3 Top Stock Picks from India

Neptune's Kunal Desai highlights 3 stocks highlighting from the structural tailwinds of India; rising middle class, accelerating urbanisation and rising wages

Emma Wall 18 July, 2016 | 1:52PM
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Emma Wall: Hello, and welcome to Morningstar. I'm Emma Wall and I'm joined today by Kunal Desai, Manager of the Neptune India Fund, to give his three stock picks.

Hello.

Kunal Desai: Hi.

Wall: So, what's the first stock you'd like to highlight today?

Desai: So the way which we manage money in the Neptune India Fund is by having three silos. Now the reason we have these three silos is because they have low correlation with each other which helps us from a risk-adjusted perspective. So, the first silo is structure growth, and structure growth are the companies that consistently earn a return on capital in excess of their cost of capital.

And the company I'd like to highlight is one called Asian Paints. Now, Asian Paints is the largest paint producer in India. It's the second largest in Asia. And really this is a company that benefit from the usual structural tailwinds of India; rising middle class, accelerating urbanisation; per capita consumption of paying a quarter of what it is in China. But what we really like about this company is the fact that they are able to take advantage of these structural tailwinds. They have phenomenal entry barriers by way of 36,000 different dealers who they sell through.

Wall: The network effect.

Desai: Exactly. Their distribution reach is far stronger than any of the other players in the market. They are very innovative. This was the first company actually back in 1970 that bought the first ever computer in the Indian corporate system and even today they look to extend that through moving into other areas such as home solutions franchise in particular.

And finally, it's a company which spend a lot and reinvest their money back in the business. When we look at A&P spending, advertising and promotions, it's three times as much as the number two player. So, this is a company for us which fulfils that ability to earn this return on capital in excess of cost. It's a company which we believe will see rising return on capital employed, moving from 30% where it is today to about 35% by 2020. And for us, given the solid management team that exists in there, that's very much structural growth for us, and it's Asian Paints, the first pick.

Wall: So, the thing about companies like these what you say are benefiting from the growing middle class in any emerging market, that's not a new story. So what sort of price are you paying for a company like this?

Desai: So, this company would trade at a premium to the market and when you look at it both on a P/E or a price to book basis, it is at a healthy premium. But when we look at what's being implied in terms of growth, it's about 12% earnings growth each year to about 2025.

Now given the levers they have not just from a pricing perspective, not just from a volume perspective, but also by able to cross sell that consumer base into different other products which they are looking to extend, this is something that we think they can beat these expectations. So, you're right. When you look at it on a static valuation basis, it might appear cheap. But given the compounding growth we expect, we still think it represents good value.

Wall: What's the second stock today?

Desai: So the second would come from our second silo. So the second silo is economic recovery. So these are typically companies who have invested a lot by way of CapEx and then look to sweat those assets, that CapEx, for free cash flow. So what we do here is we try and identify companies whose return metrics are below their mid cycle, whose margins are below their mid cycle, but we expect that to be begin to move up.

So, the company I'd like to talk about is one called Apollo Hospitals. Apollo Hospitals are the largest hospital company in India and what they have done over the past six years is this extraordinary investment phase. They have doubled the number of beds they have from 3,000 to 6,000 beds over the past six years. So as a result of that margins have been crushed, return ratios have been crushed, utilization has fallen and investors get scared. But for us this is exactly the time when you should be looking at a company like that.

They are going on a two-year CapEx holiday where no more beds are being added to their portfolio and we expect as a result of that utilizations and return ratios to move upwards. And this has an extraordinary effect on return on capital employed. Over the next three years we see it actually jump about 10 percentage points to about 27% by the end of 2019. So, for us, this is a company again who focus on capital allocation, who focus on shareholder remuneration and they are at this very interesting stage of their own investment cycle which we think can be fruitful from an investment standpoint.

Wall: What's the third and final stock?

Desai: So the third silo is turnaround companies, self-help stories. Now, a lot of people often think a turnaround is just a company that's underperformed its peer therefore there is a turnaround story. But for us, we look for three things in a turnaround. One is the ability to have a very strong franchise. The second is a change of management who can also affect change within their company. And the final is, has this new management team given us as investors financial targets?

So the company which we think fulfils that is a company called Infosys. Infosys is the big IT bellwether but it's had a pretty poor time over the past three or four year underperforming TCS, Tata Consultancy to the point where actually its valuation was at about 30% discount. Now, what's the turnaround? The turnaround was, they've got a very strong franchise, very good brand equity with their key clients. They brought in a new management team.

Dr. Vishal Sikka from SAP, who has been able to affect change within this company and he sacked complacent senior management essentially. And finally, he has given this financial target of looking to double revenues with a 30% margin. That will be very difficult to achieve, but at least it gives us as investors a goalpost for what they are trying to achieve. So, for us, again, the valuation for us looks reasonable. It has underperformed its closest competitor, but has these very strong virtues which for us make it a very exciting turnaround company.

Wall: Kunal, thank you very much.

Desai: Thank you.

Wall: This is Emma Wall for Morningstar. Thank you for watching.

The information contained within is for educational and informational purposes ONLY. It is not intended nor should it be considered an invitation or inducement to buy or sell a security or securities noted within nor should it be viewed as a communication intended to persuade or incite you to buy or sell security or securities noted within. Any commentary provided is the opinion of the author and should not be considered a personalised recommendation. The information contained within should not be a person's sole basis for making an investment decision. Please contact your financial professional before making an investment decision.

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Securities Mentioned in Article

Security NamePriceChange (%)Morningstar
Rating
Liontrust India C Acc GBP4.60 GBP0.11Rating

About Author

Emma Wall  is former Senior International Editor for Morningstar

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