Phases Of Value Creation In India

Arun Gopalan VP – Research & Investments Systematix Shares

Long-term Wealth Creation calls for selecting the right sectors to remain invested in for the right duration of time, even as the fundamental tenets of diversification and long term holding remain inviolate. Prudence pays.

Value Creation” is a fundamental feature of equity investing and tends to naturally accrue over the long term. Although it can happen by just remaining patiently invested in good, strong businesses, it seldom bears fruit if it is not supported by proactive government policy and a favorable business environment. 

It is clear that almost all value creation in the Indian markets has been has been the result of a mix of the above. But the fact that, the S&P BSE Sensex has delivered returns of only 13.7 per cent CAGR from Jan 1990 till date and given the fact that the nation’s Nominal GDP growth rate too has been around the same level, the outperformance of Equities as an Asset Class doesn’t appear to be of any significance. But this could be grossly misleading. Here’s why ... 

The components of these Indices are a constantly changing set. Couple this with the fact that during the last 23 years, various sectors have outperformed at various phases of time and one realizes that if an investor had understood even roughly, the components that were doing well and stayed invested in them, outperformance was eminently possible. I have attempted to capture here under, these value creation phases.

VC Phase I: The Seeds of Value Creation: 1991-96:

When we look back at our economic history over the last 25 years, what singularly stands out as a watershed are the landmark economic reforms of 1991-92, which liberalised and unleashed the potential of Indian companies to create enormous value. 

The stock market rally that followed saw the BSE Sensex scale heights never seen before, doubling and trebling in a matter of months.

 During 1990-92, the companies that delivered the maximum returns were from the core sector, such as cement, steel, automobiles, etc. The removal of the License Raj resulted in increased participation of the private sector in the economy, considerably increasing India’s GDP growth rate considerably from around 1 per cent in 1991 to 7.6 per cent in 1995. This period saw a surge in the FMCG and MNC Pharmaceuticals sectors as there was considerable lack of domestic capacities.

Consequently, during 1994-96, FMCG stocks such as Colgate, HLL and Reckitt and Coleman saw rapid growth. But the best example of value creation in the Indian markets was yet to come, the seeds of which were sown a decade ago. During 1993-94, the RBI for first time issued banking licenses to 10 Private Sector Banks, of which ICICI Bank, HDFC Bank, UTI Bank (later Axis Bank Ltd.) and IndusInd Bank, created exceptional value for investors.

VC Phase II: The Indian IT Juggernaut: From 1998 onwards:

The biggest example of value creation in India has been the IT Sector. India’s IT success story came to the limelight during 1998-2001 global IT boom. Companies of the likes of Infosys, Satyam, TCS and Wipro delivered near vertical growth. The seeds of this exceptional growth were sown in the early 1990s, when the depreciation of the Indian currency led to a huge surge in exports of goods and services. 

Cheaper Indian IT services gave birth to the outsourcing boom. Infosys, the iconic Indian IT value creator, went public in 1993 at `95 a share. By 1999, the stock was quoting at more than `8,500, a growth of 85x! In a matter of five years between 1999 and 2004 Infosys’ revenues grew 10 times from USD 100 mn to USD 1 bn. Other stocks such as TCS and Wipro too delivered exceptional value during the latter half of the 90s. 

While the Dot.com collapse led to the demise of a few IT companies such as Silverline Technologies, the likes of Infosys and TCS remain among the highest value creators among Indian stocks.
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VC Phase III: Reforms Ver2.0, unleash value in Banks and PSUs: 2002-04:

 The year 2002-03 saw banking stocks emerge as huge value creators. Many banks, both private and public, were holding large amounts of government securities. With falling inflation and yields, the bond prices rallied, resulting in significant gains for all banks.

 The second round of disinvestment of PSUs between 2001-03 led to huge value unlocking in PSU stocks such as CMC, GAIL, Dredging Corp., ONGC, HPCL, BPCL. In 2004, the RBI issued a second round of banking licenses to two more Private Sector Banks – Yes Bank and Kotak Mahindra Bank. The two banks since have joined their peers of a decade ago, in contributing to creating wealth for the Indian investor.

VC Phase IV: Bounty for Indian Pharma as US Patents fall off the cliff:

At around 2004, the Indian Pharmaceutical Industry was waiting in the wings to take benefit of a historic opportunity in the US Pharmaceuticals market, the “Patent Cliff ”. This is a phenomenon where a large number of patents held by global pharma majors in the US markets, are due for expiry between 2010 and 2017. As Indian pharma companies stepped up their presence in the US generic space, companies such as Sun Pharma, Lupin, Ranbaxy, DRL, Cipla, benefitted significantly. Over the last decade the Indian Pharma space has created significant value. 

VC Phase V: The Infrastructure Boom of 2002-07: 

The 2002-07 period saw the government push the Public Private Partnership (PPP) format to provide a thrust to the Infrastructure and Power sectors. Almost 15000 km of roads were added to the national network by the NHAI till 2009. Companies such as IL&FS Transportation Network, IRB Infraprojects and even many other smaller companies have gained significantly from these initiatives. 

In the power generation space too India added 80GW of capacity between 2001-02 and 2011-12. Several power generation companies have created tremendous value for investors in this space as it readies for a further 80GW of capacity addition in the next 5 years. Increasing capex led to strong credit off take from banks. Between 2002-07, the Banking Sector shot up 10 times and during the same period Infrastructure companies delivered more than 20 times returns.

VC Phase VI: Back to the Basics : 2008-13 :

 The global recession and a lack of policy action at a domestic level led to a severe slowdown in the infrastructure and related segments in the last five years. But despite difficulties in the global and domestic scenarios in the last few years, certain non-cyclical sectors and stocks have managed to outperform the markets. Despite the slump in the Commercial Vehicles (CV) segment, companies such as Tata Motors and M&M have managed to deliver value due to their geographic and segmental diversification. 

The pharma sector too continued to deliver significant value to the investor, especially companies such as Sun Pharma, Lupin and DRL. But with the General Elections around the corner, hopes of a stable, reformist government run deep, leading to a revival in the Infrastructure and PSU segments. 

The Takeaways? Long-term value creation through proactive sector rotation:

 Due to the dynamic nature of the equities as an asset class, one cannot use a passive investing method to significantly outperform the broad markets. Long-term Wealth Creation calls for selecting the right sectors to remain invested in for the right duration of time, even as the fundamental tenets of diversification and long term holding DS remain inviolate. Prudence pays.