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Published by: zerohedge on Nov 19, 2010
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 19 Nov 2010
Indian Economy Thematic
Indian Economy Thematic
 Ambit Capital and / or its affiliates do and seek to do business including investment banking with companies covered in its research reports. As a result, investors should be aware that AmbitCapital may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision.
Please refer to disclaimer section on the last page for further important disclaimers.
 Analyst contact
Ritika Mankar
Tel: 91 22 3043 3216ritikamankar@ambitcapital.com 
Reccommendations based on Megathemes
CompanyMkt Cap($ mn) ADV ($mn)Stance
Shriram HousingTransport Finance(SHTF)4,2006BuM & M Financial(MMFS)1,7003.9Bu
CompanyMkt Cap($ mn) ADV ($mn)Stance
Titan (TTAN)3,66911.7BuBajaj Auto (BJAUT)10,03916.5Bu
CompanyMkt Cap($ mn) ADV ($mn)Stance
Bank of Baroda(BOB)7,7529.3BuCity Union Bank (CUBK)4351.9Bu
Phone: +91-2230433216NBFCs Analyst : Krishnan ASV  Aspirationals Analyst : Vijay ChughBanks Analyst : Krishnan ASV Phone : +91-2230433216Phone : +91-2230433054
Source :Bloomberg, Ambit Capital ResearchNote : ADV is for a 6 month period
Five megathemes which will dominatethe next five years
The five megathemes that will characterize the Indian economy over thenext five years are the persistence of high inflation, the rise of the“aspirational consumer”, a capex boom, the rise of financial intermediationand the spread of social unrest and civil conflict. The sectors best placed tobenefit are NBFCs, Aspirational Consumer Goods manufacturers andCapital Goods providers. The sectors which stand adversely exposed areexport oriented ones, particularly IT.
Narratives on India, especially those written in a rising stock markets, tend to painta picture of a country with limitless investment opportunities. Whilst we believe thatthere are several structural drivers of such opportunities (for example, the economicand demographic boom which is driving a
surge in aspirational spending
ongoods as diverse as cars, LCDs, designer underwear, jewellery and high proteinfood – see pg 14), we also highlight in this note several major qualifiers to theseopportunities. In particular, the biggest negatives for India are
structurally highinflation
(see pg 5) which will consistently erode profit margins of all but thestrongest companies and
rising social unrest
and civil conflict (see pg 33) drivenby deep rooted divisions in Indian society. Amidst these conflicting forces, the best positioned sectors are:-
: Not only are NBFCs well placed to benefit from the surge inhousehold financial savings, they are also the least exposed to highstructural inflation (see pages 10 & 28 for details).-
 Aspirational Consumer Goods manufacturers
: The high share of youthand rising affluence suggest that consumer goods with an “aspirational”spin will outperform essentials (see pg 18 for details).-
Capital goods manufacturers
: Cross-country experience suggests thatIndia is primed for a capex boom. Capital goods manufacturers stand tobenefit most from this development (see pg 25 for details).The sectors most adversely exposed are export oriented ones (and particularly 
) ashigh inflation, high interest rates (which are likely to prevail to dampen suchinflation) and a strong rupee are likely to combine to erode their competitiveness.See pg 13 for details.Sectors where the prognosis is more mixed are:-
 Whilst banks are well-placed to gain from the rise of financialintermediation, high structural inflation will be a clear headwind on accountof exposure to high employee costs (see pages 10 & 28 for details).However, historical evidence suggests that banks outperform in a highinflation environment.
Mining & metals:
Escalation of the Maoist insurgency in the mineral-richareas of India spells headwinds for this sector. However, if you believeglobal commodity prices are set to rise then this sector is the obvious hedgeagainst inflation (see pages 11 & 35 for details).
 AmbitCapitalPvt Ltd
Executive summary of the megathemes........................................3Megatheme1: Structurally high inflation.......................................5Megatheme2: The rise of the “aspirational” consumer................15Megatheme3: A capex boom in the making...............................22Megatheme4: The coming of age of financial intermediation......28Megatheme5: India will become a hotbed of conflicts.................33
 AmbitCapitalPvt Ltd
Executive summary
Megatheme 1: Structurally high inflation (pg 5)
Supply constraints in India’s manufacturing sector have historically caused coreinflation to spike every time the economy expands rapidly (see Exhibit A on theleft). Limited access to finance, hard infrastructure deficits and labour marketissues have and will prevent timely supply responses in this demandpowerhouse thus driving manufacturing inflation higher. Furthermore, agrowing and young population with rising incomes will cause food demand togrow rapidly, while supply responses continue to be weak. This supply-demandmismatch will drive food prices higher over the next decade.
High inflation has historically been a negative for stock market returns(see Exhibit B on the left) as it crunches companies’ margins throughhigher input costs. Financial services’ companies emerge as being themost inflation-immune due to their limited exposure to employee costsas well as to raw material costs. Commodity-driven sectors emerge asan obvious hedge against higher commodities’ prices. IT and otherlabour-intensive export-facing sectors appear to be the most vulnerable to high inflation as higher domestic wages erode their pricecompetitiveness.
Megatheme 2: the rise of the “aspirational” consumer (pg14)
 As a country’s per capita incomes rise, the consumption basket of its citizenschanges away from food (see Exhibit C on the left) and essentials to non-foodand aspirational items (such as cosmetics, motorbikes and jewellery). India’sconsumption basket has been undergoing just this sort of change.
Given thestructural drivers of this trend (rising incomes, high share of youth andurbanisation), investors should focus on aspirational productmanufacturers vis-à-vis essentials within India’s broader consumptionstory. Exhibit 25 on pg19 gives a list of aspirational stocks. Exhibit 23 &24 on pg 19 show the outperformance of aspirational stock vis-à-visconsumer essentials.
Megatheme 3: a capex boom in the making (pg 21)
The experience of India’s Asian neighbours suggests that a high GDP growthrate coupled with the investment:GDP ratio hitting 33% triggers a surge incapex (see Exhibit D below). These trigger points along with India’sinfrastructure deficit and the Government’s desire to address this deficit has setthe scene for a seven year surge in capex.
History suggests that the IndianCapital Goods sector stands to gain most, both from profitability andfrom a stock price perspective, from this impending surge in capex.
Megatheme 4: The coming of age of financialintermediation (pg 26)
India’s per capita income in PPP terms recently breached the $ 3K and itssavings to GDP ratio stands at a healthy 32%. Cross country experiencesuggests that India’s savings ratio should touch ~40% in FY15(see Exhibit E onthe left) and will continue to rise until India’s per capita income reaches $ 8 K 
Exhibit A : Manufacturing inflationspikes when capacity utilisation rises
Source : RBI, CSO, Ambit Capital Research
Exhibit B : High inflation crunchesstock returns
(Average monthly returns in %)High InflationLow InflationSensex 
0.8 2.9
BSE 100
0.7 3.2
BSE 200
0.8 3.3
BSE 500
0.8 3.4
Source: BSE, Ambit Capital Research, Period under study: CY01-10 where high inflation is defined as WPIbased monthly inflation ahead of 5% yoy 
Exhibit C : Indian’s spend more oftheir wallet on non-food items
Source: CSO, Ambit Capital Research

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