What a difference a quarter makes! The recovery-rally of late 2013 turned into full-blown euphoria in the aftermath of a historic election. While we expected the scale to tip in Modi’s direction, we were surprised by how far it tipped. Such one sided results can have significant economic implications and market has perhaps started discounting some of the positive ones.
The question of the hour has changed from “Will NDA get an absolute majority?” to a longer and more complicated “Will Modi be able to reign in the fiscal deficit yet be able to spend on growth initiatives while keeping the inflation in check as he tries to make sure that he fulfills his social and foreign policy promises?” The answer of course is, unlikely. However, given how dismal things have been for the last few years, any step in the right direction will be a welcome change. The best this government can do is to perhaps get out of the way. Fortunately Modi has shown the propensity to do just that. Eliminating the Empowered Group (EGoM) and consolidating the Prime Ministerial Office were encouraging moves. The rhetoric around retroactive taxation, GST and foreign investments has also been largely positive.
To us, this election appears to be a game changer in two key aspects:
1. Firstly, for the first time in the history of the country, a candidate running largely on an economic platform has won such resounding majority. The make-up of the Indian voter somehow seems changed. We wholeheartedly welcome the change and hope that it’s permanent.
2. Secondly, long-term bullish investors, ourselves included, have lost their favorite excuse. It has been easy to blame the lack of a strong and reform oriented government for India’s recent woes. Well, now we have the verdict we hoped for, i.e., clear majority for a candidate who has the will and the skill to make things work. Obviously, not everything will be fixed (it never is) but if we don’t see meaningful improvement over the next few years then we should just “pack up and go home”.
As optimistic as we are about India’s economic future, our attitude towards macroeconomic events is that of deference. We fully acknowledge their significance yet admit to our utter inability to predict them. Our unit of analysis remains individual businesses and we’re focused on high quality companies selling at substantial discounts to their intrinsic value.
Our portfolio remains similar to last quarter’s except one change. We bought CARE, India’s third largest credit rating company. We have often professed our love for the Indian credit rating business in our letters. The business requires almost no capital and enjoys huge barriers to entry. Moreover, the miniscule Indian corporate bond market at 4% of GDP has significant room to grow making the ratings business a high growth industry here. In our 2013 annual letter we wrote about ICRA, the second largest player and our biggest holding at the time. We also wrote about the possibility of Moody’s increasing their shareholding through a tender. That possibility materialized earlier this year as Moody’s tendered for 24.5% of the outstanding shares. We sold into the tender and subsequently swapped our stake for an equivalent position in CARE.
The business and the economics of CARE are essentially the same as CRISIL and ICRA but it sells at half their valuation. In fact, both its return on capital and historical growth has been the highest in the industry. It’s a cash rich company owned by a few PSU banks that are trying to unload non-core assets to raise capital. We believe that any meaningful ownership transfer in the company will likely result in a public tender. We also expect the valuation gap to close over time. Meanwhile, the company should keep growing its earnings over time. We see multiple ways to win with relatively little downside.
In closing, we believe that quality of Indian businesses will improve substantially in the near future. The market will do its job and express that improved quality through higher valuations like it has done recently. Such rallies make it difficult for us to find the wholesale bargains that we saw in the fall of 2013. However, there are still isolated pockets of undervaluation that look interesting to us. Overall, we remain almost fully invested. Please reach out in case of questions or concerns. As usual, you will receive your statements from NAV Consulting Inc.
Notes & Letters
A collection of our thoughts, views, and excerpts from our investor letters.