(This interview, with Edward Pulling, managing director for the Pacific Regional Group of JF Asset Management, was published in DNA edition dated June 8, 2009.)
Even for someone who has, by his own admission, been optimistic about India for the past 15 years, Edward Pulling sounds over-the-top bullish. “There are no circumstances that I can imagine in which I will give up on India as an investment story,” Pulling, managing director for the Pacific Regional Group of JF Asset Management told DNA Money’s Venky Vembu in Hong Kong. “The opportunity is too extraordinary.” With breathless excitement, he then maps out a scenario where the Sensex will double over the next three years to reach 30,000 by March 2012. Excerpts from the interview:
Indian stocks have rallied strongly in recent weeks. Can this be sustained?
The markets have done extremely well in the past three months, but let’s not get carried away by short-term movements. Those of us who have been invested in India for the past 15 years have to have a long-term perspective. I can easily map out a scenario whereby the Sensex is at 30,000 by March 2012, which would essentially be a doubling over the next three years. I can justify that by saying the economy will double in size over the next five to six years. That will mean India will be a two-and-a-quarter trillion economy by March 2014 or so. Sales and earnings of corporate India can grow faster than the economy, and certainly faster than nominal GDP growth.
The EPS (earnings per share) of the Sensex in March 2009 was around 800. Earnings forecast have already been revised up for March 2011, and when you factor that in, you get a March 2011 Sensex EPS of around 1,000.
At that point, I can see things take off because a lot of big-ticket long-gestation projects – ports, roads, airports etc- will fructify from March 2011 to March 2013. They start generating earnings that did not exist before… So I can easily see earnings between March 2011 and March 2013 doubling. That gives you a Sensex EPS of about 2,000.
The long-term multiple of the Sensex (that is, the price-to-earnings ratio) oscillates around 14 to 15 (on one-year forward earnings). Anything between 18 to 22 (PE) is ‘No please’ territory; 9 to 11 is ‘Buy like there’s no tomorrow’ territory. Let’s put it on a median multiple of 14-15 times forward earnings of about 2,000, and you have the Sensex at 30,000.
Are you saying that under certain conditions the Sensex can potentially double by March 2012 or are you putting your money where your mouth is?
I don’t believe in intellectualising this. We’re all here to make money (laughs). There are a lot of people out there who are so obstinate that they know they’ll eventually be right; I don’t have that luxury. I’m saying: my Sensex target is 30,000 by March 2012.
What’s the downside risk?
Whenever we do presentations on India, on risks we always put: ‘The Unknown, the Unexpected’. I’ve been doing this for 15 years. I’ve seen border wars, I’ve seen plagues, I don’t know how many prime ministers I’ve seen, I’ve seen any number of financial scandals, whether they are cooperative banks in Gujarat or a market operator in Bombay, whether it’s a cabal in Calcutta…. I like to think I’ve seen almost everything. But of course, I haven’t! India, God bless it, always generates new surprises – good and bad.
So, what’s the downside: I don’t know what triggers the downside. But if you ask me what the quantitative downside is, I’d say 9 times trailing EPS. If trailing EPS is 750, that gives you Sensex 7,000, which is not far from where we were 12 weeks ago.
In the short term, what kind of cues do you expect from the upcoming Budget?
One of the positive developments of the past five to eight eight years is that we got away from the Budget being this annual lynchpin event. Policy deregulation, reform etc. is more dynamic. The budget is now just a once-a-year gut check.
What everybody would like to see – not just FIIs, but more importantly local industrialists, local entrepreneurs – are, in no particular order, less bureaucracy, better education, labour mobility and better infrastructure. We are going to see better infrastructure. There’s no doubt about it. The only problem is if demand for infrastructure grows faster than infrastructure, as it has been. We need to see a quantum shift in infrastructure investment beyond 3-5% of GDP and up to 7-10% of GDP, which is where China is. That’s a big leap, and it’s not going to happen in this Five Year Plan. We might see it in the next Plan from 2013 to 2017.
Does the government have the fiscal elbow room for that level of investment?
No, of course it doesn’t. But we’re looking at infrastructure investment as from the government and the private sector. So, if the economy size is $2 trillion in March 2014, we need to see infrastructure expenditure of about $140-200 billion. That’s a stretch target. This Five Year Plan ends in 2012. We might get 5 or 6%. But China is doing 8-10% of GDP – and that’s before stimulus!
Of course, there are hurdles to achieving that kind of expenditure in India: policy action, implementation, bureaucracy. We get fantastic targets for power generation, but we never come close. Generally, we get 50-60% of the power plants in a Five Year Plan. China adds as much power in one year as India does in five.
That will change. Things will improve. Those are the goals that everybody wants to see achieved in India. That doesn’t hinge on the budget.
Are you not disquieted by the high level of public debt, with the attendant risk of a sovereign rating downgrade, with implications for capital inflows?
As for the risk of a sovereign rating downgrade: how much money does India borrow internationally? We’ve dealt with this in the past, and it makes headlines. But I’m not sure it has a material effect. That could be chatter I would be willing to ignore…
What about the ratings impact on Indian companies that borrow internationally?
It doesn’t mean they can’t borrow internationally. It just means their cost goes up. But at the end of the day, there’s no shortage of domestic savings.
Are you saying high fiscal deficits don’t matter at all?
I’ve been concerned about the fiscal deficit for 15 years in India. Where has it gotten me? (Laughs) I mean, I’d be concerned about the fiscal deficit in most countries right now. We are in an environment where governments are going to spend large amounts of money to revitalise economies. Some governments are going to run a 2% fiscal, others are going to run 12% fiscal. So are we going to see a crowding out (of private investments) in India? Are we going to see inflation getting back to 6-10%? In other words, are we going back to the battle days of the mid 1990s? Structurally, probably not. If I think the economy is going to double again in 5 or 6 years and corporate profits can double again in four or five years, then I’m looking at a pretty strong surge in revenues.
I think there will be a bit of divestment along the way, but that’s actually not a big-ticket item. It would be wonderful if we could get some dynamic pricing for energy products in the country. In other words, everybody would like to see volatility of the fuel and fertiliser subsidies reduced.
I don’t mean to be insouciant, but we’ve all become so much inured to a fiscal deficit in India. Secondly, I don’t think we’re going to hit a breaking point. Thirdly, we’ve always been bottom-up investors in India, so we look at individual company opportunities much more than we ascertain the overall country risk.
Fourthly, I think it’s easy for mathematicians and economists of a certain philosophical bent to preach about subsidies. But lest we forget: there are hundreds of millions of people who live a very different daily lifestyle. And these subsidies are an important part of their existence. And hopefully we’ll be at a point in the future where subsidies won’t be necessary. But I’m hesitant to begrudge subsidies while sitting in a fancy office in Hong Kong!
From an economic perspective, these subsidies have positive effects. If people work 100 days of the year, their ability to consume is increased. If farmers are forgiven loans, their ability to consume and reinvest increases. If minimum support prices are there and fertilizer is subsidised, there is an economic benefit down the road. I understand that there are economic ramifications in the near term. And of course, politically, these are wonderful decisions by the Congress: I don’t think anybody anticipated it.
Do you expect all this growth to happen irrespective of what happens in the external environment? Is India immune to what’s happening in the world?
No, we’ve learnt in the past year that India is not the closed economy that some people have said it is. We only have to read Tom Friedman to know that globalisation has taken firm root in India. So India is not immune to many things, even if it is not the trading nation that it should be. Availability of international capital is very important to India. There’s no doubt about it.
And how is the environment for that?
Certainly it’s getting better. Look at the ease with which numerous Indian companies have raised equity internationally. The appetite for India is there. There are very few investors around the world who would gainsay the opportunity in India.
How do Indian equity valuations look after this rally?
Valuations right now in India and regionally are deceptive, frankly, because the denominators are all over the place. At the beginning of the year, most people would have been forecasting that Asian earnings would be down anywhere from 15% to 25%. Now the consensus is that it will be flat. Nobody would have had the temerity to forecast 33% earnings growth for Asia ex-Japan in 2010, but that’s where the consensus is now. So, earnings forecasts are all over the place.
The real story for India kicks in farther out. Valuation, in my opinion, is not a positive, but it’s not a negative either.
Are you buying?
Yes, we are.
What sectors turn you on?
We like infrastructure and financial services. Given my optimistic outlook, I also think that companies that have long-gestation projects are attractive. The ability of some of the entrepreneurs over the past three years to navigate the shoals of bureaucracy and secure linkages that historically were incomprehensible… whether it’s iron ore or coal or licence to operate an airport or ports or build roads… To tap into the infrastructural opportunities or tap into the country’s natural resources. These guys are going to be the next generation of business leaders in the country. There are some very exciting projects out there.
What weightage does India currently have in your regional portfolio?
It depends on the benchmark you look at. In most Asia ex-Japan benchmarks, India would be about 11-12% and our stance on India is overweight.
Under what circumstances will you give up on India as an investment story?
Never. There are no circumstances that I can imagine. I’ve been doing this for 15 years, there are times when we haven’t been making money or have gone underweight but we never take our eyes off India. The opportunity is too extraordinary.
Is this the most optimistic you’ve been on India?
No, I’ve been optimistic for the better part of 15 years. Of course, I’ve been wrong quite a lot!
If you were to plot your confidence index, so to speak, how would it be right now?
This is towards the upper end. Put it this way: from a political perspective, this is the best I’ve ever experienced. And I think there is also upside politically. If the Congress executes well over the next three to five years, there is a chance that the next time their position could be even stronger. I haven’t been able to say that for at least 10 years. I’ll be honest: I misread the political outcome. I adhered to the theory that there will be more fragmentation, that provincial parties would increase their influence. So this has been a very surprising outcome for me.
What other markets in the region are you bullish on?
We’re very impressed with how China has reacted to the economic crisis. Their ability to energise a $3.5 trillion economy, their ability to make and implement decisions is unparalleled. I think also their geopolitical policies relating to Taiwan are extremely astute. If I were to look around Asia overall, we are more excited about stock markets or sectors that cater to regional investment or consumption or benefit from asset reflation than we are about companies or sectors that cater to external, primarily First World, demand. That’s not rocket science. But at the end of the day, this part of the world is benefiting from the low interest rates that have been set by the First World to offset economic difficulty. We have significantly less economic difficulty in this part of the world. And we’re going to see another liquidity surge.
Is there risk of an asset price bubble?
There’s been a sharp recovery in the property markets in Hong Kong and Singapore and equity markets. But we are well away from asset prices – either equities or property – trading at unsustainable levels.
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