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Carnelian Update – Emergence of a new trend

Updated: Feb 4, 2022

Dear Carnelian Family,

Hope everyone is safe and fine at your end.

In our last month’s newsletter, we have said that we are making a hypothesis around trends and opportunities emerging out of the current crisis. We strongly believe that every crisis brings an opportunity, so will this….

One of the opportunities which clearly emerges out of the current pandemic is in the digital IT space. Going digital & spending on IT infra is the new normal. As per Nasscom, digital technologies will present a USD 330bn addressable opportunity by 2023 (11% CAGR). Indian IT companies will capture 33% of the above (~USD 110 bn, up from USD 40bn in 2018), resulting in 22% CAGR over next 5 years. The IT sector represents a dual opportunity of earnings compounding and a P/E re-rating on account of superior ROE/FCF generation and longevity of growth. Considering the above we have deployed our cash mainly into the emerging leaders in the IT space to capture the opportunities available.

Another mega trend we anticipate is the emergence of manufacturing led opportunities in India. Over the last one month our team has done a detailed research testing the above hypothesis. The research involved analysing global trends, deep diving into the India’s competitive landscape across various sectors and analysing the impact of various policy reforms recently implemented.

Our research reveals that India is on the cusp of a multi-billion, multi-decade manufacturing boom considering,

  • Global supply chain diversification from China,

  • Recent government reforms & initiatives

  • Cost competitiveness

  • Strong domestic markets

  • Proven entrepreneurship

Whenever a new trend emerges, it emerges gradually in the initial phase, thereafter, attaining a snowball kind of effect over a period of time.

The human mind has a strong bias to overestimate short-term and underestimate the long term. We are all victims of instant gratification and derive a lot of our comfort, hypothesis, and perspective from limited vision constrained by our ability to appreciate and visualize long term. Most of the times we also get limited by our ability to connect a larger play to a lot of smaller variables at play, which over a period of time culminate into a megatrend.

In 1995 for a lot of us information technology was only a Y2K opportunity, very few thought that this is a far superior structural megatrend which will eventually become one of the leading sectors of the economy. Lot of small variables like availability of extremely talented pool, entrepreneurship, cost & skill arbitrage were at play – along with the available opportunity size it eventually resulted into a USD 150bn industry and is still growing. Trends develop slowly, but ultimately, they develop into megatrends provided the right variables are at play, and one is ready to seize the opportunity.

We currently believe a lot of variables are at a play, and we will experience a gradual but a swift trend in manufacturing across identified sectors. We believe that the cumulative impact of government led initiatives in the last 4-5 years, coupled with cost competitiveness (labour, power, logistics) will put India into the next orbit as far as manufacturing is concerned.

Global diversification from China

China currently contributes 28% to the global manufacturing and 50+% of global supplies in several sectors. The China-US trade war and the current Corona crisis has shaken the confidence of western world and many countries are exploring options to reduce dependence on China. India emerges as a strong contender to capitalise on this opportunity as a preferred partner.

Fig 1: Global supply chain diversification – some early trends…

Recent government reforms:

At 1.7%, India’s manufacturing export share is a tiny fraction of China’s (~13%). The government being cognizant of this, aims to raise the manufacturing sector’s contribution to GDP to 25% from the 16% currently (3x opportunity over next 5 years) and has implemented a series of reforms to push manufacturing in India.

Some of the prominent reforms are reduction in direct tax rates making it the lowest in the world, state level labour reforms, usage of non-tariff barriers, setting up industrial parks, production linked incentives and many more. All these coupled with earlier carried out reforms like GST, FDI, DFCC makes it a very good probability.

Fig 2: Government initiatives and reforms

Cost and resource competitiveness

India offers the lowest tax rates globally @ 17%, labour cost is 1/2-1/3x of China’s, power cost is comparable and logistic costs are likely to drift down by 25-37% owing to DFCC, Fast Tag and other developments. Moreover, India offers a large growing domestic market – which enables enterprise to attain economies of scale at a much faster pace. It will be very difficult for global entrepreneurs to ignore India considering the above advantages.

India also offers the advantage of availability of skilled and unskilled manpower

By 2030, India will add 113mn workers, close to one-fifth of the world’s working-age population with a median age of 28 which is 10 years below the median age in China. China’s working-age population, in comparison, peaked in 2015 and is on track to decline by 27mn by 2030.

Sectors where we foresee a large opportunity includes Chemicals & API, Consumer Electronics & Durables, Defense, Auto and Auto ancillaries and Capital Goods.

Case studies/recent trends

It is very interesting to observe how focus and right policies can set the stage for development of an ecosystem for an industry. India was a net importer of cell phones; however, a beginning was made with a focus on assembling. Gradually, manufacturing of components is beginning to happen as ecosystem builds and eventually this will result in building a full-fledged manufacturing ecosystem (draws similarity with what Maruti did to the auto/auto comp industry). We are happy to see initial encouraging signs of this trend which will further be accelerated by investment announcements by MNC’s in this space.

  • India has become Samsung’s second largest handset producing location.

  • According to media reports, Apple plans to move one fifth of its China capacity to India over the next five years; it’s iPhone assembly partner Pegatron is also planning to set up shop as well.

  • Foxconn, the Taiwanese electronic contract manufacturer, which assembles Apple iPhones in India is also planning a USD 1bn investment in India.

In order to capture the above opportunities, we are launching a separate strategy in our PMS fund “The Shift Strategy”. The fund will focus on the above mega trend.

Luck can also be defined as “when opportunity meets preparation” - we believe India is well prepared in terms of the right cost structure, right tax structure, entrepreneurship, and political will. Anti-China sentiments are at peak and the World is looking to de-risk the supply chain. We believe time has arrived for India and we will be extremely lucky this time! A Megatrend is in the making..


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