Investing in India – The case for heading east

Why invest in India? The 8 per cent GDP growth rate in 2010, and the forecast repeat 8 per cent growth rate for 2011, are tempting when compared with the 0 to 1 per cent growth rate of the UK.

Dig down into those figures, and you see that the headline number is being held back by the 4 per cent growth in agriculture – most people in India still live off the land. The service sector is forecast in the latest five-year plan for 10.5 per cent growth, industry for 12 per cent growth. Unlike the world’s other major high-growth economy, China, foreign investors get fair treatment. The performance of Chinese shares quoted on AIM was, until this year at least, poor. Some research we have undertaken at Hardman & Co shows Indian companies on AIM to have a more pleasing performance.

Of course, private investors don’t have to restrict themselves to AIM when investing in India. Most electronic SIPP and share purchase platforms can undertake direct investment in companies quoted on the Mumbai Stock Exchange. Also, there are ETFs in the Sensex, the Mumbai Stock Exchange’s equivalent of the FTSE 100.

A study that we conducted and published in early April showed that on a weighted basis (by market cap, the way that all major indices have been compiled for the past 30 years), the 24 Indian companies quoted on AIM gained an average of 18 per cent over the previous 12 months. This was double the increase in the key Indian stock market index, the Sensex. It also beat the FTSE 100 index, although not the AIM All-Share index, with its heavy oil and mining exploration exposure.

Of these 24 companies, six are in real estate and development, four are investment holding companies, four are in energy generation (one of them wrongly categorised by the authorities as ‘industrial machinery’), three are in broadcasting and entertainment, two each are in oil and gas, transport and business support services, and one is a restaurant and bar operator. Looking more closely at the businesses, these range from a toll bridge operator to a wind farm. In terms of size, the list tops out with the giant £1.3 billion capitalisation Indus Gas, but also includes two companies with sub-£10 million market capitalisations –  there is something here for every investment taste.

Before we look at the individual companies, are there any conclusions that can be drawn from a general study of the list as a whole? We think there are.

• Avoid IPOs. Four out of the five companies floated on AIM in H2 2010 are under water. This is logical when you think about it. Relentless roadshows stressing the good points expose the company to the entire marketplace at a time when its recent trading history is at its best. And then management’s attention is focused on the float process rather than the trading business for four months or more.

• Avoid unpopular sectors. As far as 2010 and Q1 2011 were concerned, real estate was certainly out of favour. All six of the companies in this sector were losers in share price terms. In the UK, the FTSE Actuaries Real Estate Investment and Services Index is under water, so this is not just an Indian issue.

• Cut your losses, let your profits run. The overall returns of these companies are hugely impressive. But just over half the shares actually lost money. The winners were winners in some style. The charts on most of the losers in this selection show them moving pretty much in one direction only – downwards. If a share heads consistently downwards, there may be a reason for it, and you might be the only person on the share register who doesn’t know what that is.

• Just because you like small companies, don’t ignore the big ones. Three of the five largest companies made gains – big gains. Only one of the five smallest companies was in positive territory. Three of the five best performers were also in the top five in terms of size.

Sadly, looking at issuing houses, nomads and brokers gives no clue for the investor. Cenkos was adviser to two of the top five performers, which is interesting but not conclusive, and at the bottom end the five worst performers were spread between five different advisers, one of which also had a top five winner.

Now for the individual companies.

OPG Power Ventures
This Cenkos IPO floated at the worst possible time for investors, June 2008. It started life at 70p a share, and six months later was trading at 28p. This was the fault of the market, though, not the company, and anyone who held on is showing a sensible profit. OPG is a power generation company. It has 107MW of generation capacity at the moment, scheduled to rise to 662MW by 2013 and 1,250MW by 2015. After raising fresh equity in February, there looks to be enough risk capital in place to finance this expansion. The market cap is £340 million. This is a good old-fashioned generator, working largely with coal, partly with gas. It will end up as a kind of Indian Drax (Market cap £1.6 billion, output 4,900MW operating and planned).

Is this value for the investor? Well, OPG is valued at £270,000 per installed and planned megawatt, while Drax comes out at £326,000 per megawatt. Drax may have all its capacity installed and in operation, unlike OPG, but OPG has two significant plus points compared with Drax. First, Drax has a real problem with carbon limits and OPG doesn’t. Second, OPG sells its electricity direct to local industrial users, not to the grid, and therefore ought to obtain rather better margins.

Eredene Capital
You could almost go to sleep holding shares in this company. The fluctuation between its high and low over the past 12 months has been only 20 per cent (for OPG, it has been 100 per cent). Sometimes, however, boring can be good. Dig down under the surface here and you see a very interesting situation.

Eredene has 22 per cent of an international consortium that is building one of the largest single-operator container ports in India. This will be at Ennore, on the Northern outskirts of Chennai (Madras) on India’s South-East coast.

The new port will have capacity to handle three large container ships simultaneously, and for 1.25 million TEUs (i.e. 20-feet containers) a year. Construction starts this year, and the port should be operational in 2014, so there is not long to wait. Ultimately, capacity will be expanded to 2.4 million TEUs. When you remember that the whole of the UK handled only 10 million TEUs in 2010, you see just what a massive undertaking this is. In 2014, Ennore will be one third larger than Tilbury.

At its current market capitalisation of £50 million, Eredene is capitalised at a modest £200 per TEU of capacity. And the company has ten other Indian projects in operation, six of which are producing revenue and a seventh of which is taking sales deposits.

iEnergizer
iEnergizer is what many British people imagine when they think of an Indian company. It operates call centres and supplies back-office outsourcing systems. It floated on AIM in September 2010, raising £37 million at 116p a share; the shares are currently trading at 190p, an impressive gain of 70 per cent on the IPO price and well ahead of all the Indices. It is the exception to the rule about not buying a share at IPO. In fact, when at Hardman & Co we calculated our Indian AIM performance figures, we gave iEnergizer a ‘start’ price of 140p, not 116p, because right from the first morning it never traded anywhere near its issue price.

This company declared its first profit for the six months to the end of September 2010, and has stated that it will pay its first dividend for the year to March 2011. Its last trading statement talked of three major new client wins, and of ‘substantial growth’ to come from the telecoms market in particular. The company brokers, Arden, look for EPS of 6.3p in the year just concluded, so the rating is pretty high. But you can’t argue with what the company has achieved, or with the share price performance.

Eros International
If you like an exciting ride, Eros is the share to hold. It floated in 2006 at 190p and promptly rose to 550p before collapsing, but is now trading at well above its IPO price again and at more than three times its low point in 2009.

Eros is the big noise among the quoted film companies. It has a global reach and makes good money distributing Indian-made films to people of Indian descent who live in other countries. It pre-sells a large proportion of its output to Indian satellite channels, giving it good visibility of earnings. It owns loads of IP and is hugely profitable – pre-tax profits were US$49 million last year with 32 per cent margins. EPS were 36 cents (24p) for a p/e ratio of 10. Analyst consensus is for very much unchanged results for the year to March 2011, then for a 20 per cent uplift in EPS for the year to March 2012.

Photon Kathaas Productions
Photon Kathaas is the baby of the AIM Indian group. Its market cap is only £7 million, and its shares are tightly held and have traded only 19 times since their listing at the end of last year.

The company operates in South India and hopes to have ‘first-mover advantage’ as the first properly capitalised film company in the region. It will need more money to do this – Seymour Pierce’s IPO in September really ought to have raised more money for them than it did. But film-making in India is a lot cheaper than it is in Hollywood, and Photon Kathaas has already completed and released its first three films, with another three due for release by the end of July. The next set of results from this company, therefore, should see the first revenue flows.

Why invest in Photon Kathaas rather than the larger and very successful Eros International? India is a federation of 19 different states, many of which have their own languages and all of which have their own cultures and identities.

Tamil is spoken in Tamil Nadu, for example, and Malayalam in Kerala. There are huge local markets to cater for, and also the wider diaspora of expats in other countries, particularly the Middle East and the UK. Also its creative adviser is the renowned A H Rahman of Slumdog Millionaire fame. There is room for both Eros and Photon Kathaas. We would say Eros is the investment, Photon Kathaas is the speculation.

Unitech Corporate Parks
This is an interesting company for bottom fishers. Its shares have fallen by a third in the past six months, and are trading at just a third of their 2006 float price. It is a developer and funder of call centre properties, which it undertakes on a JV basis with its Indian-quoted one-time parent, Unitech International. Unitech has had problems in its telecoms business, but this issue does not extend to Unitech Corporate Parks. Unitech now owns only 4 per cent of the UCP equity.

Aubrey Adams, the highly respected ex-CEO of Savills, has just taken over as chairman, and that gives us huge confidence. NAV is 50p a share and the company has around £13 million of annual rental income, which we expect to double in two years. Stripping out exceptionals, it already operates at broadly break-even.  

Roger Hardman is head of research at Hardman & Co, a leading City-based corporate research and index compilation specialist that has particular focus on the small- and mid-cap areas. He has a small personal shareholding in Eredene.