It is true that inflation is a problem in the developing world as the consumer price indexes are very different there. In the United States, we have the luxury of having the CPI overweight almost 40% toward real estate-related components, which brings the overall rate down and makes it seem low.
In India — the BRIC market with the deepest correction so far in the first quarter — we saw a bad surprise for February inflation numbers. Inflation unexpectedly accelerated in February, increasing pressure on the central bank to act more decisively.
The wholesale price index rose 8.31% from a year earlier after an 8.23% jump in January, while the forecast was for a 7.8% increase. But, this still leaves India with negative real interest rates as the central bank’s key repurchase rate is 6.5%.
Wholesale inflation is likely around 7%, but the Reserve Bank of India (RBI) shoots for inflation of 4% to 4.5%, so I expect that tightening measures here will likely continue.
As a result, the Indian market may underperform for the next three to six months, but Indian companies are some of the best-run in the BRIC universe and habitually post some of the highest earnings growth rates. This central bank action gives long-term investors an opportunity to buy quality emerging market stocks on sale.
Here are some favorite stock picks that might be of interest to put on your watch list:
Infosys (NASDAQ: INFY) is probably the least affected by the tightening measures of the RBI as it targets global businesses in order to save them money with the patented Indian IT outsourcing strategy.
The company is actually leveraged to the improving U.S. economy, but since it is viewed as a cost-cutting measure by many U.S. corporations, the business does not suffer all that much in economic contractions. Service contracts are reliable and long term in nature and software businesses usually carry high margins. INFY has return on equity of 27.5% and operating margins of 29.7%. Over the latest quarter, revenues grew at 28.7%.
Currently, shares trade at 27 times current and 23 times forward earnings. They are not cheap, but management certainly has delivered over the years to command that valuation.
HDFC Bank (NYSE: HDB) and ICICI Bank (NYSE: IBN) had much deeper corrections than INFY as the Indian central bank is not only targeting inflation, but also credit growth (something the Federal Reserve could learn from the RBI).
With credit growth in India still running over 20%, the biggest impact from the policy to slow credit growth down is felt by property developers and other real estate sector plays, and, naturally, commercial banks. Since HDB and IBN are large Indian banks, investors fear that if the central bank overshoots it might hurt them disproportionately. However, we have no evidence of the central bank overshooting, so I would use any weakness in both stocks to build positions, which should be very rewarding after this tightening cycle is over.
A growth rate of 9% for Indian GDP results in a 25% growth rate for the banking sector, which is a remarkable, and more importantly, sustainable way to grow a banking business. HDB is very expensive at more than 5 times book value, while IBN trades at 2.5 times book value. Generally, HDB trades at a big premium to the Indian banking sector due to the better management of its loan portfolio when it comes to bad loans.
Tata Motors (NYSE: TTM) is India’s biggest car maker, and the company also makes commercial vehicles and other equipment. The company is also owner of Jaguar and Land Rover. Tata is in a good spot despite any monetary tightening as car sales in India rose to a record in February, while consumer penetration is still quite low. India has a large and growing middle class, which will be buying Tata products and upgrading to Jaguars for years.
The government has tried to put more money in people’s pockets with payroll tax cuts. Salaries in India this year are forecasted to rise the most in the Asia-Pacific region — an average 12.9% in 2011, compared with 11.7% last year — which should keep car sales strong and the broad economy on a firm footing despite any actions by the RBI. Tata’s grew sales at 21.3% last quarter, and the shares trade at 8.8 times forward earnings.
Finally, for a broader approach at making a good long-term buy, consider the emerging market Market Vectors India Small-Cap ETF (NYSE: SCIF). Small caps often tend to do better in inflationary times than large caps, and the big correction we saw in emerging market ETF SCIF is probably an overreaction. 2011 is likely to be bumpy for SCIF, but I see considerably more upside than downside from present levels.