India's Weightage In Global Indices Can Expand Further, Says Macquarie Capital's Aditya Suresh

Aditya Suresh: I think, the backdrop is still fairly constructive. When you think about India’s growth outlook, thematics which are at play, India is still one of the larger emerging markets which can actually grow labour, capital, factor productivity and it is something which you can kind of get behind as a theme over let's say, a decade. There's a bunch of work which you've done around this with a big group of friends. So I think the thematic backdrop and the growth kind of backdrop is clearly something which attracts investors. I mean, this is priced in, I guess. The second part of that piece, and it's kind of where we kind of have more challenges answering that question in particular, in that six-month to 12-month window in the short term. That's one side of the equation.

But then like, even when I think about it as you are putting up on the chart here, which is India within emerging markets, our share continues to increase. Today we're about 18% of emerging markets, while China has come down from 40% to 25%. If you kind of push and ask a little bit, what do you think India’s weightage could expand to over the next couple of years, we are more on the camp that it further expands even with these rich kind of valuation backdrop. So I think it is this thematic undertone though, which is a very key support factor here for India as a market. You have not seen that in the flows in Jan. and Feb. but you did see that through last year where we saw about $20 billion worth of inflow, even with these high valuations.

Aditya Suresh: I think that there is an element of that, when you're kind of getting into these investment committee kind of meetings. There's probably like, let's get this kind of hurdle formally crossed out before allocating incremental dollars to India. Maybe that's at play here as well. That would be a consideration.

Aditya Suresh: I think it's just an ongoing recognition of the theme that India's weightage in all these indicies is set to further rise and therefore, how do we position, where do we position, it's kind of more of a conversation rather than anything else. So I think it is more about what do we do with this kind of increasing allocation and kind of valuations, what's baked in across earnings, etc. That becomes where the conversations tend to flow. But I think all these are clearly very big policy support factors here. It also clearly impacts the rupee perspective and therefore, in terms of dollar returns, all these index inclusions and these natural dollars coming in, it helps overall dollar returns as well.

Aditya Suresh: We did do that a couple of weeks back, but the main message was that in terms of the top down, we actually struggle a lot to defend empirically and kind of fundamentally why India is trading, where it is trading.

So when you think about fundamentals, if you can break down this kind of multiple as three parts, in simplistic terms, it is EPS growth, ROE and cost of capital. Whilst it is true to say maybe 12 months back, maybe four months back, we had a very large EPS growth premium compared to emerging markets, what you'll notice in the broader backdrop is that after fairly sharp cuts in terms of emerging market expectations whether it be Korea, China, all these markets, we need to put EPS growth to the expectations, emerging markets about 15%, India about 15%, so that relative growth premium in itself is not really a support factor.

What is the support factor—simply that India can see estimates being revised upward, and there's more visibility and quality of earnings, but growth premium itself is barely in line. So it actually is going to work against multiple if it is purely on that factor.

Similarly, return and equity as a factor is barely in line. So our 300 basis points kind of premium to emerging markets is not really explained why our premium multiple is now close to about three standard deviation above normal.

So I think the crux of the story remains about liquidity dynamics and we started off with foreign liquidity, and that so far this year has been a mild negative factor. But then domestic liquidity continues to be surprisingly positive and so to that extent, for us where we are is really a function of the liquidity conditions here in the marketplace and where we end up by in say 12 months to 18 months, for me, it is going to be a function of what's happening to domestic liquidity. If domestic liquidity can sustain at this kind of $2.2-2.3 billion kind of natural inflow, which we're seeing, clearly that support we have from markets but whether it be the SEBI actions or RBI, etc, if that leads to a tightening of liquidity conditions, that then would point to downside to markets because as I say, purely on fundamentals, EPS growth, return on equity, etc., we are stretched as a market. And that stretch kind of comment is coming on expectations, which are already elevated across all the different sectors that we're looking at.

Earnings growth in itself—the relative growth—is merely in line. It is not a support factor for multiple.

Aditya Suresh: This is also a hard question because 12 months back, or 24 months back when we had these discussions, we might have made a comment along the lines of—if earnings is kind of where we’re going to allocate so on and so forth, that financials is a sector where you see earnings, upgrade risks. Industrials similar comment, where there's upside to earnings estimates is what we kind of argued for. Similarly, with autos as well. But now when you kind of look at where earnings estimates are at, I don't have that comment for you.

So when you kind of look at financials as a sector and what's taken to consensus expectations, there's a fairly sharp kind of uplift in earnings expectations for fiscal 2025 to 2026 at the margin rate. When you kind of speak to our financial team, they will speak about whether it be kind of growth normalisation, credit costs being as good as it gets, margin compression. So even with financials, while we are seeing kind of decent numbers, we are still seeing cuts there.

Industrials again, a lot of the kind of the large order backlogs is only in estimates. So the broader point about that whilst 12-18 months back, it was easier to give you a comment about earnings upside in certain sectors and that being a proxy for where to allocate, when I can zoom out and look at what's already baked into estimates across all the different sectors, I'm not seeing clearly which areas you can see upside to numbers.

So then, the layer below this is what we do therefore. We got to kind of allocate Rs. 100 across India. It then kind of comes down to the bottom-up and very selective ideas. So I don't have that generic sector-level comment to give you here today. It was easier to do this, maybe as I say, two years back. But as we sit here today, I think it's very, very selective, focused, kind of incremental earnings with confidence there. Those are some of the considerations.

Aditya Suresh: You know, just to kind of add to the previous comment as well on this kind of EV policy and potential implications, etc. So when you kind of look at auto as a sector and India's share of global trade within automobiles, up until 2015, we were making kind of steady gains and then over the past 7-8 years, we've been basically flatlined. So we have really lost out, in terms of further market share gains. So any of these type policies and a lot of it has to be tied back to the fact that we have not made much progress in the EV space. So to the extent that we are going to be looking to kind of address that, then maybe we can be back again on the path of capturing global market share.

But it has been a bit of an area of underperformance for me in terms of India's capture of global market share, because they have not developed an ecosystem. So all these policies and measures which are kind of pushing to encourage local ecosystem, I think, we are fairly constructive on this. We are constructive on manufacturing, in general as a theme. And areas within these with existing ecosystems, whether it be pharma or autos, etc. stand out, but I would just call out that these sectors have really not captured incremental share in the past a few years. Auto ancillaries, I think would be really interesting.

Aditya Suresh: Yes, just on the first point on pharma in India’s share of global pharma trade, we are actually flatlined. In fact, most recently, we went down a bit despite the expectation, let's say two or three years back that because of what's happening in China, we've seen Indian pharma continue to kind of gain global market share, in particular in API. Frankly, that’s not yet happened. So within our coverage, we actually do like some of the larger traditional pharma companies, which are now kind of expanding their specialty chemicals kind of portfolio. That's going to be our preferences.

I think CDMOs are an interesting opportunity. It ties back to what I was trying to get at when you think about the global phrma trade. China's well above India, or China is above India, and if you were going to close that gap, it will be in that CDMO space and that could be interesting, but it's not yet kind of playing out in estimates.

Within the hospitals and diagnostic space, our analyst is less optimistic. I think thematically, it is a really interesting space to be positioned in, but when you can tie the thematic back to numbers and supply demand pricing, we are less constructive there.

Aditya Suresh: Thematically, I think the main point is about scaling local manufacturing. So local manufacturing to GDP is about 15%. The aspiration is that when we're 25. When you look at the kind of investment intentions in areas like electronics and machinery and when you scale this compared to intentions over the past 8-10 years, we are materially up. So when you think about electronics and machinery, investment intentions in those spaces is almost tenfold what has been announced in those sectors in the past 10 years. So that's kind of where we're seeing a lot of kind of incremental investment intentions that then translates into capex and then kind of potentially into kind of return accretive kind of growth over time. Other areas, we're not seeing that as clearly. So as I say, even within areas like autos, etc, it's not at sector-level that we are seeing that trend, kind of specifically play out.

Renewables is an area, where we are seeing investments being made. Intentions are high. There's a stronger thematic backdrop, there is strong government push towards incentivizing that sector as well. But we still have question marks around the unit economics and does this work at scale, in a returns accretive manner. So I think that that needs to be derisked. We don't have a strong conviction view that this is going to generate strong returns, despite the kind of high capex kind of going into that space. Those are some of the thoughts around this, but I think electronics and machinery is really leading in terms of where investment intentions are at.

Aditya Suresh: I think it's really, really selective. And you're correct that these spot multiples look really punchy. I think where you are seeing buying coming in incrementally, as you started the call as well. So India is a market you're seeing at least for the past couple of months. Foreigners have been reducing their exposure here, at a market level. Within that, when you think about say small midcaps where a lot of these manufacturing companies are, valuations are further kind of elevated, so on so forth, and some of this is more on the narrative and thematic rather than being on the tie back to fundamentals and numbers. So, where the tie back is not there, I think that's kind of largely kind of a no-go zone, at least today. But I think it's about getting confidence in that 10-year growth story and therefore, even if my current point was against the 60–70 times, if I'm fairly comfortable that this multiple can kind of collapse to 15 times, 20 times in that medium term time period, that's still potentially interesting. But it's a very selective comment. It's not an enmasse buy manufacturing because it's a strong theme.

Aditya Suresh: It's a tough market. We are trying to navigate this space, and we'd love to kind of engage more.