Strong Growth Potential Trumps India’s High Valuations: Aberdeen

Officials walks out of an ICICI Bank branch in New Delhi. (Photographer: Amit Bhargava/Bloomberg News)

Written by
Agam Vakil
Written by

Agam Vakil

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Expensive valuations in India is a cause for concern only in the short term, and that too for shorter-term investors, Hugh Young, managing director of Aberdeen Asset Management Asia said on Thank God It's Friday.

While India may be the most richly-valued market in Asia, its strong growth potential will make these valuations appear irrelevant over time, he added.

Here are edited excerpts from the conversation.

Indian benchmark indices in the last week surpassed Japan's as the most expensive in Asian markets. How do you read valuations in India?

Yes. You are right. It has been largely a revaluation in India rather than strong earnings growth coming through. Way back into last year and before, we found India to be one of the most expensive markets within the region. From our time horizons – we look at 5-10 years – we think today's expensive stocks will appear irrelevant because the growth potential is so large still. But short term, it is a cause for concern, for shorter-term investors, not so much for us. We being fundamental investors prefer to buy good companies, which India has, as cheaply as possible. As far as valuations are concerned, you can't argue that they are cheap just looking ahead at one year's earnings or two years' earnings.

Your funds have held the likes of HDFC Bank, Kotak Mahindra Bank, as well as ICICI Bank for quite some time now. There has been a little bit of reduction in ICICI Bank specifically. Do you have any concerns on private banks in India?

Of the banks you mentioned, HDFC Bank, Kotak Mahindra and ICICI Bank, ICICI is the weaker of the three. Where we have outflows, we have probably taken money from ICICI and held on to HDFC Bank and Kotak both of which are stronger fundamentally than ICICI. Of course, we like all three, and in part, their related strengths are reflected in valuations with HDFC Bank and Kotak being more expensive in terms of price-to-book.

There are several concerns with regards to the U.S. Congress, especially on Bills related to immigration which may make things difficult for the information technology sector in India. There has been little change in your holdings in stocks such as TCS, Infosys and Cognizant. You are not perturbed?

I don't think we are too perturbed. Yes, we do hold Infosys and TCS. I would say we are concerned because the industry is changing. The dramatic growth that we saw 10-20 years ago is certainly over. The companies are maturing, the business is having to shift focus as well. It's a less exciting future but there are clearly companies where India excels and there is still some growth. But it's just not going to be the rates of growth that we have seen in the past. And that's also reflected in the ratings.

How would you read Reliance Jio's impact on incumbent players? Will those who have invested in these telecommunication companies have to wait a lot longer before they see substantial returns? If your view is favourable towards the sector, would you consider buying into some other companies as well?

It's a sector where we are relatively tighter. We have held Bharti for quite a while. It's been a bumpy ride with the price competition we are seeing from Reliance Jio. That's made it very tough. It has had a damaging effect on short-term profitability. It's a powerful sector be in. We expanded our holdings in Infratel a year or two ago. But it's not a sector we have got massive weight into.

Consumer companies like HUL and ITC have traditionally traded at a premium to other sectors. When would you be really concerned about valuations because growth in these companies hasn't been great. But a lot of that has to do with the economy.

The broader point, even beyond the consumer stocks, is that we haven't yet seen a sharp rate of growth broadly across the markets in terms of earnings per share and certainly in consumer stocks, in particular, where ratings can be up in the mid 30s price earnings ratios. You need those earnings to come through to justify them. So, although the portfolio that Unilever has, or an ITC has is very strong, so far the growth has not been coming through strongly as we would like to see. So, a lot is in the price for future growth. We still think that's possible. But again you need to be patient investors and we are certainly patient with our holding horizons.

What we have noticed is an absence of stocks in the industrial metals and oil sector. There is a resurgence in commodity-based companies and by that, I mean materials and oil and gas marketing and distribution companies. Would you consider allocating funds to these stocks and sectors or would you stay away?

Technically, those are sectors we tend to avoid. They are highly cyclical and commoditised. Where we have had far more cyclical exposure has been in the cement sector. It's where we are fairly heavy. For us that is a longer-term India's broad infrastructure spend. The stocks you earlier mentioned are something we'd avoid.

With the implementation of Goods and Services Tax regime almost out of the way, what are the reforms that you would like to see in India?

Not so much as reform as much as business operating smoothly and efficiently. India has gotten better and GST is a big step in the right direction. It is a matter of less regulation and less red tape, making things simple, accessible whether it be bank accounts, various permits etc. Not necessarily dramatic big scale reforms but just the efficiency of the systems like courts and legislation that would include all sectors in the government.