By Aniket Dharamshi • Arvind Ananthanarayanan • Vishrut Bubna
From legacy importer to global defence contender — India’s push towards self-reliance and high-tech manufacturing
India’s defence sector is undergoing a strategic shift—shedding its import-heavy past and stepping confidently into a future driven by self-reliance, innovation, and private sector agility. At the heart of this transformation is the Defence Acquisition Procedure (DAP) 2020, which mandated an increase in domestic content in Indian weapon systems and mandated the procurement of Indian systems. The emphasis remains on Indian designed, developed and manufactured (IDDM) systems.
This also allowed the Defence Public Sector Undertaking companies (DPSU) to emerge as lead integrators. The private sector companies catering to defence then aligned with the DPSUs requirements to create a tiered eco-system. Post DAP-2020, the Indian defence eco-system has the DPSUs as lead integrators with systems, sub-systems and components provided by the private sector.
The arrival of orders and consequent growth ensured that the DPSUs turned into growth stars. However, the growth opportunity has not benefitted all private sector participants equally. Most private sector participants suffer from elongated working capital cycles, and poor return ratios. In this sector deep dive, we discuss the evolution of the Indian defence sector and distil the qualities of winning companies. The growth of export opportunities is also expected to benefit companies with an innovation capability. A multi-billion-dollar growth journey has just started for the Indian defence sector.
The rules of engagement in India’s corporate landscape are being dramatically rewritten. What was once a playground for a select few has transformed into a battleground.
Our latest VQ Perspectives examines how innovative disruptors and conglomerates with cash-rich balance sheets are venturing into previously untouchable sectors, creating whirlwinds of competition and market shake-ups. The analysis reveals how four key factors are fuelling this transformation: • Strong balance sheets & easy availability of capital • Large enough profit pools to attract established players • Weakening of brand & distribution moats • Tech as the Trojan Horse enabling business model reinvention
For investors, these developments present both opportunities and challenges. Understanding which companies can adapt to this new paradigm and which might falter is crucial for portfolio positioning in 2025 and beyond.
We are pleased to share with you the annual edition of VQ Perspectives | Seeing the Glass Half Full.
2024 may not have filled the glass to the brim, but investing isn’t about perfection—it’s about perspective. Whether you see the glass as half full or half empty often makes all the difference. As the late Rakesh Jhunjhunwala said, “Successful investors are both opportunistic and optimistic.”
CRDMO 2.0: From Mastering the Process to Mastering New Technologies
India’s pharma industry is entering a new era of Pharma R&D Outsourcing, aiming to capture a larger share of the $302 billion global CRDMO market by 2028. While India currently holds just 3.6% of the global market, opportunities abound as innovators diversify supply chains post-COVID.
Indian pharma has come a long way, from being an ancillary supplier to the dominant low-cost generic manufacturer of the world. It is now time for Indian companies to chart the next leg of value addition by moving up the value chain and becoming more strategically aligned to innovators both large and small.
The global CRDMO market is a $300 bn opportunity where India still has a relatively small market share of ~3.6%. However, the stars seem to be aligning in the form of regulations, reorganization of supply chains and capability/ capacity building by Indian companies to address this massive opportunity.
In this note we deep dive into the evolution of the CRDMO market and the potential for wealth creation. Indian companies have a right to win in the segment and the enablers seem to be in place.
Be prepared to hear a lot more about biologics, peptides, ADCs, oligonucleotides amongst many other new technologies.
#MegaTrends #PharmaInnovation #CRDMO #Inflexion Point #Investing #ValueQuest
Ravi Dharamshi shared his playbook on harnessing megatrends for non-linear wealth creation at the 8th Value Investing Pioneers Summit. (link)
He explained how megatrends are identified, and how beneficiary sub-sectors and companies are assigned probabilities of success by using a unique blend of top-down and bottom-up thinking.
In the context of managing the part and parcel volatility and sensitivity of such new megatrends, he also talked about keeping an eye on macros such as regulations, technology cost curves, unit economics and levels of adoption, allowing one to adjust probabilities, guiding better investment decisions.
We’re excited to bring you the latest edition of VQ Perspectives | Trump 2.0: Pause or Continuity for Renewables.
In this issue, we explore the potential impact of Trump’s comeback on the US and the Indian renewable energy landscape. Will it be a pause in progress, or can the momentum continue? Dive into our analysis to understand the forces at play and what it could mean for the future of green energy.
We’re excited to bring you the latest edition of VQ Perspectives | Beyond the Matrix: Illusion of Comfort or Uncomfortable Reality.
In this issue, we tackle the bull versus bubble debate, inspired by The Matrix—urging you to see beyond comforting illusions and confront the real market landscape. We hope these insights spark fresh thinking and offer valuable perspectives.
Investing in the energy transition involves recognizing a substantial external opportunity, but that’s only the beginning. To maximize returns, this opportunity must be paired with a predictable environment where differentiation and industry maturity play crucial roles.
As the world embarks on energy transition, transmission stands out with remarkable potential:
Large Addressable Market: Currently valued at approximately $300 billion per annum as of 2023.
Exponential Growth: Market size is expected to double to $600 billion by 2030.
Industry Maturity: The transmission sector is mature, with established leadership and manageable rates of change.
Differentiation Potential: Depending on sub-segments, the scope for differentiation ranges from medium to high.
Within the energy transition value chain, our transmission grids are poised for a major overhaul. This transformation impacts the grid in three pivotal ways: the need to build more grids, the demand for more efficient grids, and the imperative for smarter grids. These elements not only drive growth within the transmission industry but also serve as critical differentiators for leading companies in this space.
We are pleased to share with you the latest edition of VQ Perspectives | You must let go of the illusion of control…
This edition draws a parallel between road trips and investment journeys, emphasizing the importance of resilience, adaptability, and keeping an eye on the destination despite the bumps along the way. We hope you find the insights valuable and thought-provoking.
We have arrived at an inflection point as far as wealthy Indians are concerned. Despite being the 5th largest global economy, we already have the 3rd highest number of billionaires, leading the way in new billionaires addition over the last few years. Alongside the growth in wealth, a real change has been the increasing financialisation of this wealth, as Indians discover their love for equities and gradually allocate the incremental rupee to equities vs. real estate/gold.
Similar changes in the USA a couple of decades back were accompanied by a period of massive wealth creation by US alternate and wealth managers.
India is poised to chart a similar path and there is a decadal opportunity in the space. To dive deeper into this please click the link ‘Riding the Wealth Wave’
The energy transition is emerging as a transformative megatrend, reshaping how we consider and consume energy. Analogous to how Wi-Fi has become a fundamental need in Maslow’s hierarchy, energy is quickly establishing itself as an essential, foundational requirement.
This transition is not merely significant; it represents a pivotal, multi-decadal opportunity, marking one of the most critical shifts since the industrial revolution. It has reached an inflection point, making it an imperative and inevitable shift.
Ravi Dharamshi, CIO of Valuequest Investment Advisors, outlines several areas for investments within the renewable energy space in his “Playbook for Investing in the Energy Transition”:
Few of the Focus Areas:
Transmission grids: Transmission serves as a vital cog in the wheel of electrification. A smarter, more efficient grid is necessary to meet the demands of the energy transition.
Energy efficiency: The push for electrification, particularly using renewables, alongside advancements in clean cooking, electric vehicles and likes will require optimizing current energy systems and innovating new technologies
Shovel Sellers Over Gold Miners It is often more predictable and potentially profitable to invest in equipment providers (“shovel sellers”) rather than the unpredictable (“gold miners”). Equipment sellers, who supply the necessary tools and technology, typically experience steadier demand and earnings compared to the producers.
Listen to Ravi Dharamshi’s talk, which he delivered at the 4th India Investment Conference organized by the CFA Institute.
IPL mania is again upon us, like every summer. The last few years, however, have seen a new feature added to these matches: the “Strategic Time Out”.
For those who are uninitiated, time outs in sports, often plays a strategic role that can end up altering the course of the game. Drawing up key plays, making substitutions, maintaining possessions and building strategies for the match ahead are the key features of a time out.
These matches and almost all sports, if you observe minutely, have many similarities to the markets. Markets are often run by emotions, full of paradoxes and cradled between the antonyms of supply-demand, greed-fear, recessions-growth, inflations-deflations.
Strategic Time Out – Inflexion Point
Back in June 2020, we argued that India was just entering a robust economic cycle, with plenty of room for growth. This sentiment was reaffirmed in January 2021 during our webinar with Shri Madhu Kela ji, where it became clear that we were not in bubble territory.
Last year, we hosted our own “VQ Inflexion Day,” where we extensively discussed the opportunities within mega trends that could potentially serve as significant wealth creators as the world embarks on the path of Energy Transition. India’s journey towards self-reliance (Atmanirbhar), coupled with its emergence as a preferred destination for the China +1 strategy, particularly in manufacturing and defence, presents yet another significant area for wealth creation opportunities.
The prevailing concern in India today is about overvaluations and whether our markets are in a bubble. However, this view is an oversimplification of the situation.
As Warren Buffett rightly said:
In light of the significant events spanning from 2010 to 2020, such as the Rupee crisis, Demonetisation, GST implementation, NBFC crisis, and the unprecedented impact of the Covid pandemic, the trajectory of positive economic growth has been notably absent. Understandably, this prolonged period of uncertainty has left many discerning market observers cautious about the current upswing. While markets may have pre-empted a resurgence in economic activity, the underlying reality suggests that we are merely at the nascent stage of this recovery. Corporates, perhaps understandably so, remain apprehensive about committing to significant investments for the future until a more tangible and sustained economic rebound is evident.
Some of our own apprehensions about volatility materialised in the first quarter of 2024 itself. Significant volatility spurred by nudges from both regulators, RBI and SEBI has effectively reduced frothiness in the SME market and corrected valuations of mid and small caps as well. While this can be looked as the glass half empty, we look it as a glass half full as this intervention has probably set the stage for markets to emerge stronger as we move forward.
After the inflexion point, it’s a time of reflection and we find ourselves facing a similar dilemma, albeit at even higher market levels and valuations.
Strategic Time Out – Observations and Navigation
In December 2007, India’s GDP stood at $1.5 trillion, while its market capitalization peaked at $1.8 trillion. This marked the pinnacle, coinciding with India’s corporate profits after tax (PAT) reaching 7% of GDP, its highest point. Typically, markets reach their peak when there’s maximum growth and profits, leaving limited room for further profitability. Factors like leverage, compounded by external events, often trigger a downturn in the economic cycle, leading to prolonged and deeper value destruction.
However, the current conditions don’t reflect peak growth, profits, profitability, or leverage that typically precede such severe downturns. While a correction is always a possibility, it’s essential to heed Peter Lynch’s cautionary wisdom: “Far more money has been lost by investors in preparing for corrections, or anticipating corrections, than has been lost in the corrections themselves.” While it’s natural to anticipate downturns, excessive fixation on them can cause us to overlook potential opportunities. Despite inevitable market pullbacks, our investment strategy should remain focused on maintaining a prudent and balanced approach. We mustn’t let short-term fluctuations overshadow our long-term objectives.
From 2007 to 2020, India’s GDP surged from $1.5 trillion to $3 trillion, but corporate profits after tax (PAT) as a percentage of GDP plummeted from 7% to a mere 1% at the bottom of the Covid crisis. Since then, corporate PAT to GDP has rebounded to 4.8% currently. Initially, this uptick in corporate profits was fuelled by gross margin expansions and cost-cutting measures implemented during the pandemic. Much of the profits generated during this period were directed towards reducing debt burdens on balance sheets.
Since 2016, the Modi government has pursued various reforms aimed at long-term benefits but causing short-term disruptions, particularly in informal sectors of the economy. Initiatives such as the introduction of GST, demonetisation, the NBFC crisis, and the subsequent Covid-19 pandemic have acted as successive shocks to the informal economy, accelerating the process of formalisation.
In this current corporate profit expansion cycle, which began in March 2020, there’s a strong case to suggest that we may surpass the peak achieved in December 2007.
Here’s why:
01–Not all engines of growth are firing yet: Unlike in 2007, when global growth was robust mainly due to China’s expansion, we are currently experiencing a more gradual recovery. This suggests that there’s still untapped potential for growth.
02–Utilization levels are below peak: Currently, we are operating at around 75% utilization, with the capex cycle expected to gain momentum as we approach 80% utilization. Increased utilization levels not only lead to higher profitability through operating leverage but also boost confidence in investing for the future.
03– Re-leveraging cycle is just beginning: Indian corporate balance sheets remain relatively deleveraged, with Debt:Equity ratios at around 0.4x. As the economy rebounds, we can expect to see companies taking on more debt to fuel growth, contributing to increased profitability.
04– Lower corporate taxes: Compared to the previous cycle, corporate taxes are significantly lower, standing at 25% currently, with further incentives for greenfield capex at a reduced tax rate of 15%. This favourable tax environment is likely to result in higher accumulation of profits during this cycle compared to the previous one.
Taken together, these factors indicate the potential for a robust and sustained corporate profit expansion cycle, setting the stage for significant growth opportunities in the Indian economy.
The Indian economy is projected to reach $5 trillion by 2027, even if we consider a slight delay in achieving this target. Assuming we surpass the corporate tax to GDP ratio of the previous cycle, we could peak somewhere between 8% and 10%. For context, the US corporate profits after tax (PAT) to GDP peaked in 2021 at 14%.
Even if we conservatively estimate a peak of 8% for this cycle, we could potentially see corporate profits ranging from $400 billion to $500 billion in the next 4 to 5 years. Return on equity (ROE) for Indian corporates hit a low of around 10% during the Covid bottom and has since expanded to 14%. However, with the expected expansion of corporate PAT to GDP over the next few years, we could ideally see ROE expanding to more than 20%
Such high growth coupled with high ROE is rare in today’s growth-starved world. This justifies the argument that India deserves a sustained higher multiple. Currently, the trailing PE of the entire market is at ~26x, and if we assume that there won’t be any further increase in multiples from here, then a corporate profit of $400 billion could lead to a market capitalisation of ~$10 trillion. This highlights the immense growth potential and attractiveness of the Indian market for investors.
However, the journey from point A to point B won’t be smooth sailing. As we discussed earlier, market volatility is not a flaw but a characteristic. It’s volatility that often presents us with favourable entry points. As Peter Bernstein says “Volatility is often a symptom of risk but is not a risk in and of itself. Volatility obscures the future but does not necessarily determine the future.”
Strategic Time Out – Game On
Markets are rich in valuation in a season of geopolitical news and shifts. Maintaining some dry powder will prove invaluable in seizing opportunities that may arise during market fluctuations. More importantly, it is imperative that we reduce our expectations on future returns and expand our time horizon to accommodate for market correction which is most likely in our current investment horizon.
In our base case scenario, a giant flywheel has been unleashed in India, one with several structural reforms and changes, be it supply related, being self-sufficient, in energy transition and financialisation or an impetus in manufacturing.
The wheel has just begun to roll and each turn of the flywheel builds upon work done earlier, compounding the investment of effort. A thousand times faster, then ten thousand times faster, then a hundred thousand times faster. This huge country is bound to fly forward with almost unstoppable momentum and thus continue remaining a bright spot in the investment horizon across the globe.
However, Indian markets may become further stretched, potentially reaching two standard deviations above their long-term average valuations. At such junctures, any reason could serve as a trigger for correction like current geopolitical tensions stemming from the Israel-Iran hostilities can introduce uncertainty into markets, prompting investors to reassess their risk exposure and strategies . It’s crucial to recognise that heightened valuations increase the market’s vulnerability to negative shocks.
Keeping both in mind, we continue to navigate the ups and downs of the market roller-coaster. We will make our best attempts at understanding the market cycles and how we can align ourselves to it and optimise our portfolio.
Until the next strategic time out – happy investing, and may your portfolios be as resilient as a cat with nine lives!
Warm regards, Ravi Dharamshi Founder and CIO, ValueQuest
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