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As India’s consumption boom broadens into smaller towns and rural areas, we
think companies like Raymond, Tube Investments of India, Redington India and
Pidilite Industries, which sell consumer durables and lifestyle products, will be frontline
beneficiaries. Unlike retail and F&B stocks, they look undervalued despite solid
business models, 20%-plus earnings CAGRs in FY10-13F and high return ratios.
Catalysts
Continuing strong economic data will result in increased interest in alternative
consumption plays given high valuations for retail and F&B stocks.
Anchor themes
Rising incomes (across rural and urban India) and current underpenetration is likely
to result in strong growth for auto products, consumer durables, IT goods, apparel
retailing and IMFL over the next few years
Consumption plays with a difference
Playing Indian consumption
We believe that consumption will continue to be an important and growing part of
India’s GDP. Also, the share of discretionary spending in the consumption basket
is likely to increase much faster. However, many of the retail and F&B stocks in our
coverage are already market favourites and overvalued. We think the next big
wave of consumerisation will be in durables and lifestyle products.
Playing smaller towns and cities
Rural incomes are being boosted due to higher crop prices, government schemes
and the “wealth effect” from rising land prices and urban incomes due to income
transfer to government employees, large-scale hiring in the IT sector and salary
hikes across sectors. Also, the penetration of autos, IT goods (such as PCs and
laptops), consumer durables and alcoholic beverages (IMFL) is quite low in India
compared to other countries. Although finding listed pure rural plays is tough,
companies such as Raymond, Tube Investments of India, Redington India and
Pidilite Industries have an expanding footprint in smaller towns and rural areas.
Undervalued, strong financials, surprise potential
The small/mid-cap space remains under-researched, in our view, and we believe
investor interest will pick up with positive economic data. We believe our four stock
picks also have strong company-specific stories that should catalyse their
valuations. We initiate coverage of Raymond Limited (80% earnings growth over
FY10-13F, 15% FY13E ROE, 14.4x FY12 P/E, restructuring story); Redington
(India) Limited (28% earnings CAGR over FY10-13F, 22% FY12E ROE, 9.5x FY12
P/E, new products, potential subsidiary value unlocking); Tube Investments of
India Limited (25% earnings CAGR over FY10-13F, 17.2% FY12E ROE, 15.8X
FY12 P/E, value unlocking of financial subsidiaries); and Pidilite Industries Limited
(19% earnings CAGR over FY10-13F, 28% FY12E ROE, 20.7x FY12 P/E,
investment in new product line) with BUY ratings. We also present “Nomura
Nuggets” (commentary on non-rated names) on Tilak Nagar industries (TLNGR IN).
Executive summary
Playing Indian consumption
Consumption has been a large and important part of Indian GDP, contributing almost
60% of it during the FY98-FY10 period. We believe this is likely to continue, as the
discretionary component of consumption spending is expected to go up in the next few
years, mainly due to rising incomes.
Rising incomes, in our view, will be the main reason for the rise in consumption. Rural
incomes are being boosted by higher crop prices, government schemes and the
wealth effect from rising land prices and urban incomes due to income transfer to
government employees, large-scale hiring in the IT sector and salary hikes across
sectors. Also, the penetration levels of many categories of consumer goods are quite
low compared with other countries at a similar development level.
We believe this increase in discretionary consumption spending along with current
underpenetration is likely to result in robust growth of autos, consumer durables, IT
goods, houses construction and alcoholic beverages, amongst other things.
Our consumption-leverage stocks, apart from having solid business models, 20%-plus
EPS CAGR in FY10-13F, relatively high return ratios and attractive valuations have
strong up-front catalysts and upside surprise potential. In our view, these catalysts are
likely to play out and lead to stock outperformance over the next 12 months.
Redington (28% earnings CAGR over FY10-13F, 22% FY12E ROE, 9.5x FY12 P/E) is
one of the largest distributors in India and Middle East and is set to benefit from growth
in consumer goods industry in India. Pidilite (19% earnings CAGR over FY10-13F,
28% FY12E ROE, 20.7x FY12 P/E) is an innovative company with strong brands
names (Fevicol, Dr. Fixit, M-Seal) and is likely to benefit from the country’s
construction boom. Tube investments (25% earnings CAGR over FY10-13F, 17.2%
FY12E ROE, 15.8x FY12 P/E) has dominant market shares in bicycles and autocomponents
— both categories play again on discretionary spending. Raymond (80%
earnings growth over FY10-13F, 15% FY13E ROE, 14.4x FY12 P/E) is likely to benefit
from retailing boom supply in tier-3/4 cities, with the monetization of real-estate
providing the immediate trigger for the stock, in our view.
Mid-cap beneficiaries of consumption boom
We initiate coverage on Redington, Pidilite, Tube investments and Raymonds with
BUY ratings. We also provide comments on Tilak Nagar Industries
Stocks with strong catalysts and surprise upside potential
As shown below, our consumer and auto teams favour only a few consumption-related
large-cap companies. In our view, all four of the stocks on which we are initiating
coverage are unique in that there are identifiable triggers and surprise upside potential
for each. Raymond has Rs14bn in expected post tax real-estate cash flow, Tube
Investment has stakes in two financial service businesses that can potentially be
divested (and their value unlocked), Pidilite has made investment of Rs3-4bn in
elastomers, the earnings from which are likely to come by end-FY13F, and Redington
has, apart from stakes in two subsidiaries (in which value can be unlocked), the
potential to tap unlimited array of electronics good which it can distribute through its
already robust infrastructure (such as warehouses, retailer partners, NBFC).
Raymond Limited (RW IN, BUY, PT: Rs470)
Raymond is a play on the growth of retailing and premium clothing in India, especially
in tier-3 and 4 cities, and the company is one of the most recognized brand names in
premium categories. The company has restructured and is set on a path of growth and
profitability, in our view, with the monetization of its real-estate assets acting as a
trigger for unlocking value. With projected 80% earnings CAGR over FY10-13F, 15%
ROE by FY13F and trading at a P/E of 14.4x FY12F EPS, we initiate coverage of the
stock with a BUY and target price of Rs470.
Redington (India) Limited (REDI IN, BUY, PT: Rs104)
Redington is India’s second-largest distributor and the largest one in the Middle East
for IT goods and has enjoyed consistently high EPS growth (15% plus) and return
ratios (ROCE of 20%-plus) over the past few years. The company has a strong,
conservative management team, in our opinion, as well as world-class riskmanagement
capabilities and is set to benefit from growth in India’s consumer goods
sector. We project EPS CAGR of 29% over the period FY10-13F and initiate coverage
with a BUY rating and price target of Rs104 (11x 1-year forward P/E).
Tube Investment of India Limited (TI IN, BUY, PT: Rs184)
Tube Investment aims to leverage India’s consumption spending on luxury bicycles
and automobiles, and has dominant market share in all its business segments. With an
expected earnings CAGR of 25% in FY10-13F, the company trades at an attractive
P/E multiple of 12x FY12F EPS once we adjust for its investments in insurance and
financial services. Our sum-of-the-parts valuation results in a price target of Rs184,
and we initiate coverage with a BUY rating on the stock. Divestment of financial
services business could be a potential stock price trigger.
Pidilite Industries Limited (PIDI IN, Rs180, BUY)
With a dominant market share (~70%) in the organized adhesives market and almost
generic brand names such as Fevicol, M-Seal and others, Pidilite has been able to
consistently create new products categories, maintain margins and realise consistently
high return on capital employed. The company is a play on India’s construction boom
(including spending on furniture). We project EPS CAGR of 19% over the period FY10-
13F and initiate coverage with a BUY rating and price target of Rs180 (22.5x one-year
forward EPS)
Private consumption has been important
contributor to growth in India
Consumption contributes almost 60% of India’s GDP and has played a larger role in its
GDP growth compared to other developing countries, in which growth is led more by
investment.
In terms of GDP at market prices, we estimate the rates of private final consumption
expenditure (PFCE) at current and constant (2004-05) prices during Q2FY11 at 57.0%
and 60.6%, respectively.
Growth in consumption likely to continue
The growth in private consumption has been an important contributor to GDP growth in
India for many years. This trend is likely to continue, in our view.
The combination of rapidly rising household incomes and a robustly growing
population should lead to a striking increase in consumer spending.
According to a study, “Foresight 2020,″ conducted by the Economist Intelligence Unit
(EIU) and sponsored by Cisco Systems, though the US will continue to be the largest
consumer market, China will emerge as the world’s second-largest and India will rival
the bigger European markets. India’s share in world consumer spending is set to
increase from 1.9% in 2005 to 3.1% in 2020.
According to a study by McKinsey Global Institute (MGI) - India, aggregate
consumption will quadruple from 2005 to 2025 to Rs70 trillion and will make India’s
consumer market the fifth largest in the world, surpassing the size of Germany’s.
The MGI study states that 80% of consumption growth will come from rising incomes,
while 16% will be due to an increase in the number of households and only 4% will be
due to changes in India’s household savings rate.
Rising incomes across Rural and Urban India
The main reason for increase in consumption spending is likely to be increase in
incomes, in our view.
Rural incomes have multiplied, consumerism is fast catching on
Rural India is reaping the benefits of supportive government policies and favourable
farm economics. Crop prices have multiplied and benevolent wealth effects of sharply
rising land prices are underpinning rural incomes and the propensity to consume.
Positive spill-over effects of strong economic growth are providing more trade
opportunities. Higher incomes are providing the seed capital to diversify into ancillary
farming and other non-farm sources of income. With income and wealth effects both in
the bag, rural consumption is on a roll. We reckon that rural consumption is still in the
early stages of its evolution. Even as incomes have increased dramatically, the
propensity to spend will change only slowly as the multiplier works its way over time.
Seven analysts from our research team travelled to rural regions across the country to
get a better understanding of the rural story. They spoke to farmers, shopkeepers,
auto dealers, farm labourers and general rural folk.
Universal rise in income: The over-arching feedback from our field trips was the
impressive rise in rural incomes across the country. Incomes have risen anywhere
between 2-4x times (even higher in some cases) over the past four years. Several
factors are at play here.
Higher crop prices: Crop prices are up on account of government-administered
minimum support prices, the rising prices of cash crops and export items (such as
grapes) and the ever-rising demand for food in a high-growth economy. While input
costs have also risen, the increase in incomes has been much stronger
Government schemes: Government schemes have affected rural incomes in two
ways. First, the national rural employment guarantee (NREGA) scheme has
increased the bargaining power of marginal farmers and landless labourers, leading
to a surge in wages and a shortage of rural labour in general. Second, the general
push by the government in rural infrastructure has resulted in better roads, wider
connectivity and greater availability of electricity. We note that the primary driver of
rural prosperity is increasing farm product prices, and NREGA and government
spending have been the icing on the cake.
Availability of financing: The availability of financing has improved, partly
because of the push by the government and partly because of better penetration of
banks and other rural financing companies. Competition among NBFCs is heating
up, and lending terms and conditions have become easier for farmers.
Wealth effect from rising land prices: As owners of a highly inelastic factor of
production such as land, farmers have benefited immensely from the benevolent
wealth effects of sharp recent increases in land prices across the country. Land
(and gold) is the preferred instrument of savings for most in rural India. Land prices
get a further leg up as farmers plough their savings back into land. Also, the inflow
of remittances from Indians living abroad is chasing land prices higher, especially in
Punjab and southern states of the country.
Spill-over effects of nationwide economic growth: Years of strong nationwide
growth are paying off for rural India. Better and more roads have facilitated
increased trade with neighbouring villages, cities and states. The widening reach of
media, cable TV and mobile phones has spurred aspirational demand and
consumerism while mitigating business risk through timely dissemination of
information (about crop prices and weather patterns, for example). Broad economic
growth in the country and rising aggregate demand are providing fast-expanding
markets for food products and putting upward pressure on farm output prices.
Improving terms of trade for farmers imply rising incomes and consumption.
Farmers turning into entrepreneurs: Higher economic activity on an overall basis,
rising incomes and benevolent wealth effects from the manifold increase in land
prices are providing seed capital to supplement farm incomes and diversify into
ancillary activities such as dairy, retail, infrastructure (eg, supplying sand) and
transportation (eg, renting tippers and tractors). Rising incomes mean that
consumption in rural India is moving up the value chain, providing fresh
opportunities for new business expansion (eg, retailing).
Susceptibility to droughts is falling: The other important takeaway from our rural
trips is that monsoons are no longer a key driving force as farmers, in general, are
significantly wealthier, and their wealth in land significantly higher. Moreover, the
shortage of labour created by government policies and a general tilting of terms of
trade in favour of the rural economy means that both landless labourers and landowning
farmers are less susceptible to the risk of monsoon failures. We also note
that non-agricultural activities are rising in rural areas, and this is reducing the level
of dependence on pure agriculture as the predominant source of income.
Urban Incomes also expected to rise
Income transfers to government employees have boosted aggregate
demand:
Government-led salary hikes for both central and state employees have led to a
significant income push in the government sector. Salary hikes have also come
through in all the Public Sector Undertakings (PSUs). The rise in expenditure on
wages and salaries of state-level employees — largely on account of the
implementation of states’ own pay commissions and the Sixth Central Pay
Commission — yielded a further US$25bn in extra total income in FY09 and FY10
over FY08. This is reflected in the increase in states’ expenditure on wages and
salaries as a percentage of revenue expenditure to 32.6% in FY10 vs. 28.4% in FY08.
Do note that even though PSUs have upped their salaries, this is not captured in this
data. Thus, the total has been north of US$75bn (which is the aggregate of central and
state government wage hikes, but does not include PSU salary revisions).
Resumption of hiring in the tech sector: We have borrowed the Exhibit below from
our IT services research team. What leaps out from the data is the significant ramp-up
in the hiring of engineers planned for FY11 and FY12 by the IT sector, with
incremental hiring of engineers by IT firms accounting for two-thirds of total graduates
entering the job market in FY12. We think such aggressive hiring plans could exert
significant upward pressure on wages not only in the IT sector, but also on salaries
across other sectors that absorb engineers.
Rise in income of urban labour
We are seeing increasing signs of labour shortages building up, which we think is a
common theme across the country in both urban and rural India. Evidence based on
field trips to rural areas by our analysts suggests that the supply of labour has not kept
pace with demand in a rapidly growing economy, resulting in higher labour costs. This,
we think, is one of the main reasons why even exceptionally high food inflation did not
lead to a significant social unrest in India. The story is very much the same in urban
areas. Labour, especially skilled manpower, has become scarce, in our view.
Improving job prospects and improving wealth effects
Despite higher inflation, we expect strong job prospects and wage increases to support
higher urban consumption. The RBI’s employment survey shows job prospects are
back to their peak. In addition, positive wealth effects and resurgence in retail credit —
particular housing and consumer durables loans — will be a positive.
Changes in consumption patterns
However, the composition of private consumption has been changing and is expected
to change dramatically over the years. This includes the following:
Rise in discretionary expenditure
In PFCE, the share of food, beverages and tobacco came down from 43.3% in 2002-
03 to 39.4% in 2005-06 to 35.3% in 2008-09.
According to the MGI study, the relative share of food, beverages and tobacco is
expected to decline to 25% by 2025. This is similar to what other countries such as
South Korea witnessed during their high-growth phases.
The steep decline in household consumption of food, beverages and tobacco from
43% of PFCE in 2005 to 25% in 2025 (as per MGI forecasts) would bring India in line
with the current spending of countries such as the US and Germany in this category
Growth indicators for our coverage universe-
We discuss below some broad consumption trends likely to lead to secular and rapid
growth for products and companies linked to them. The main drivers of these trends
are rising incomes and consequent increasing consumption, and the current relative
underpenetration of these companies’ products. In our view, these consumption trends
are likely to drive demand for the companies we are covering in this report.
Auto consumption boom likely to continue-
The automotive sector has been one of great success stories during the past two
decades of India’s liberalization
Consumption trend and company that should benefit
Trend Company to benefit
Auto consumption boom Tube Investment
Consumer goods set on a growth path Redington
Secular growth of organized retailing and Indian Apparel market Raymond
IMFL set to grow Tilak Nagar
Despite this rapid growth, the penetration of cars in India is much below what is found
in developed countries such as Germany and the US.
According to MGI, the transportation sector is forecast to grow rapidly at a compound
annual growth rate of 8.3% until 2025 to US$301 bn.
According to the MGI study, total household spending on cars is expected to grow at a
rapid annual rate of 12% to US$7.7bn by 2025. Similarly, two-wheeler consumption is
also expected to grow rapidly at 8.4% annually, taking the total to US$10.9bn by 2025.
The main reasons given for this expected growth are:
As incomes rise, people have a tendency to rely more and more on personal
vehicles.
The rapid growth of financing, which accounts for almost 80% of car sales now.
The provision of wider range of products especially low-cost cars such as Nano and
other global cars made suitable for Indian conditions.
According to management consulting firm Booze & Co.’s report on the India auto
sector, Reviving the Growth Engine: India’s Automotive Industry Is on Fast Track, for
the past eight years, the two-wheeler market has grown at a CAGR of 13%; in 2007,
8mn units were sold. Over the next seven years, the number sold is expected to nearly
double, to 15mn units per year.
Several studies have found that the relationship between vehicle ownership and per
capita income is typically S shaped. This implies that vehicle ownership increases
slowly at the lowest income levels, and then more rapidly as income rises, and finally
slows down as saturation is approached. Typically, the income elasticity of vehicle
ownership starts low but increases rapidly over the range of $3,000-10,000, when
vehicle ownership increases twice as fast as per capita income. Europe and Japan
were at this stage in the 1960s. Many developing countries, especially in Asia, are
currently experiencing similar development and will continue to do so during the next
two decades. When income levels increase to the range of $10,000-20,000, vehicle
ownership increases only as fast as income. At very high levels of income, vehicle
ownership growth decelerates and slowly approaches the saturation level. Most of the
OECD countries are at this stage now.
According to a study by global consultancy firm Ernst & Young, the Indian market will
clock the fastest CAGR between 2009 and 2020, more than double that of China and
the triad of North America, Europe and Japan. India's CAGR between 2009 and 2020
is expected to be 14%, compared with China's 6%, other emerging markets' 6% (which
includes BRIC nations) and the triad's 4%.
The Indian auto component industry expects to grow over fourfold to US$113bn by
2020, according to the Automotive Component Manufacturers' Association (ACMA).
Total passenger car production in the country will jump four times to reach 9mn cars
over the next 10 years, the industry body said in its forecast report. Although a major
chunk of this will come from the fast-growing domestic market, exports are likely to
form around 35% of the total market by 2020; that would put India among the top-five
vehicle-producing countries in the world by 2020.
Consumer goods set on a growth path
The Indian consumer durables market, with a market size of around US$30bn, has
recorded a CAGR 20% over the past few years.
The market for white goods will be one of the fastest-growing markets, in our view, as
India is reaching the tipping point for several consumer durable categories. Importantly,
the top 22% of Indian households are earning incomes in the range of 2.5x the
national average (higher than per capita income in China). These consumers have
already crossed these tipping points and are driving consumption, and we believe this
is likely to continue going forward.
Product penetration for most consumer good categories is quite low in India compared
with other countries, and we believe there is considerable potential for growth.
Secular growth in organized retailing
The Indian retail industry (estimated size of Rs1.2tn, or US$24bn) has witnessed
robust growth of 12% over the past five years as rising income levels, favourable
demographics and urbanisation trends have helped drive a consumption boom.
Organized retail has seen an even sharper increase of 43% over the same period,
helped by a combination of factors including low penetration levels, rising awareness
and aspirations, and increasing consumerism. Private final consumption expenditure
has been the key driver of economic growth over the past few years. To put this in
perspective, in FY08, PFCE was cUS$650bn, or c62% of the nation’s GDP. Of this,
retail contributed cUS$410mn, or 63% of PFCE.
However, even after taking the growth over the past few years into consideration,
organized retail penetration continues to be amongst the lowest in the world at an
estimated c7%. We expect the organised retail industry register a steady growth of
c15% over the medium term, thus implying a penetration level of c12% in 2012, rising
to c20% by 2020.
However, this would still mean that the share of organized retail in the total retail
market would still be well below the levels seen in developed countries (US c90%),
Japan (c85%). The level of penetration of organized retailing in India also compares
unfavourably with some other developing countries such as Poland, Thailand and
Vietnam, where organized retailing share in overall retail market is over 20%. We
believe the opportunity size in India will continue to remain big in the medium to long
term, as penetration levels remain low even after the robust growth the sector has
seen over the past few years.
According to a McKinsey & Company report entitled, The Great Indian Bazaar:
Organised Retail Comes of Age in India, 12 October 2008, organised retail in India is
expected to increase from 5% of the total market in 2008 to 14-18% and reach
US$450bn by 2015.
Clothing — an important component of retail
Clothing is the second-largest segment in the overall retail market, accounting for a
12% share, but has the largest share of the organized retail market at approximately
32%. The organized retail market for apparel stood at Rs400bn in 2010. Apparel retail
in India began with manufacturers such as Raymond, Bombay Dyeing, and Arvind
Mills opening up their EBOs. EBOs such as Color Plus, Van Heusen, Louis Philippe,
Wills and MBOs such as Lifestyle, Shoppers Stop, Pantaloons and Westside
expanded their operations in metropolitan areas and tier 1 and tier 2 cities, thereby
bringing a retail boom in the Indian retail market. Today, menswear is the most
organized segment in the Indian apparel industry, with a large number of organized
retail stores in India.
The penetration level of organized retail in apparel was approximately 14-15% in 2009.
We expect this to increase at a faster pace over the next few years, primarily due to
the opening up of EBOs, MBOs and malls in the tier 1 and 2 cities. Rising brand
consciousness among Indian consumers and the introduction of foreign brands in India
should serve as additional growth drivers.
Indian Apparel Market
The domestic market is estimated to have been worth Rs1,250bn in FY10 (at the
wholesale level). Spending on domestic retail apparel has grown at a high rate of
approximately 13-14%. The apparel market size at the retail level is estimated by
CARE Research at Rs2,000bn in FY10. According to CARE Research, retail
purchases on apparel are expected to double to approximately Rs4,000bn by FY15, a
CAGR of approximately 15%. Factors expected to contribute to the growth of the
Indian apparel industry include:
Rising levels of disposable income;
Growing preference for ready-to-wear apparel;
Increasing penetration of organised retail;
Changing consumer habits;
Increasing trend toward urbanisation; and
Comparatively younger population.
According to CARE Research, the combined market share of the premium shirts and
trousers segments is expected to increase from 13.0% and 23.9%, respectively, in
2010 to 14.8% and 28.0%, respectively, by 2015, while the market share for suits is
expected to grow from 10.5% in 2009 to 11.2% by 2014. Growth in these segments is
driven by an increasing proportion of India’s working population as well as increased
brand consciousness among India’s youth. CARE Research also believes that the
increasing affluence of the Indian middle class will be characterised by material social
awareness and competition, resulting in premium and super premium brands being
viewed as symbols of wealth and status. As a result, these two segments are expected
to see greater growth in the medium term compared to the economy and mid-price
market segments.
Indian Made Foreign Liquor (IMFL) set to do well
The IMFL market has grown at a 15 % CAGR over the past five years, with volumes
increasing nearly 1.5x in FY10. The growth in demand has been primarily due to rapid
economic growth, rising disposable incomes, favourable demographics and greater
social acceptability of alcohol consumption in India. According to CRISIL Research,
IMFL market production volume was 210-240mn cases in the FY10.
Also according to CRISIL Research, IMFL consumption is expected to increase at a
14-16% CAGR to 440-480mn cases by FY14-15. A shift from country liquor (locally
made alcohol) to IMFL, particularly in the northern states, is expected to primarily drive
IMFL consumption. The continuing ban on country liquor in the southern states is likely
to ensure that south India remains the key market for IMFL.
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As India’s consumption boom broadens into smaller towns and rural areas, we
think companies like Raymond, Tube Investments of India, Redington India and
Pidilite Industries, which sell consumer durables and lifestyle products, will be frontline
beneficiaries. Unlike retail and F&B stocks, they look undervalued despite solid
business models, 20%-plus earnings CAGRs in FY10-13F and high return ratios.
Catalysts
Continuing strong economic data will result in increased interest in alternative
consumption plays given high valuations for retail and F&B stocks.
Anchor themes
Rising incomes (across rural and urban India) and current underpenetration is likely
to result in strong growth for auto products, consumer durables, IT goods, apparel
retailing and IMFL over the next few years
Consumption plays with a difference
Playing Indian consumption
We believe that consumption will continue to be an important and growing part of
India’s GDP. Also, the share of discretionary spending in the consumption basket
is likely to increase much faster. However, many of the retail and F&B stocks in our
coverage are already market favourites and overvalued. We think the next big
wave of consumerisation will be in durables and lifestyle products.
Playing smaller towns and cities
Rural incomes are being boosted due to higher crop prices, government schemes
and the “wealth effect” from rising land prices and urban incomes due to income
transfer to government employees, large-scale hiring in the IT sector and salary
hikes across sectors. Also, the penetration of autos, IT goods (such as PCs and
laptops), consumer durables and alcoholic beverages (IMFL) is quite low in India
compared to other countries. Although finding listed pure rural plays is tough,
companies such as Raymond, Tube Investments of India, Redington India and
Pidilite Industries have an expanding footprint in smaller towns and rural areas.
Undervalued, strong financials, surprise potential
The small/mid-cap space remains under-researched, in our view, and we believe
investor interest will pick up with positive economic data. We believe our four stock
picks also have strong company-specific stories that should catalyse their
valuations. We initiate coverage of Raymond Limited (80% earnings growth over
FY10-13F, 15% FY13E ROE, 14.4x FY12 P/E, restructuring story); Redington
(India) Limited (28% earnings CAGR over FY10-13F, 22% FY12E ROE, 9.5x FY12
P/E, new products, potential subsidiary value unlocking); Tube Investments of
India Limited (25% earnings CAGR over FY10-13F, 17.2% FY12E ROE, 15.8X
FY12 P/E, value unlocking of financial subsidiaries); and Pidilite Industries Limited
(19% earnings CAGR over FY10-13F, 28% FY12E ROE, 20.7x FY12 P/E,
investment in new product line) with BUY ratings. We also present “Nomura
Nuggets” (commentary on non-rated names) on Tilak Nagar industries (TLNGR IN).
Executive summary
Playing Indian consumption
Consumption has been a large and important part of Indian GDP, contributing almost
60% of it during the FY98-FY10 period. We believe this is likely to continue, as the
discretionary component of consumption spending is expected to go up in the next few
years, mainly due to rising incomes.
Rising incomes, in our view, will be the main reason for the rise in consumption. Rural
incomes are being boosted by higher crop prices, government schemes and the
wealth effect from rising land prices and urban incomes due to income transfer to
government employees, large-scale hiring in the IT sector and salary hikes across
sectors. Also, the penetration levels of many categories of consumer goods are quite
low compared with other countries at a similar development level.
We believe this increase in discretionary consumption spending along with current
underpenetration is likely to result in robust growth of autos, consumer durables, IT
goods, houses construction and alcoholic beverages, amongst other things.
Our consumption-leverage stocks, apart from having solid business models, 20%-plus
EPS CAGR in FY10-13F, relatively high return ratios and attractive valuations have
strong up-front catalysts and upside surprise potential. In our view, these catalysts are
likely to play out and lead to stock outperformance over the next 12 months.
Redington (28% earnings CAGR over FY10-13F, 22% FY12E ROE, 9.5x FY12 P/E) is
one of the largest distributors in India and Middle East and is set to benefit from growth
in consumer goods industry in India. Pidilite (19% earnings CAGR over FY10-13F,
28% FY12E ROE, 20.7x FY12 P/E) is an innovative company with strong brands
names (Fevicol, Dr. Fixit, M-Seal) and is likely to benefit from the country’s
construction boom. Tube investments (25% earnings CAGR over FY10-13F, 17.2%
FY12E ROE, 15.8x FY12 P/E) has dominant market shares in bicycles and autocomponents
— both categories play again on discretionary spending. Raymond (80%
earnings growth over FY10-13F, 15% FY13E ROE, 14.4x FY12 P/E) is likely to benefit
from retailing boom supply in tier-3/4 cities, with the monetization of real-estate
providing the immediate trigger for the stock, in our view.
Mid-cap beneficiaries of consumption boom
We initiate coverage on Redington, Pidilite, Tube investments and Raymonds with
BUY ratings. We also provide comments on Tilak Nagar Industries
Stocks with strong catalysts and surprise upside potential
As shown below, our consumer and auto teams favour only a few consumption-related
large-cap companies. In our view, all four of the stocks on which we are initiating
coverage are unique in that there are identifiable triggers and surprise upside potential
for each. Raymond has Rs14bn in expected post tax real-estate cash flow, Tube
Investment has stakes in two financial service businesses that can potentially be
divested (and their value unlocked), Pidilite has made investment of Rs3-4bn in
elastomers, the earnings from which are likely to come by end-FY13F, and Redington
has, apart from stakes in two subsidiaries (in which value can be unlocked), the
potential to tap unlimited array of electronics good which it can distribute through its
already robust infrastructure (such as warehouses, retailer partners, NBFC).
Raymond Limited (RW IN, BUY, PT: Rs470)
Raymond is a play on the growth of retailing and premium clothing in India, especially
in tier-3 and 4 cities, and the company is one of the most recognized brand names in
premium categories. The company has restructured and is set on a path of growth and
profitability, in our view, with the monetization of its real-estate assets acting as a
trigger for unlocking value. With projected 80% earnings CAGR over FY10-13F, 15%
ROE by FY13F and trading at a P/E of 14.4x FY12F EPS, we initiate coverage of the
stock with a BUY and target price of Rs470.
Redington (India) Limited (REDI IN, BUY, PT: Rs104)
Redington is India’s second-largest distributor and the largest one in the Middle East
for IT goods and has enjoyed consistently high EPS growth (15% plus) and return
ratios (ROCE of 20%-plus) over the past few years. The company has a strong,
conservative management team, in our opinion, as well as world-class riskmanagement
capabilities and is set to benefit from growth in India’s consumer goods
sector. We project EPS CAGR of 29% over the period FY10-13F and initiate coverage
with a BUY rating and price target of Rs104 (11x 1-year forward P/E).
Tube Investment of India Limited (TI IN, BUY, PT: Rs184)
Tube Investment aims to leverage India’s consumption spending on luxury bicycles
and automobiles, and has dominant market share in all its business segments. With an
expected earnings CAGR of 25% in FY10-13F, the company trades at an attractive
P/E multiple of 12x FY12F EPS once we adjust for its investments in insurance and
financial services. Our sum-of-the-parts valuation results in a price target of Rs184,
and we initiate coverage with a BUY rating on the stock. Divestment of financial
services business could be a potential stock price trigger.
Pidilite Industries Limited (PIDI IN, Rs180, BUY)
With a dominant market share (~70%) in the organized adhesives market and almost
generic brand names such as Fevicol, M-Seal and others, Pidilite has been able to
consistently create new products categories, maintain margins and realise consistently
high return on capital employed. The company is a play on India’s construction boom
(including spending on furniture). We project EPS CAGR of 19% over the period FY10-
13F and initiate coverage with a BUY rating and price target of Rs180 (22.5x one-year
forward EPS)
Private consumption has been important
contributor to growth in India
Consumption contributes almost 60% of India’s GDP and has played a larger role in its
GDP growth compared to other developing countries, in which growth is led more by
investment.
In terms of GDP at market prices, we estimate the rates of private final consumption
expenditure (PFCE) at current and constant (2004-05) prices during Q2FY11 at 57.0%
and 60.6%, respectively.
Growth in consumption likely to continue
The growth in private consumption has been an important contributor to GDP growth in
India for many years. This trend is likely to continue, in our view.
The combination of rapidly rising household incomes and a robustly growing
population should lead to a striking increase in consumer spending.
According to a study, “Foresight 2020,″ conducted by the Economist Intelligence Unit
(EIU) and sponsored by Cisco Systems, though the US will continue to be the largest
consumer market, China will emerge as the world’s second-largest and India will rival
the bigger European markets. India’s share in world consumer spending is set to
increase from 1.9% in 2005 to 3.1% in 2020.
According to a study by McKinsey Global Institute (MGI) - India, aggregate
consumption will quadruple from 2005 to 2025 to Rs70 trillion and will make India’s
consumer market the fifth largest in the world, surpassing the size of Germany’s.
The MGI study states that 80% of consumption growth will come from rising incomes,
while 16% will be due to an increase in the number of households and only 4% will be
due to changes in India’s household savings rate.
Rising incomes across Rural and Urban India
The main reason for increase in consumption spending is likely to be increase in
incomes, in our view.
Rural incomes have multiplied, consumerism is fast catching on
Rural India is reaping the benefits of supportive government policies and favourable
farm economics. Crop prices have multiplied and benevolent wealth effects of sharply
rising land prices are underpinning rural incomes and the propensity to consume.
Positive spill-over effects of strong economic growth are providing more trade
opportunities. Higher incomes are providing the seed capital to diversify into ancillary
farming and other non-farm sources of income. With income and wealth effects both in
the bag, rural consumption is on a roll. We reckon that rural consumption is still in the
early stages of its evolution. Even as incomes have increased dramatically, the
propensity to spend will change only slowly as the multiplier works its way over time.
Seven analysts from our research team travelled to rural regions across the country to
get a better understanding of the rural story. They spoke to farmers, shopkeepers,
auto dealers, farm labourers and general rural folk.
Universal rise in income: The over-arching feedback from our field trips was the
impressive rise in rural incomes across the country. Incomes have risen anywhere
between 2-4x times (even higher in some cases) over the past four years. Several
factors are at play here.
Higher crop prices: Crop prices are up on account of government-administered
minimum support prices, the rising prices of cash crops and export items (such as
grapes) and the ever-rising demand for food in a high-growth economy. While input
costs have also risen, the increase in incomes has been much stronger
Government schemes: Government schemes have affected rural incomes in two
ways. First, the national rural employment guarantee (NREGA) scheme has
increased the bargaining power of marginal farmers and landless labourers, leading
to a surge in wages and a shortage of rural labour in general. Second, the general
push by the government in rural infrastructure has resulted in better roads, wider
connectivity and greater availability of electricity. We note that the primary driver of
rural prosperity is increasing farm product prices, and NREGA and government
spending have been the icing on the cake.
Availability of financing: The availability of financing has improved, partly
because of the push by the government and partly because of better penetration of
banks and other rural financing companies. Competition among NBFCs is heating
up, and lending terms and conditions have become easier for farmers.
Wealth effect from rising land prices: As owners of a highly inelastic factor of
production such as land, farmers have benefited immensely from the benevolent
wealth effects of sharp recent increases in land prices across the country. Land
(and gold) is the preferred instrument of savings for most in rural India. Land prices
get a further leg up as farmers plough their savings back into land. Also, the inflow
of remittances from Indians living abroad is chasing land prices higher, especially in
Punjab and southern states of the country.
Spill-over effects of nationwide economic growth: Years of strong nationwide
growth are paying off for rural India. Better and more roads have facilitated
increased trade with neighbouring villages, cities and states. The widening reach of
media, cable TV and mobile phones has spurred aspirational demand and
consumerism while mitigating business risk through timely dissemination of
information (about crop prices and weather patterns, for example). Broad economic
growth in the country and rising aggregate demand are providing fast-expanding
markets for food products and putting upward pressure on farm output prices.
Improving terms of trade for farmers imply rising incomes and consumption.
Farmers turning into entrepreneurs: Higher economic activity on an overall basis,
rising incomes and benevolent wealth effects from the manifold increase in land
prices are providing seed capital to supplement farm incomes and diversify into
ancillary activities such as dairy, retail, infrastructure (eg, supplying sand) and
transportation (eg, renting tippers and tractors). Rising incomes mean that
consumption in rural India is moving up the value chain, providing fresh
opportunities for new business expansion (eg, retailing).
Susceptibility to droughts is falling: The other important takeaway from our rural
trips is that monsoons are no longer a key driving force as farmers, in general, are
significantly wealthier, and their wealth in land significantly higher. Moreover, the
shortage of labour created by government policies and a general tilting of terms of
trade in favour of the rural economy means that both landless labourers and landowning
farmers are less susceptible to the risk of monsoon failures. We also note
that non-agricultural activities are rising in rural areas, and this is reducing the level
of dependence on pure agriculture as the predominant source of income.
Urban Incomes also expected to rise
Income transfers to government employees have boosted aggregate
demand:
Government-led salary hikes for both central and state employees have led to a
significant income push in the government sector. Salary hikes have also come
through in all the Public Sector Undertakings (PSUs). The rise in expenditure on
wages and salaries of state-level employees — largely on account of the
implementation of states’ own pay commissions and the Sixth Central Pay
Commission — yielded a further US$25bn in extra total income in FY09 and FY10
over FY08. This is reflected in the increase in states’ expenditure on wages and
salaries as a percentage of revenue expenditure to 32.6% in FY10 vs. 28.4% in FY08.
Do note that even though PSUs have upped their salaries, this is not captured in this
data. Thus, the total has been north of US$75bn (which is the aggregate of central and
state government wage hikes, but does not include PSU salary revisions).
Resumption of hiring in the tech sector: We have borrowed the Exhibit below from
our IT services research team. What leaps out from the data is the significant ramp-up
in the hiring of engineers planned for FY11 and FY12 by the IT sector, with
incremental hiring of engineers by IT firms accounting for two-thirds of total graduates
entering the job market in FY12. We think such aggressive hiring plans could exert
significant upward pressure on wages not only in the IT sector, but also on salaries
across other sectors that absorb engineers.
Rise in income of urban labour
We are seeing increasing signs of labour shortages building up, which we think is a
common theme across the country in both urban and rural India. Evidence based on
field trips to rural areas by our analysts suggests that the supply of labour has not kept
pace with demand in a rapidly growing economy, resulting in higher labour costs. This,
we think, is one of the main reasons why even exceptionally high food inflation did not
lead to a significant social unrest in India. The story is very much the same in urban
areas. Labour, especially skilled manpower, has become scarce, in our view.
Improving job prospects and improving wealth effects
Despite higher inflation, we expect strong job prospects and wage increases to support
higher urban consumption. The RBI’s employment survey shows job prospects are
back to their peak. In addition, positive wealth effects and resurgence in retail credit —
particular housing and consumer durables loans — will be a positive.
Changes in consumption patterns
However, the composition of private consumption has been changing and is expected
to change dramatically over the years. This includes the following:
Rise in discretionary expenditure
In PFCE, the share of food, beverages and tobacco came down from 43.3% in 2002-
03 to 39.4% in 2005-06 to 35.3% in 2008-09.
According to the MGI study, the relative share of food, beverages and tobacco is
expected to decline to 25% by 2025. This is similar to what other countries such as
South Korea witnessed during their high-growth phases.
The steep decline in household consumption of food, beverages and tobacco from
43% of PFCE in 2005 to 25% in 2025 (as per MGI forecasts) would bring India in line
with the current spending of countries such as the US and Germany in this category
Growth indicators for our coverage universe-
We discuss below some broad consumption trends likely to lead to secular and rapid
growth for products and companies linked to them. The main drivers of these trends
are rising incomes and consequent increasing consumption, and the current relative
underpenetration of these companies’ products. In our view, these consumption trends
are likely to drive demand for the companies we are covering in this report.
Auto consumption boom likely to continue-
The automotive sector has been one of great success stories during the past two
decades of India’s liberalization
Consumption trend and company that should benefit
Trend Company to benefit
Auto consumption boom Tube Investment
Consumer goods set on a growth path Redington
Secular growth of organized retailing and Indian Apparel market Raymond
IMFL set to grow Tilak Nagar
Despite this rapid growth, the penetration of cars in India is much below what is found
in developed countries such as Germany and the US.
According to MGI, the transportation sector is forecast to grow rapidly at a compound
annual growth rate of 8.3% until 2025 to US$301 bn.
According to the MGI study, total household spending on cars is expected to grow at a
rapid annual rate of 12% to US$7.7bn by 2025. Similarly, two-wheeler consumption is
also expected to grow rapidly at 8.4% annually, taking the total to US$10.9bn by 2025.
The main reasons given for this expected growth are:
As incomes rise, people have a tendency to rely more and more on personal
vehicles.
The rapid growth of financing, which accounts for almost 80% of car sales now.
The provision of wider range of products especially low-cost cars such as Nano and
other global cars made suitable for Indian conditions.
According to management consulting firm Booze & Co.’s report on the India auto
sector, Reviving the Growth Engine: India’s Automotive Industry Is on Fast Track, for
the past eight years, the two-wheeler market has grown at a CAGR of 13%; in 2007,
8mn units were sold. Over the next seven years, the number sold is expected to nearly
double, to 15mn units per year.
Several studies have found that the relationship between vehicle ownership and per
capita income is typically S shaped. This implies that vehicle ownership increases
slowly at the lowest income levels, and then more rapidly as income rises, and finally
slows down as saturation is approached. Typically, the income elasticity of vehicle
ownership starts low but increases rapidly over the range of $3,000-10,000, when
vehicle ownership increases twice as fast as per capita income. Europe and Japan
were at this stage in the 1960s. Many developing countries, especially in Asia, are
currently experiencing similar development and will continue to do so during the next
two decades. When income levels increase to the range of $10,000-20,000, vehicle
ownership increases only as fast as income. At very high levels of income, vehicle
ownership growth decelerates and slowly approaches the saturation level. Most of the
OECD countries are at this stage now.
According to a study by global consultancy firm Ernst & Young, the Indian market will
clock the fastest CAGR between 2009 and 2020, more than double that of China and
the triad of North America, Europe and Japan. India's CAGR between 2009 and 2020
is expected to be 14%, compared with China's 6%, other emerging markets' 6% (which
includes BRIC nations) and the triad's 4%.
The Indian auto component industry expects to grow over fourfold to US$113bn by
2020, according to the Automotive Component Manufacturers' Association (ACMA).
Total passenger car production in the country will jump four times to reach 9mn cars
over the next 10 years, the industry body said in its forecast report. Although a major
chunk of this will come from the fast-growing domestic market, exports are likely to
form around 35% of the total market by 2020; that would put India among the top-five
vehicle-producing countries in the world by 2020.
Consumer goods set on a growth path
The Indian consumer durables market, with a market size of around US$30bn, has
recorded a CAGR 20% over the past few years.
The market for white goods will be one of the fastest-growing markets, in our view, as
India is reaching the tipping point for several consumer durable categories. Importantly,
the top 22% of Indian households are earning incomes in the range of 2.5x the
national average (higher than per capita income in China). These consumers have
already crossed these tipping points and are driving consumption, and we believe this
is likely to continue going forward.
Product penetration for most consumer good categories is quite low in India compared
with other countries, and we believe there is considerable potential for growth.
Secular growth in organized retailing
The Indian retail industry (estimated size of Rs1.2tn, or US$24bn) has witnessed
robust growth of 12% over the past five years as rising income levels, favourable
demographics and urbanisation trends have helped drive a consumption boom.
Organized retail has seen an even sharper increase of 43% over the same period,
helped by a combination of factors including low penetration levels, rising awareness
and aspirations, and increasing consumerism. Private final consumption expenditure
has been the key driver of economic growth over the past few years. To put this in
perspective, in FY08, PFCE was cUS$650bn, or c62% of the nation’s GDP. Of this,
retail contributed cUS$410mn, or 63% of PFCE.
However, even after taking the growth over the past few years into consideration,
organized retail penetration continues to be amongst the lowest in the world at an
estimated c7%. We expect the organised retail industry register a steady growth of
c15% over the medium term, thus implying a penetration level of c12% in 2012, rising
to c20% by 2020.
However, this would still mean that the share of organized retail in the total retail
market would still be well below the levels seen in developed countries (US c90%),
Japan (c85%). The level of penetration of organized retailing in India also compares
unfavourably with some other developing countries such as Poland, Thailand and
Vietnam, where organized retailing share in overall retail market is over 20%. We
believe the opportunity size in India will continue to remain big in the medium to long
term, as penetration levels remain low even after the robust growth the sector has
seen over the past few years.
According to a McKinsey & Company report entitled, The Great Indian Bazaar:
Organised Retail Comes of Age in India, 12 October 2008, organised retail in India is
expected to increase from 5% of the total market in 2008 to 14-18% and reach
US$450bn by 2015.
Clothing — an important component of retail
Clothing is the second-largest segment in the overall retail market, accounting for a
12% share, but has the largest share of the organized retail market at approximately
32%. The organized retail market for apparel stood at Rs400bn in 2010. Apparel retail
in India began with manufacturers such as Raymond, Bombay Dyeing, and Arvind
Mills opening up their EBOs. EBOs such as Color Plus, Van Heusen, Louis Philippe,
Wills and MBOs such as Lifestyle, Shoppers Stop, Pantaloons and Westside
expanded their operations in metropolitan areas and tier 1 and tier 2 cities, thereby
bringing a retail boom in the Indian retail market. Today, menswear is the most
organized segment in the Indian apparel industry, with a large number of organized
retail stores in India.
The penetration level of organized retail in apparel was approximately 14-15% in 2009.
We expect this to increase at a faster pace over the next few years, primarily due to
the opening up of EBOs, MBOs and malls in the tier 1 and 2 cities. Rising brand
consciousness among Indian consumers and the introduction of foreign brands in India
should serve as additional growth drivers.
Indian Apparel Market
The domestic market is estimated to have been worth Rs1,250bn in FY10 (at the
wholesale level). Spending on domestic retail apparel has grown at a high rate of
approximately 13-14%. The apparel market size at the retail level is estimated by
CARE Research at Rs2,000bn in FY10. According to CARE Research, retail
purchases on apparel are expected to double to approximately Rs4,000bn by FY15, a
CAGR of approximately 15%. Factors expected to contribute to the growth of the
Indian apparel industry include:
Rising levels of disposable income;
Growing preference for ready-to-wear apparel;
Increasing penetration of organised retail;
Changing consumer habits;
Increasing trend toward urbanisation; and
Comparatively younger population.
According to CARE Research, the combined market share of the premium shirts and
trousers segments is expected to increase from 13.0% and 23.9%, respectively, in
2010 to 14.8% and 28.0%, respectively, by 2015, while the market share for suits is
expected to grow from 10.5% in 2009 to 11.2% by 2014. Growth in these segments is
driven by an increasing proportion of India’s working population as well as increased
brand consciousness among India’s youth. CARE Research also believes that the
increasing affluence of the Indian middle class will be characterised by material social
awareness and competition, resulting in premium and super premium brands being
viewed as symbols of wealth and status. As a result, these two segments are expected
to see greater growth in the medium term compared to the economy and mid-price
market segments.
Indian Made Foreign Liquor (IMFL) set to do well
The IMFL market has grown at a 15 % CAGR over the past five years, with volumes
increasing nearly 1.5x in FY10. The growth in demand has been primarily due to rapid
economic growth, rising disposable incomes, favourable demographics and greater
social acceptability of alcohol consumption in India. According to CRISIL Research,
IMFL market production volume was 210-240mn cases in the FY10.
Also according to CRISIL Research, IMFL consumption is expected to increase at a
14-16% CAGR to 440-480mn cases by FY14-15. A shift from country liquor (locally
made alcohol) to IMFL, particularly in the northern states, is expected to primarily drive
IMFL consumption. The continuing ban on country liquor in the southern states is likely
to ensure that south India remains the key market for IMFL.
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