BMO’s Patel: India’s bottom-up opportunities

India is one of the world’s strongest economic growth opportunities today. It offers the long-term investor a great opportunity to invest in some extremely high quality companies operating in a structurally attractive market.

India is often portrayed as a backward country that faces many political, economic and cultural challenges. However, if we take a wider and long term view, the potential for economic growth and societal wealth creation is extremely high. Gross Domestic Product (GDP) per capita (USD) has gone up by 3.5x in the last 15 years under different economic and political regimes. It is also abundantly clear that its people want and indeed strive for a better standard of living. There are multiple factors that we believe reflect this opportunity from a top-down perspective but also, and more importantly, from a bottom-up level. Here we focus on some of the big trends that should drive secular growth in the long-term and how some truly great companies are positioning themselves to benefit.

The demographic dividend

Since independence, India’s population has swelled from around 360 m to 1.33 billion* accounting for nearly a fifth of the world’s total population. It is even more relevant that we consider the age profile, as around 70% of the population under the age of 35. This provides India with a massive labour force and a huge potential consumer base that is increasingly more skilled; better educated and whose demands are increasing. Demographic trends such as these are highly stable, predictable and feed positively into economic growth. With more people having the potential to be productive, to consume and contribute to growth of the economy, India should enjoy the benefits of the “demographic dividend” for some time.

Convergence

While India’s total economy is worth around $2.3 trillion (already the world’s sixth largest), per capita GDP is only around $1,700 annually. With expectations that India’s per capita GDP could potentially double in the next 10 years, this will have profound effects on consumption patterns. What we know is that when an economy begins to grow its GDP per capita over $2,500, consumption and demand patterns change, shifting from subsistence to secular demand for goods and services such as convenience food and bank accounts.

The bottom-up perspective

For us, this is where India really gets exciting. India has a long tradition of capital markets and has over 5,000 listed companies. This is impressive when you consider that Mexico, currently only has 136 listed companies. While clearly this in itself will not allow you to benefit from potential of the economy it does provide some comfort in terms of market depth and the ability to build a diversified portfolio.

While we have discussed some of the long-term secular growth trends that are occurring in India, it would be naive to think it is “easy” to exploit and participate. History is littered with examples of secular and powerful trends that have ultimately led to little in terms real investment returns.

The complexity of operating in India with infrastructure that has a long way to develop creates opportunities as well as entry barriers for incumbent companies. Successful companies that have dominant franchises and which have created scalable and profitable businesses tend to have high profit persistence and the ability to deploy capital with high returns over a long period of time.

Colgate India, the locally listed subsidiary of the Colgate-Palmolive Company, dominates the oral hygiene market in India, with close to a 55 per cent market share in toothpaste. Colgate has the best distribution reach in the oral category with over five million points of sale across this highly fragmented country. The oral healthcare category itself is highly underpenetrated, with per capita consumption low even when compared to other emerging markets. Hence, there is significant scope for category expansion as disposable incomes rise. Indeed, if India were to match China’s consumption levels then its oral care market could actually quadruple in size.

While Colgate commands a dominant market share, the potential to grow cash flow is significant given that the low penetration rates for their product categories remains low at present. This, combined with the growing middle class population and expected increases in incomes, offers significant scope for the company to expand its reach and grow their profit pools.

There are clear and powerful drivers of secular growth present in India, presenting attractive long-term opportunities for investors. We believe that investing in high quality businesses that supports sustainable cash flow generation is the best way to participate in India’s secular growth potential.

Rishikesh Patel is lead portfolio manager on the BMO LGM Global Emerging Markets Growth and Income fund