Emerging Markets: Selective Buying in India and Russia
February 10, 2017
by Edward Lam, Lead Fund Manager
In bull markets the reverse is true. The stock market’s goal is to get as high as it can with as few investors participating as possible. Savage frightening corrections appear from time to time to shake out the weak holders.
– Kiril Sokoloff, The Thinking Investors Guide to the Stock Market, (1978)
Emerging markets continue their upward drift despite what the skeptics guess about Trump’s policies and impact. We wrote about this in December. In the meantime, we continued our policy of selective buying.
We made a partial switch in positions in India. Yes Bank Ltd. replaced most of our position in Axis Bank Ltd. It is worth recalling that we first bought Axis Bank at the bottom of the Indian correction in 2013. At the time, many were selling Indian banks and not many wanted to buy Axis Bank, which, in particular, was seen as a conservative but second-rate private-sector bank ranking behind HDFC, ICICI and, to a certain extent, Yes Bank. My reasoning in going for Axis Bank at the time involved the conservative balance sheet positioning and the greater potential for a valuation rerating. Having been through the extensive rerating and reappraisal of risk in that time, Axis looks fairly valued to me and it is time to add to a growth position.
Founded only in 2004, Yes Bank is an entrepreneurial enterprise with one major advantage: it has no legacy business. It is focused on banking the new economy, which means it needs a lower level of retail branch coverage and it eschews administratively cumbersome business lines like cheque clearance. It is focused on building a modern online platform, which is where most of the growth in the Indian banking sector is and will be. Meanwhile, topically, it has invested in lending to newer business, which should be much less impacted by Modi’s aggressive withdrawal of cash from circulation. It is trading on just over 20x P/E with a dividend yield under 1%, but this is supported by a strong underwriting track record and a lot of potential growth.
The other area of addition is Russia. We made a trip there at the end of last year and were struck by some of the restructuring and reforms that have been made to the policy environment since 2014. Firstly, having followed the central bank since 2007, this is the first time I have ever been able to think, let alone say, that it has a credible inflation-fighting agenda under the most recent Governor Elvira Nabiullina. This is reflected in a surprising liquidity surplus in the banking system, which is not well understood by the international markets, in my view.
Meanwhile, Russia has been through the kind of recession that Ben Bernanke’s analysis of the great depression and most consensus thinking suggests to be impossible for a large broad economy: a jobful real wage recession. This also puts the economy in a surprisingly robust position. We added X5 Retail Group to the portfolio, which is the #2 Russian supermarket company behind Magnit. Over the years that we have followed the company, we had always been of the view that it was not particularly well run. However, in the last three years, new management has finally put in place the strategy and investment that should make their business durable. When we first saw one of X5’s retail outlets in 2008, we wondered who would want to shop here. Last year, we visited one of X5’s shops and their flagship distribution centre and were quietly impressed. The stock is not cheap at 23x P/E, but there is a lot of operational gearing in this business that is deferred whilst we are in the investment phase. There is also no dividend yet, but we expect that is on its way.
We haven’t had to sell stock to fund these purchases – or where we have, we have taken a gradual approach. This is in keeping with our long-term positive outlook for emerging markets.
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