In light of a spectacular six-month rally in the Indian Rupee and the SENSEX a few topics of concern have been repeatedly coming up in our conversations with fellow investors. We list these topics below and offer our thoughts.
#1: Indian market has rallied too far too fast and the moment of reckoning is nigh
We have absolutely no idea if the market is going to rally further, stop, or make an abrupt U-turn. However, there’s nothing quite that spectacular about this rally. In fact, the beauty of this rally depends largely on the anchor of its beholder.
Use September 2013 as the anchor and you see an unprecedented move. Use January 2013 as the starting point and things suddenly look quite bland. The following chart of BSE Dollex 30 index, the US Dollar linked version of SENSEX, illustrates the point.
In fact, compared to the 32%+ rally in the US markets, India’s 15 month performance looks utterly disappointing. The underperformance is even starker for small and mid cap companies that make up the bulk of our portfolio.
#2: There is no economic justification for this rally
While this is certainly true if one looks at Industrial Production numbers or GDP figures, we think that a good portion of this slowness is due to pre-election caution. Capital Expenditure often comes to a screeching halt before the elections as approvals get more difficult, Election Commission questions every significant policy change and the policy makers are busy politicking.
Moreover, we clearly remember the 2013 sell off being squarely blamed on India’s bulging Current Account Deficit (CAD), rampant inflation and a cornered central bank. CAD is now at four-year lows of 1.2%. Inflation, at 8%, is the lowest it’s been in 25 months. RBI, with its new chief, has presided over some of the most progressive policy decisions in a long time.
#3: The market is pricing in a favorable election outcome that may not materialize
We’d rather not speculate the cumulative decisions of an electorate as vast, complex and diverse as India’s. Polls predict all sorts of outcomes with the common thread being that incumbents have little chance of winning outright.
There is no doubt that a huge opportunity has been squandered by India in the past decade. We don’t know if we should blame the government or the circumstances. However, firing the management team that presided over such horrible performance seems logical to us. The market, perhaps correctly, anticipates a change in governance for the better and has rallied accordingly. We see nothing wrong with this.
Maybe we are naïve but we believe that India’s political and corporate governance will be better in the next decade than the last. Ironically, part of the reason for this is the depths to which our political and corporate system sank in the past few years. Like a typical contrarian investor we see upside from here, though not in a straight-line fashion.
Recent Portfolio Addition
Our mantra remains the same: Invest in great companies at highly discounted prices. Shriram Transport Finance Limited (STFL), a company we recently bought for our portfolio, squarely falls in that category. STFL is the only game in town when it comes to financing used commercial vehicles (CV). Being mobile assets, CVs are quite difficult to value and collateralize. Moreover, the borrower is often a first time small trucker with very little credit history. STFL has been profitably lending in this risky niche for more than two decades with an average ROE of 28%. The company has one of the best NPA ratios in the non-bank finance sector and sources its funds at a cheaper rate than any of its competitors. In fact, several auto lenders have publicly acknowledged their inability to compete with STFL in its niche. It is a model of corporate governance and is run by one of the cleanest management teams in the country. Attrition rate runs around 12-15% with 40% being the industry average. Despite all these virtues the stock was selling at a measly 11x earnings and about 2x book when we bought it. We believe that investors are unreasonably extrapolating the current slump in CV sector into the foreseeable future. Even if there’s no end in sight for the worst CV cycle in decades (something we seriously doubt), STFL will keep earning double digits returns on equity. When we do see a pickup then this stock should trade at least 20x earnings giving us substantial upside. We are getting paid to wait.
In closing, our posture is no different than it was in the previous quarter. We remain cautiously optimistic and firmly believe that we own a portfolio of special companies at special prices. As usual, you will receive your statements from NAV Consulting Inc. Please reach out in case of questions or concerns.
Notes & Letters
A collection of our thoughts, views, and excerpts from our investor letters.