Indian companies have suffered severe pain over the last few years. If we look at the top 500 listed companies, only 23% have been able to grow profits by more than 20% in the last five years. Debt levels are high and profit margins have got squeezed. As a result, corporate capital expenditure (especially by the private sector) has seen a sharp drop. Also, India’s corporate profit-to-GDP ratio is at a 10-year low. So, what’s happening?
While this situation has been around and building up for the last few years, the first reaction for most participants over this period has been to link it to the macroeconomic cycle rather than any other structural issues. Markets have been stuck in the seeming endless loop, where every year you pencil 15-20% growth, get disappointed and yet restart the next year with the same hope.
We believe that what has happened is a structural shift and for large parts of corporate India, there will be no revival of the old glory days. Two forces are tearing apart the old order. First is the impact of technology-led disruption across sectors (accelerated by heavy private equity investment). Second, the government’s policy changes designed to formalize the economy and tackle crony capitalism.
Historically, an era of stable business models and lower competition in many resource-intensive and over-regulated sectors enabled Indian promoters to make easy money even without executing efficiency improvements or coming up with product or technology innovations. Even when the going got tough, they had a number of aces up their sleeve, such as lobby with the government for favourable regulations and protectionism, ever-greening and restructuring of loans, use of related party transactions.
Not that the stock market was complaining. Even though minority investor rights were a small item on the agenda, when businesses got rescued (by the government or banks), the shareholders also ended up benefiting. This old order is now dead.
The change in attitude towards making the economy more formalized is going to cause pain to businesses and enterprises even as a fast changing technology environment splits open their inefficiencies. The old guard is also facing competition from new tech entrepreneurs that are extremely aggressive and backed by investors that have seemingly bottomless pockets.
The clash between the new-gen and traditional entrepreneur is going to transform businesses altogether. The sheer brains, money power and ability to take the short path to growth by using some modern edge technology is going to fundamentally disrupt many models. The incumbents who don’t change will see slow death. The role of managers, hence, will get tougher. Change in the rules of banking means that default can now lead to the promoters getting thrown out of their businesses.
As markets have come to realize these issues, they have become more and more ruthless with the old inefficient approaches and are not ready to give struggling promoters a second chance.
On the flip side, this disruption is bringing a number of new winners and leaders to the fore. The last decade has shown us how quickly leaders and disruptors can evolve from nowhere. Take a look at online streaming businesses, mobile apps, e-commerce and more. Even India is seeing change coming fast. The likes of app-based cab booking, food delivery and many more are changing the game in their sectors.
We have also seen a few traditional businesses respond by proactive use of technology and innovation—and wherever it has been executed well, these have created strong leadership franchises for companies. One successful template has been strong promoter involvement through their ability to make long-term strategic investments beyond the push and pull of quarterly earnings targets. The other differentiator is balance sheet strength as a running debt clock significantly impacts the managements’ operating elbow room to take long-term counter-cyclical calls.
For the government, there needs to be sensitivity that while the focus on making Indian businesses stand on their own feet and to give up government crutches is praiseworthy, the dramatic change in the overall landscape is making the transition tough for even some of the well-run businesses. Some of the steps that the government has taken and which it should continue to push are strong focus on making Indian industry competitive within the global context (by bringing down factor costs) and continued push to make India a preferred destination for global capital.
From a stock market perspective, as we live through this paradigm shift in our economy, one lesson to remember for both fund managers and investors is that from here on getting returns will require a lot of efforts. The easy days of investing in any and everything are over. Lots of smart work and agility is needed in this dynamic environment to stay the course.
Jinesh Gopani is head of equity at Axis AMC