India Capital Growth (IGC) has announced its annual results for the year ended 31 December 2020, during which it says that, in the second half of 2020, after the changes to the investment process and investment team came into effect, it benefitted from significantly improved performance. In 2020 as a whole, IGC’s NAV rose 10.4%, underperforming the benchmark, the BSE Midcap TR Index, which was up 14%. IGC’s share price increased by 19.1%, reflecting a narrowing of the discount over the year. Over the second half of 2020, IGC’s NAV increased 39%, outperforming the benchmark by 10% over the six months. Turnover in the portfolio was higher than usual during the year (29%), as the IGC’s manager re-balanced the holdings following the improvements to the investment process and to capture opportunities that arose from COVID 19 market disruption. The investment team in India was strengthened with the addition of two sector specialist analysts and the creation of a new role for an ESG analyst.
Investment manager’s comments on portfolio activity
“As the Pandemic was flaring overseas we exited our most global consumer facing business, Motherson Sumi Systems (an auto-components manufacturer) and subsequent to India’s lockdown, we lowered our banking exposure, particularly to businesses most exposed to unsalaried borrowers and SMEs. Beyond this, underlying stock specific risks were re-assessed name by name but as volatility, it was clear that the market was offering an opportunity to purchase exceptional businesses at deeply discounted prices.
We added to our four remaining private sector banks that each offer different types of exposure. While City Union Bank and Federal Bank are regional in nature focusing on SMEs and corporate banking, IndusInd Bank and IDFC Bank are more retail driven. They are well capitalised and have used the RBI’s moratorium to boost their provision coverage ratios in anticipation of higher non-performing loans – something that has not yet transpired as India’s economy continues to re-open.
Switching from borrowing to spending, our long-held thesis that companies most geared to rural consumers in India will provide the strongest returns has been tested over the last two years in the wake of disruptive government reforms and a credit crunch in early-2019. Our confidence has however been reinforced of late. Rural India has been less impacted by COVID-19 and has a lot of tailwinds – a good Monsoon and massive doses of investment by a government now looking to stimulate rather than disrupt. Our three names most focused in this space are dominant players to whom we have added-to during the volatility. Bajaj Consumer Care in almond hair oil, Emami in the increasingly popular Ayurvedic segment and Jyothy Laboratories in household and personal care. They have participated in the sharpest end of the recovery in sales and are still very attractively valued relative to both their own history and the peer group.
In terms of new additions to the portfolio we were looking for market leaders and companies who had the ability to thrive in a post-COVID world. Dixon Technologies is one such example of the both. Using its dominance in LEDs (it is a top four global player), it has expanded its base to be an outsourced manufacturer for the likes of Xiaomi, Panasonic, and Samsung for items including televisions, mobile phones, and medical equipment. At a time when global companies are looking to broaden the geographic sources of their production, and the Indian government is providing significant incentives to reduce its electronics import bill of over $40bn (mainly from China) – Dixon is in the right place at the right time. It is rapidly adding brands to its portfolio across segments and is set to grow at a substantial pace over the next few years. Currently a small cap, we don’t expect it to be so for very long.
Beyond electronics, an area of the portfolio that has performed well during this period is the broader chemicals space. Long term holdings such as Divi’s Laboratories, Neuland Laboratories (active pharmaceutical ingredients and custom research) and PI Industries (agrochemicals) have seen strong growth as their customers have sought to build up their inventories. To this we added Aarti Industries a global leader in benzene chemistry supplying to the likes of global companies such as Pfizer, Bayer, BASF, 3M, Dow and Unilever, as well as a whole host of Indian blue chips. Both these sets of customers are looking to de-risk their sourcing from China whose chemicals manufacturing base is ten times the size of India’s. Our holdings have a strong order book and have an excellent track record in executing on their product pipeline. With huge structural tailwinds we have high visibility of a conservative 20% annual growth trajectory for the coming years.
We introduced ICICI Lombard to the portfolio which is India’s largest private sector general insurance company that is building a technology platform like no other in India. The company has been replacing manually-repetitive paper-intensive processes with artificial intelligence in areas such as claims adjudication and fraud detection to lower costs and improve customer experience. It is set to gain market share from cumbersome public sector companies and is well placed to capitalise on a historically underpenetrated but growing part of India’s wallet-spend.
A position was built in CCL Products which is the world’s largest private label instant coffee manufacturer. Aside from steady growth of 19% per annum over the last five years, we think the business can earn a higher valuation as it takes on Nestlé in India with its domestic brand Continental. It will do this armed with low cost manufacturing and economies of scale, a strong reputation amongst its long term client relationships for consistency and quality, and technical know-how to produce high-quality instant coffee using all grades of raw coffee beans.
Multi Commodity Exchange, India’s largest commodity exchange was also a new addition. It has near monopoly position in trading non-agricultural commodities such as energy, base metals and bullion. The sophistication of India’s financial market ecosystem is accelerating as the regulator has permitted new distribution channels (banks’ broking subsidiaries), new products (option contracts, commodity index futures) and new participants including mutual funds. These initiatives will go a long way in growing the commodity market in India, and MCX being the dominant player is well placed to benefit the most due to its head start and the strong network effects the business enjoys.
The final new entrant of the year was Persistent Systems, an IT Services company which has been among the first movers in digital technology. It has projects in key areas of cloud, analytics and mobility. Following a period of restructuring (having revamped its management team), the company is now scaling up and margins are expanding. India’s broader IT services sector is seeing a boom in demand as companies around the world look for support to facilitate their transition to a cloud-based infrastructure. This is Persistent’s core strength, and importantly the Company’s clients are no longer seeing IT services as way to cut costs, but as an enabler for top-line growth.
Portfolio turnover (at 29%) has been higher than usual this year as we sought to re-calibrate to deliver the best possible returns over the coming three years at the lowest risk exposure. The outlook from the management team of our companies for the coming year is very positive which tallies with our broader assessment of what is happening in India.”
Investment manager’s comments on Outlook
“Going forwards, the core driver for returns will be a shift in earnings expectations, and in this regard our conviction is growing. We also believe that India may be poised for a recovery in cyclical businesses which have struggled over the last four years. Having now increased our banking exposure, we believe the portfolio is well geared to take advantage of this with 46% of its weight comprising of banks, auto, cement, infrastructure and gas utilities.
As international investors grapple with challenges within their respective countries, the prospective resumption in demand and expansion of profitability in India is largely going unnoticed. The country historically produced 60% of the world’s vaccines and will produce a greater proportion of doses for COVID-19. It has a strong vaccination infrastructure which should help to mitigate the impact of a potential second wave of infections which has yet to occur.
Thus far, the economy is virtually back to being fully re-opened but the key question is how sustainable is the economic bounce-back? We choose to be macro aware rather than macro driven and our conviction on the answer being a positive one is driven by our analysis of the investible universe. More broadly, at the time of writing the country is more open than it was in 2020 and liquidity is more abundant than it was in 2019. This is exactly what is needed following several years of disruptive structural reforms that climaxed in the pandemic. The portfolio is forecast to deliver substantial earnings growth over FY22 and, as greater clarity on the operating environment has continued to come through, our confidence in this is strong. That this portfolio is valued by the market at a multiple of 16x is a strong signal and one that matches our conviction that India is poised for a sustained period of positive surprises for investors.”
[QD comment: An improved investment management process that has driven a significant improvement in performance is clearly good news for IGC’s shareholders. These changes were initially discussed in our May 2020 note (Click here to read) and then again in our December 2020 notes as the changes were showing signs of paying off (Click here to read).]