The worst is definitely over for earnings

Samir Arora, founder and fund manager of Helios Capital Management Pte Ltd, says earnings growth has bottomed out for Indian companies. "The worst is definitely over for earnings. Big picture, this is a great time to invest as an earnings pickup in the next two quarters is very likely," Arora said in an interview.

2015 was a record year in terms of funding for the start-up community, and the country became one of the biggest start-up destinations. From past conversations, you've never been impressed with the Indian start-up scene. Ripe moment: Samir Arora says this is a great time to invest as an earnings pickup in the next two quarters is very likely.

Edited excerpts:

2015 was a record year in terms of funding for the start-up community, and the country became one of the biggest start-up destinations. From past conversations, you've never been impressed with the Indian start-up scene.

I think the Indian Internet space is seriously hyped. Today, angel investing is being done as a fashion statement. The issue is that the last round investors are anyway protected for downside so that no one knows the true valuations till these companies get listed. My feeling is that Internet investors are getting conned by the illusion of a 'Billion Consumers'. We have the numbers but no spending ability to match.

In industry after industry, we have seen that actual buying power of the Indian consumer is very limited. For example, our cable bill per month is perhaps $5, whereas in US it might be $100 per head. So, if investors come here thinking we have a potential billion consumers, they need to also remember that the high-end customer pays $5 and the new phase 3 customer wants to pay less than $3 per month.

Similarly, look at our movie industry, which, by any definition, is a mature industry and has super deep penetration. The total global ticket sales of Indian movies is less than $2.5 billion annually which is equal to the expected global collections for the new Star Wars movie alone.

Look at the market cap of listed Indian companies in domestically focused sectors with their US counterparts to see the real difference. India's biggest travel site-MakeMyTrip- has a $700 million market cap, whereas PriceLine plus Expedia have a market cap of $78 billion.

In India, a new brand crossing Rs 100 crore-S$15 million-is celebrated as a power brand and many companies in consumer and pharmaceutical sectors proudly present how they have so many Rs 100 crore brands.

A big company like Dabur has sales of approximately $1.2 billion. In the US, a single yoghurt brand, Chobani-started seven to eight years ago-has sales of approximately $1 billion.

If in any domestically focused sector, the market cap of the Indian sector-broadly defined -is more than 2-5% of a similar US sector, we think it is a big red flag.

We would actually like Indian Internet companies to get even higher valuations by the time of their IPO (initial public offer) for then it would be more lucrative to short them when they list.

The year 2015 was a big year for IPOs in India. Do you see 2016 being even bigger?

In general, the public will make less money from IPOs than they have in the past due to IPOs happening at later stages. Robust private equity flows allow these companies to come to the market later on. Also, we have seen that either an IPO issue is so bad that investors will not make money or it is so good that it gets seriously oversubscribed and, therefore, investor does not get any real allocation so they still do not make meaningful money.

Where do you see the Indian equity markets in 2016? Which are the sectors you are bullish on?

We believe the (Narendra) Modi government has done an adequate job in 2015 and that positive impact of all these steps will start reflecting gradually. The government was obviously helped by low oil and commodity prices but the same low prices negatively impacted many Indian companies and their lenders. Over time, while the absolute benefit of these low prices remain, the significant year-onyear decline of earnings that negatively affected companies will bottom out due to base effect. Markets will start seeing still reasonable fiscal deficit while earnings growth of the corporate sector will not appear as bad.

In recent days, we have become relatively more bullish on the Indian equity markets and are going into the new year with a positive view.

We believe that there is finally some on-the-ground impact of government policies and actions. Clear progress can now be seen in insurance FDI (foreign direct investment), coal and gas sector, power sector, Jan Dhan, renewable sector, etc.

Roads, railways and power sectors are seeing significantly higher government capital expenditure. Tax collections are robust, IPOs are getting good subscriptions, mutual funds are seeing strong inflows and urban consumer spending is back.

Base effect will make our yearon-year earnings appear reasonably strong in the next few quarters since the slowdown or crash in commodity prices started about a year ago. The Reserve Bank of India (RBI) is putting serious pressure on banks to recognize NPLs (non-performing loans), which is also positive. Sometime during the early part of the year, the GST (goods and services tax) bill will go through Rajya Sabha and it will be implemented in April 2017.

Is the worst over for earnings?

The worst is definitely over for earnings. Big picture, this is a great time to invest as an earnings pick-up in the next two quarters is very likely. A massive reduction in fiscal deficit obviously slowed the economy significantly in the second half of last fiscal. Earnings decline in the second half-i.e. September 2014 to March 2015-was of the order of negative 13%. This year, there is no such government induced tightness; so the base effect itself will be very helpful, going forward. Bigger problem with earnings is that 44% of earnings also come from commodities and export, excluding technology sectors. Stocks in global sectors have seen earnings decline of 80%.

Two successive weak monsoons have also hurt earnings in a few sectors. Other domestically oriented stocks have had reasonable earnings growth even this year. All in all, even if there was no earnings visibility in 2015 at the consolidated level, the difference in different groups was very large, allowing investors to add significant alpha.

Going forward, these differences between sectors may become less as commodity earnings bottom out, government-induced spending improves the health of many sectors, India has a normal to good monsoon and favourable base effect optically helps earnings growth. We would expect 12-15% earnings growth for the market in 2016-17.

Will India be the top pick in emerging markets?

Within emerging markets the Indian market should definitely do well. However, overall emerging market investing will have less interest for the world. Today, China is around 26.5% of the index and India is 8.6%. Taiwan and Korea-which could easily be classified as developed markets, or at least developed economies-are approximately 27%.

Over time, we should position ourselves as a standalone investment destination rather than as 8.6% of the emerging market allocation. We have a serious shot at this if we can get our reforms back on track. The world is lacking long-term growth markets to invest significant fresh funds and India has a strong case. Developed markets can do better than emerging markets in 2016 but if we can first get higher allocation from the emerging markets pie to start with, it will not be a bad deal.

You have joined the debate online on Facebook's Free Basics. You are among the few who have taken a contradictory stance in support of FB. Has the entire debate taken a moral tone when it should be about who benefits and how?

I felt the arguments against Free Basics are very weak. Let me explain them one by one.

First, Indian Internet-e-commerce-companies use discounts as their main strategy to compete with mom-and-popdriven Indian retail industry.

Now, when Facebook uses essentially discount as a strategy -not even clear solely for its own benefit-the Indian Internet industry claims they cannot fight with global companies and are projecting themselves as momand-pop players in the Internet space who need to be protected.

Second, I saw some IIT (Indian Institute of Technology) professors argue that content in India cannot be decided by a foreign company. Well, as you know, most Indian Internet companies are anyway owned and funded largely by foreign investors; so this argument is very weak. If our system can call HDFC (Housing Development Finance Corp.) a foreign company-as they do for calculating foreign ownership-level of HDFC Bank, for example-nearly all of the Indian Internet companies are foreign firms in my view.

I don't think any of these professors objected that foreignfunded Internet firms were taking on Indian mom-and-pop stores to take away their business via unsustainable discounts.

Third, many people are objecting that the poor Indians who takes advantage of this free basic are so innocent that they will never step out of the "walled garden".

These same people would also object that government should not offer subsidized rice and wheat to Indian poor till the government can also give them vegetables and dairy products needed for a balanced diet. In my view, the people of India are intelligent enough to decide for themselves what they like and what they are willing to pay for and no one should bully them or make decisions on their behalf. Funny thing is that Trai (Telecom Regulatory Authority of India) is asking people to comment on this issue and most of the respondents would already be on the Internet.

Fourth, the weakest argument I heard is that FB will take away data of all these Indians. If a person is so poor or so uninterested in accessing the real Internet, what is his data worth? Data is not an end in itself but to sell to advertisers to sell products and services to the user. If the user does not have the money or inclination to upgrade to the Internet, what is the real value of his data? It should also be noted that data of an average Indian visitor is by any simple logic worth less than 4-5% of that of a US Internet visitor, for India's per capita income is about 1/20th or less of the US's. Due to the high disparity of incomes in India, incomes of the people currently not on the Internet would be much lower than the average itself.

Fifth, this argument is more like a suggestion. If FB is so worried about the Indian public, why don't they subsidize general access to all? Well, that is their choice; but self-interest can work with a larger interest. If a hospital does free heart surgery for poor patients, it does not imply it will also be willing to pay people to go to other hospitals for treatment if they prefer that instead.

I may talk about the merits of investing in India at a conference but that does not mean I will also present them with marketing material of all my competitor funds.

An Indian software firm may talk about the benefits of outsourcing to India in general but in the end it would still like the client to come to it for business. Another variant of this suggestion is that government should instead subsidize the public for Internet access. These are the same people who want government out of business and to reduce government subsidies, etc., but at the first sign of some change in environment want government to intervene.

The sixth point, and this is another argument that I have heard: "Why is FB advertising so much? What is in it for (Facebook founder Mark) Zuckerberg?" Well, these are the same people who ask as to why Gates is visiting India so much and why he spends time in poor states like Bihar.

I heard someone say he (Gates) is doing this because he has a stake in some company which makes toilets! We are a nation of cynics and we do not believe-for we have never seen-other than once in a while with people like Azim Premji and Shiv Nadar-people who combine business with some bigger picture goals.

The best we can come up with as motivation for such people is it must be tax-driven. We need to grow up and access the general Internet more ourselves. Also, for a company like FB with a market cap of $289 billion and Zuckerberg's own net worth, Rs 100 crore, is not a big deal anyway, even though we may have never seen such an advertising blitz-other than, ironically, another Internet firm-Housing.com-advertising like this recently.

In arrangement with HT Syndication | MINT