean, bear in mind, India went into a fairly severe lockdown at the back end of March and that continued through most of the summer. I think the first point I was going to make was just on economic recovery and the second half of the year, as basically new cases and active cases have fallen by about 90 odd per cent since the peak that we saw in mid-September. The recovery rate has been quite healthy and the fatality rates are much lower than global average. And you can blame it on the weather, the kind of average age being meaningfully lower than the rest of the world, or just some kind of natural immunity. But I think the end product of that is clearly that the fatality rates are meaningfully lower. And I think that’s one of the reasons for optimism.
[2:00]
The second is also just the positive news flow around vaccine rollout has clearly boosted investor confidence and especially on the recovery side of things, as that lockdown was lifted in at the end of the second quarter, you basically have industrial activity at this point back to pre COVID levels. If you were to look at automobiles, electricity, steel consumption, cement, and kind of some high-frequency indicators. Services side I think is probably less positive, but still, we’re about 10% off from kind of pre COVID level. So I think that’s one key reason the economy opened up much more aggressively than most people would have anticipated.
The second one I think was just on the government support and policy side of things. Clearly India’s fiscal stimulus was nowhere close to the rest of the world, but you’ve probably seen somewhere in the 12% of GDP degree level of fiscal stimulus, which are a little more, it’s a little more measured, but also better targeted than previous episodes that we’ve seen, where we’ve had some degree of direct transfers into bank accounts. You’ve had kind of transfer, of [inaudible] credit guarantees for various kinds of SME businesses and so on, which have obviously been quite helpful.
The central bank also, due credit, has ensured that there’s adequate liquidity in the system, that there are a host of other measures around lowering policy rates, six month loan moratorium for [inaudible] from [inaudible] kind of classification and so on. So I think that’s the second key reason.
The third one. And I think we can discuss this in much greater detail, which is the government using COVID as an opportunity to pass some of those significant reform agenda items that most investors would have desired over that timeframe. And kind of the Churchillian quote comes to mind where “never let a good crisis go to waste.”
[3:30]
JY: Yeah. Well tell us a little bit more about those reforms because we always hear how reform is famously difficult to achieve in India. So…
MS: Yeah, absolutely. I’d say the first point here is just the backdrop is helpful – obviously in 2019, the government came back to bar with an even stronger majority than in 2014. So they’re obviously in a comfortable place from that perspective. And at least we know there’s policy visibility, at least for the next five years.
I’d say post pandemic, the reforms have basically been in kind of four key buckets. The first was this deregulation and rationalisation of labour laws. There were 24 different labour codes that needed to be adhered to. And I mean, the joke on the street was that you couldn’t adhere to one of them without breaking another one of those rules. So I think realistically, this was quite challenging for a lot of businesses.
The fact that these were streamlined to just five labour codes, the fact that you don’t have to go and kind of queue up and wait for approvals for hiring and firing individuals, if you were more than, the thresholds have now been increased. And as well as, there’s a bit of an automated kind of approval methodology, where unless you hear back on your application, it’s assumed that your application has gone through, which I think just puts the onus of approval or rejection on the bureaucracy as opposed to on the company that that could be waiting indefinitely. So just those kinds of small tweaks have been quite significant and labour unions as well. I mean, there was a point where, I think the poster child example for this would be where one of our auto companies was having to negotiate with 20 plus labour unions at one point, famously, clearly I don’t think those kinds of situations are likely to occur in future because the onus is on the labour unions now to identify one representative voice and the management has to negotiate with one labour union. So I think those kinds of measures on the labour side were clearly quite significant and they’re already in place.
[5:41]
The second one I think is a little more contentious is for the farm reforms. And I’m sure you’ve seen some of those protests that are happening right now.
Just maybe a step back to look at what the reforms were actually were. The reforms basically targeted a couple of key aspects. One was just the categorisation of essential commodities, a broad range of goods basically meant that investing in and storing some of these commodities beyond kind of very low limits was deemed illegal and kind of punished with jail time. Which obviously prohibited investments in cold storage, prohibited investments in kind of those logistics facilities and so on because clearly, and also prohibited to kind of contract farming, and those kinds of initiatives.
The second point here is also farmers were restricted in terms of who they could sell to – most of these sales would happen through regulated agriculture or market produce, marketing commissions and obviously these institutions then had monopolies. These intermediaries would have monopolies. I think that that’s kind of reduced the scope for farmers to go out and sell more broadly, sell directly to corporates, supermarket chains and so on, like you’ve seen in most other parts of the world.
So look, that’s where the, those, I think both of those are significant positives where instead of having a small chunk of intermediaries kind of eat up a lot of that profitability. I do think that this can now, both farmers and consumers can benefit from being able to go through other channels as opposed to just this narrow distribution channel. But yeah, I think ultimately our view is that the protests they’re really only happening in a couple of major States out of the 29 States in India. So clearly in vast majority of the, of the land, it’s still seen to be fairly acceptable.
You’d probably end up with kind of some degree of additional subsidies for the dissenting voices or kind of options to opt out of the reform itself at the individual state level in order to make it a little more palatable to the dissenting voices. But ultimately I would think of this as being fairly well entrenched.
[8:10]
I think the final point I wanted to mention just on the reform side to round the discussion off, would be on the manufacturing side of things where there’s probably been the most amount of movement.
Basically, the plan here is to give out 4% to 6% of the value of the goods manufactured in India as a subsidy to attract a lot of international manufacturing and promote that “Make In India” initiative. To give you a sense of scale, India used to be from an import perspective, India’s biggest import was obviously co-accrued, but the second biggest head would be under consumer electronics. Last year was a watershed moment for India, where we went from a commodity, from a kind of consumer electronics net importer to actually a small net export, which gives you a sense of that domestic manufacturing capability coming through.
Clearly you’ve seen your Apple supply chain and kind of other Android makers move into to kind of diversify their production based out of China, especially as you’ve seen with the pandemic or just tariffs and other trade tensions. It became quite apparent that there was a fair amount of consolidation and concentration of risk in global manufacturing in China, and India is offering these initiatives at a point where there is both a push and a pull factor, India trying to attract this, but also companies proactively trying to diversify. So just from a timing perspective, I think this could be quite interesting. And clearly we’ve seen the success on the smartphone side and now that’s expanding into other segments, as I mentioned.
[9:50]
JY: And much is made of the rising Indian middle class. Is that a theme which you’re playing in your portfolio?
MS: Yeah, no, absolutely. I think there are a couple of major shifts that we’ve seen in kind of consumption patterns. First and foremost, let’s recognise India’s got a 1.3 billion person population. Within that, if you were to pull out millennials, almost a third of that would be millennials. So clearly young individuals who are entering their prime consumption years. As you have established you know, when people go from a lower income threshold into upper middle and upper income thresholds, that’s when the kind of amount of money spent on discretionary consumption tends to be the highest. When you go from a middle to upper, for instance, that’s probably when you’re investing in houses or your stock market and kind of other, your second home and so on.
The second point I think I wanted to make was just in terms of the consumption kind of patterns of these millennials, there’s clearly a lot of online consumption that has picked up quite meaningfully. So if I were to look at, let’s say some key product categories where air travel, for instance, 40% of that is booked online. Online payments as kind of non-cash transactions are now reaching up to 30%, advertisements about 20 odd percent already in paid-for online, hotel bookings 20%, e-commerce on the other hand is only 5% of retail transactions are e-commerce and similar levels for food services and groceries. So that gives you a sense of how under-penetrated some categories are. And if you were to compare this with China on all of those India’s at least it’s kind of half the penetration levels as China is. And I think kind of similar, maybe even slightly kind of higher levels against developed markets. So that kind of gives you a sense of how the evolution of this is going to be. And I think the second piece of the puzzle for that to converge is really on kind of mobile phone smartphone penetration and internet penetration.
And on that trend, I think it’s a great story because clearly India has one of the cheapest call and data rates in the world. And mobile usage, mobile data usage per user in India, is something like 15 GB a month, compared to let’s say China at about 8.5 GB a month, or maybe closer to home the UK at, let’s say about 4 gigabytes a month. So, I mean, the average Indian on their mobile phone consumes three and a half times as much data as the average Brit. That should kind of give you a sense I think a lot of this is really a function of how cheap data rates are, but also how people use their phones. This is for most people, their primary means of accessing the internet as opposed to, and not through their laptops or through their televisions and so on. Most of this is through smartphones and hence as smartphone penetration picks up, we still have half a billion feature phones. We clearly will evolve over time as smartphone penetration increases and does away with the feature phone kind of category, which then would also result in additional data usage and additional penetration of each of those categories that I spoke about. So clearly that’s a segment we’re quite excited about and own a fair amount of companies in those segments, that should benefit from these themes.
[13:36]
JY: Very interesting, and just finally, is India getting involved in the decarbonised world?
MS: Again, I think that’s of particular interest and very topical for kind of our client base here in Europe. What prompted this question within emerging markets last year was clearly kind of China’s big move to announce its carbon-neutrality pledge by 2060, and kind of these, put in place these five-year targets and then clearly kind of measure on each of those aspects.
India I think it’s fair to say is at a much earlier stage, but there’s no kind of necessary target on carbon neutrality yet, but I think they’ve made a lot of progress and other kind of key parameters. So if let’s say you were to look at today coal still accounts for about 50%, more than 50% of India’s installed capacity of electricity generation, but it is already a market leader compared to other countries on renewable goals, for instance, where greater than 30%, 35% of installed capacity is actually in kind of the renewable space.
The second point I’d make is kind of according to the direction of travel, according to kind of India’s Paris Climate Accord commitment, we’re expecting 55% to 60% of energy use by 2030 to come from renewable. So clearly that’s kind of a meaningful move up.
I think the third point I’d make is probably on the more near-term perspective in terms of renewables. You’ve seen wind capacity quadruple, solar energy kind of capacity has increased 10 fold in the last five years alone. So clearly there are significant kind of state level initiatives that are helping this. Take more recently you’ve seen the tax levied on coal increased quite meaningfully over the last, let’s say four or five years, you have seen a corresponding subsidy for wind and solar companies in order to get them off the ground and encourage adoption of those technologies.
EV, I think India is probably going to be, at least we’ve got ambitious targets, but as of today, we’re still kind of lagging something like a China, which has got about 5% to 7% of EV penetration already. India is I think at a much slower pace. Where we’ve seen progress is clearly on kind of commercial vehicles like public buses and those kinds of tenders are clearly going in the electric direction. But clearly that initial outlay, the charging infrastructure and just information in consumer minds are hurdles for EV. But even on that, the government does have a target now of being 100% electric vehicle economy by as recent as 2030, again, it remains to be seen. For those I think you do need to see these big hurdles kind of being overcome, but I think the headline comment would still be India is making good strides in the right direction. And I’m sure in the next couple of years you should see headline kind of targets on carbon neutrality and so on come through as well, like most other developed countries.
JY: Brilliant. Well, Mithran thank you very much for joining us today. That’s been very interesting. And if you’d like to learn more about the Goldman Sachs India Equity Portfolio fund, please visit fundcalibre.com and please also remember to subscribe to the Investing on the go podcast.
