India: Good Growth, Bad Growth

PERSPECTIVES: In a blind chase for growth, it is easy to forget that only the growth accompanied by economic profits creates value

Matthews Asia Funds 21 August, 2012 | 6:27PM
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This  is a "Perspectives" feature, one of a series of articles written by third-party contributors. Here, Sunil Asnani, portfolio manager at Matthews Asia Funds, takes an in-depth look at investing in India. If you are interested in Morningstar featuring your content on our website, please email submissions to 
August 2012
When almost all sectors are growing in India, it is probably fair to be discerning in our investments and avoid the potholes in the path of growth. One can understand the attraction of growth to investors who are looking to beat recessionary forces in developed markets. However, in a blind chase for growth, it is easy to forget that only the growth accompanied by economic profits creates value. Perhaps we should review some of the once-celebrated, top-down investment ideas that did not live up to expectations and compare them to less exciting ideas that actually did deliver.
The Infrastructure Boom
Not long ago, India's infrastructure companies were expected to multiply many times over in just a matter of years. It was hard to argue a few years ago with the need for better roads, more power (clearly needed considering the country's recent massive power outage) and efficient ports in India. Public policy had also laid out ambitious plans to develop infrastructure. Capital availability did not appear to be a major hurdle since many state-owned banks seemed willing to lend. 

Despite all the positive sentiments, however, negative shareholder returns were generated by some leading developers in the past five years—in sharp contrast to the top-line growth they achieved. This should not have surprised bottom-up investors, given how frequently these companies diluted shareholders by issuing more stock to grow beyond what could be funded through internal cash generation or could realistically be borrowed. Accessing capital markets to fund growth in itself is not value destroying, but developers turned to markets too frequently and made unwise business moves such as overbidding for projects—a recipe for losses. Policy inaction by lawmakers and high interest rates, which the media love to blame, are actually only recent phenomena that have merely compounded an existing problem created by these firms. 

In most parts of the world, infrastructure development is perceived to be a tough business since success largely hinges on management acumen and execution, with demands for the right mix of entrepreneurship and cash flow oversight. In India, developers that have recklessly chased growth, perhaps for non-economic reasons such as prestige or track record, have created a classic case of "a winner's curse"—a tendency for the winning bid in an auction to exceed the intrinsic value of the project won. Investors in these firms may also share some blame as their lack of scrutiny could have enabled developers to cheaply access shareholder capital. Investors globally may have viewed Indian firms through a "positive India" lens a few years ago, clouding their judgment. At one point, for example, the market value for a leading developer was at a double-digit price-to-book multiple and triple-digit price-to-earnings ratio, suggesting that too much was baked into its future. Such a valuation creates perverse incentives for companies to raise more capital from markets, which ends up bidding up the prices of the limited infrastructure projects available. 

Retail Hyper Growth
Another industry that was hyped a few years ago in India was that of organized retail, which is characterized by its larger scale, a network of stores and corporate ownership (e.g., supermarkets, hypermarkets). The premise was that the less organized "mom and pop" stores did not offer the variety or the ambience expected by newly rich middle class. 

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Matthews Asia Funds  is the largest dedicated Asia-only investment specialist in the United States.

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