India growth a catalyst, local arms trump MNCs

Growth visibility has done enough to burnish the allure of these stocks with investors – both at home and overseas. It is no wonder, therefore, that the India-listed stocks of these MNCs trade at premium valuations relative to their parent entities beset with inevitable growth challenges that mature markets present.

Premium valuations are a feature of companies operating across industries as diverse as restaurants, consumer goods, cars or heavy machinery.

Jubilant FoodWorks, the Domino’s pizza franchise in India, trades at a premium of more than three times that of the US owner of the global brand, which generates seven times more revenue than the local firm.

Hindustan Unilever (HUL), India’s biggest consumer goods company, currently trades at a price-to-earnings (PE) ratio of 62. That compares with a PE of 16 for its Anglo-Dutch parent Unilever Plc. HUL’s price to book is twice that of Unilever. On operational parameters, too, HUL outdoes its parent. The company’s revenue in India has expanded at a compounded annual growth rate (CAGR) of 11.2% over the past five years, compared with 2.2% for its parent. HUL has a profit margin of 17%, at least 400 basis points higher than that for the parent. One basis point is 0.01%.

Meanwhile, capital goods major ABB reported India revenue expansion at twice the rate than that of its global parent in the past five years. Timken India’s revenues expanded at a CAGR of 18% over the past five years, compared with 8.4% for its parent. The trend was similar for companies such as Kennametal, Blue Dart Express, BASF, and 3M Co.

Stellar Growth Justifies Premium
“India is growing at a relatively higher rate compared with most developed economies and most of India’s emerging market peers. Hence, the Indian equity market generally trades at a premium of 75-80% to the MSCI Emerging Market Index,” said Gaurav Dua, head of capital market strategy at Sharekhan. “Even compared with the developed markets, India commands a premium due to its higher growth trajectory driven by strong macro fundamentals and continued policy reforms.”

Global growth expectations for the current year top out at about 2%, with several economists predicting economic contraction across vast swathes of Europe’s richer neighbourhoods and, probably, across the Atlantic. Against that backdrop, India’s economy is expected to expand faster than 6%, with some analysts pencilling in a rate closer to 7% through this period of modest global growth.

India is central to the fortunes of several global companies operating here. One of the directors of Suzuki Motor, among the global leaders in compact cars, wrote in the annual report last year that the Japanese company’s future business expansion will largely be in lockstep with India’s growth.

Similarly, ABB’s annual report says that orders in Asia, the Middle East, and Africa have increased 6% in local currencies, with India helping offset the noticeable slowdown in China.

Unilever’s India business expanded 16% last year, compared with 8% in the US or a contraction of 1.3% in China. Sanjiv Mehta, the just retired former head of Hindustan Unilever, recently said India would inevitably become Unilever’s largest market by revenue, potentially sooner than the next decade.

Profitable Expansion
“The multiples seen in the India business reflect growth and, in some cases, reflect the fact that the return on equity (ROE) in India is higher,” said Anish Tawakley, deputy CIO-equity at ICICI Prudential AMC.

To be sure, a small minority of MNCs such as Holcim, Ford, Cairn, Daiichi Sankyo, and Metro have decided to exit India. But several global giants in high-growth businesses, such as Apple, Amazon, Foxconn, Cisco Systems, and Walmart, are now turning their attention to India due to market potential, policy reforms, ease in operations and availability of top-draw executive talent.

Yet, these benefits are available at lower overhead costs.

For instance, staff costs to sales at Unilever were around 9.75% last year, whereas HUL spent 4.71%. Similarly, Siemens India’s staff cost to sales is one-third that of its parent, while Nestle’s staff cost to total expenses is 9.7%, compared with 16% for its global parent.

A recent Harvard Business Review article said that Indian firms have better growth prospects, higher profitability, and more efficient asset utilization than their overseas parent units.

“That’s why every multinational must have an India strategy, or else it will miss out on one of the most promising market opportunities in the world today,” it added.