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Carnelian Update – Learn from history to do an encore

Updated: Jan 12, 2022

The worse a situation becomes the less it takes to turn around, the bigger the upside”

– George Soros

This is precisely what seems to have happened this time as well! The market has surprised everyone with a faster than expected recovery. Markets are back to pre-covid levels and it doesn’t seem to be a bit worried about the looming fears of the second wave of virus spread and the US elections, thereby making it a daunting task for investors to allocate capital to equity and other high risk asset classes. History tells us this is not the first time and certainly not the last time, that investors are/will be facing this dilemma.

“There is no better teacher than history in determining the future…… There are answers worth billions of dollars in a $30 history book “– Charlie Munger

History has consistently taught us that bull markets are always borne on the back of some crisis, as crisis usually bring some natural or forced structural shifts. If one can be convinced about those shifts and their long-term impact through detailed research devoid of emotions and by connecting the dots, it becomes easier to commit capital and stay invested even if there is short term market correction. The only approach one should adopt here is to avoid looking at MTM (marked to market) and work with a HTM (hold to maturity) mindset.

In our previous newsletters, we have presented our hypothesis of the emergence of a mega structural trend likely to benefit the Indian manufacturing companies and digital players. We have also highlighted the combined Lollapalooza effect of several smaller variables creating a much bigger non-linear impact, leading to significant value creation in certain sectors similar to what has happened historically.

We foresee a ~USD 90 bn digital opportunity and ~USD 500 bn manufacturing opportunity over the next 5 years as a first order effect…. second and third order effects yet to follow.

In this newsletter we have shared some experiences from the past crisis and the dilemma one faced. Our analysis reveals how the combined effect of various structural events in history resulted in the creation of enormous compounding opportunities.

This time is no different!

2003-2008 – Infra Boom:

The dot-com crisis compelled Fed Governor Alan Greenspan to reduce the interest rates by a whopping ~6% in a short span of time coupled with a balance sheet expansion. This cue was followed by central banks across the globe including India. Substantial interest rate cuts accompanied with abundant available liquidity led to a massive scale up in the investment cycle. India also dropped interest rates and received sizeable flows during this period. The Infra push in India (viz Golden Quadrilateral and investments across the Telecom and Power sectors) led to significant wealth creation. Market cap of infra/capital goods leaders grew almost 6x from INR 42,000 crores to INR 2.6 lac crores.

Interestingly, this meteoric rise happened on the back of a widespread disbelief and a spate of continuous uncertain events including the political regime change (nobody had predicted UPA coming to power - despite this change in government markets did well), SARS breakout, Indonesian Tsunami, Moscow attack etc.. of course, each of them did create volatile moments but if one was only focused on those issues, one would have missed the boat of massive wealth creation.

2009-2014 – FMCG Boom:

The Global financial crisis of 2008 caused massive wealth destruction and Wall Street faced huge criticism; political pressure forced governments across the globe to act for the Main Street. In India, populist measures like the MNREGA and aggressive increase in MSP were undertaken to combat the challenges arising out of the crisis. A sharp increase in rural incomes coupled with increased rural connectivity and low commodity prices, led to a big Shift for the FMCG companies seeking new avenues of growth. Higher volumes and low commodity prices led to a significant margin expansion for FMCG players resulting in considerable wealth creation opportunities with stocks delivering 3-8x returns over a 5 year period (market cap of FMCG leaders multiplying from INR 1.6 lac crores to INR 4.60 lac crores)

Similar to 2004, the picture was no different - the belief was missing, and most investors were underweight and non-believers in consumption stocks until very late 2012-13.

2010-2015 – Pharma Boom:

With billions of dollars of drugs going off patent, the US was looking for cheaper generic option. With India being ready with superior Chemistry and R&D skills - generic sales tripled in a short span of 3 years resulting in market cap of pharma leaders multiplying 3.5X from INR 1.4 Lac crores to INR 5.5 lac crores.

2013 onwards – Chemical Boom:

Around 2012-13, China started rebalancing its economy by implementing stringent environmental regulations and increasing labour costs. This would impact several sectors considering China’s dominance as a major supplier to several sectors globally. India was well placed in chemicals, auto components, textiles and engineering services then – however the risk reward for the chemical sector seemed most compelling as investors at large shied away from the sector. During our tenure with Edelweiss we published a report presenting this hypothesis in 2013, which went unnoticed by most investors – most companies grew ~10x in market cap with domestic chemical leader’s market cap up from INR 6.5K crores to INR 65K crores in this period. Belief started building only in 2017-18 when most institutional investors started participating.

2020 onwards – Covid Crisis: Ready for encore

COVID is an unfortunate event in the history of mankind; however, it has brought about significant Shifts which will create decadal opportunity for India.

There is no denial that technology consumption and pattern has changed. Every organization and individual is using more of technology & data. It is not that Digitization and cloud migration was not happening pre COVID, but the pandemic has brought about a sense of urgency and acceleration. What would have happened in next 10 years will happen in next 3-4 years. Every organization has to gear up to the new reality on a SOS basis. This will create ~USD 90 bn - 100 bn digital opportunity flowing to Indian IT players over the next 3-5 years. This is one sector where Indian companies are unmatchable and have little competition. This Shift is likely to create USD 200-250 bn of wealth creation opportunity.

Likewise, India’s manufacturing GDP is expected to grow from USD 450bn to USD 1tn+ (more than double) over the next five years. India’s focus on becoming self-reliant in critical sectors, supply chain diversification by global players, India’s improved cost competitiveness and huge domestic demand are key catalysts for this big opportunity that lies ahead of us. This can surprise most of us as there is widespread skepticism around it.

Moreover, if we look beyond first order impact of these trends, it is likely to create a huge delta impact on job creation and investment cycle. On the digital side alone, we expect USD 30-35 bn of incremental job creation; manufacturing will add anywhere between 50-75 bn. This will kick start the dual engine of demand and capex cycle fueling each other resulting into a sustainable and long lasting Atmanirbhar growth engine.

History tells us that this will also cause sizable operating leverage benefits resulting in profitability growth surpassing revenue growth at superior ROEs. History also taught us that the outcome of above results in sizable P/E expansion resulting into numerous wealth creation opportunities. Taking advantage of hindsight and having witnessed FMCG/Chemical/Pharma/Infra boom, we remain fairly confident of our hypothesis.

In order to put money where our conviction lies, we have launched a new strategy under our PMS - “The Shift” mainly targeting to invest in select leaders likely to benefit out of the upcoming manufacturing and digital boom. Please refer our last 3 months newsletters for more details on above scheme.

We would like to end this month’s newsletter by a famous saying:

While they were saying among themselves it cannot be done, it was done.

-Helen Keller


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