INCO - INCO: Invest In The Most Populous Nation Via The Indian Consumer

2023-05-17 14:19:27 ET

Summary

• The Columbia India Consumer ETF's winning run looks set to continue this year following the April/May rally.
• With the near-term setup improving post-earnings season and demographic tailwinds also boosting the long-term outlook, there remains a lot to like about INCO.
• A lot of the positives are priced in at current valuations, though given the growth and ROE generation potential of the portfolio, investors could still come out ahead.

Per the UN , India is now projected to be the most populous nation in the world this year – almost four years earlier than prior estimates. Beneath the surface, however, the implication of this demographic shift isn't as straightforward. On the one hand, India will benefit from a relatively younger population (i.e., a 'demographic dividend'), yet a disproportionate number of Indians live in rural areas. This entails significant value accrual for consumer franchises with the distribution capabilities to penetrate the scale and complexity of rural India. Case in point – Indian consumer leaders such as Hindustan Unilever and Nestle India have been able to leverage their moats into consistent high-double-digit percentage ROEs through the cycles. In the near term, the setup is improving as well. Recent trading updates point to an emerging rural demand recovery , and with the Indian consumer sector also entering a deflationary input cost environment (mainly from the raw materials/commodities downcycle), further margin expansion is likely on the cards. Valuations don't screen as cheaply following the rally in the sector-focused Columbia India Consumer ETF ( INCO ) since I last covered the name. But relative to the quality of the portfolio holdings and the growth potential, there remains ample upside potential from here.

Fund Overview – Gain Low-Cost Exposure to India's Leading Consumer Franchises

The US-listed Columbia India Consumer ETF tracks, before fees and expenses, the performance of the market cap-weighted Indxx India Consumer Index, which comprises India-listed companies operating in the consumer sector (staples and discretionary, as defined by Indxx). Per the latest disclosures, the ETF maintained a 0.77% gross expense ratio (0.75% net of waivers and reimbursements), making it a cost-effective option for US investors looking to gain single-country/single-sector exposure to the Indian consumer. A summary of key facts about the ETF is listed in the graphic below:

The fund's sub-sector allocation continues to lean toward discretionary at 53.2% (albeit below the ~56% contribution prior), with the remaining 46.8% allocated to staples. By industry, the portfolio composition is largely consistent with prior reporting as well. Automobiles remain by far the largest allocation at 28.6%, though the industry's portfolio weightage is down from ~35% prior. Food Products has been the most notable gainer, reaching 18.0% of the fund (up from ~14% prior), while Personal Products has declined to 13.4% (from ~17% prior). Automobile Components (7.7%), Textiles Apparel & Luxury Goods (7.2%), Beverages (5.6%), and Hotels, Restaurants & Leisure (5.6%) are the other industries with a >5% allocation. On a cumulative basis, the top five sectors accounted for ~75% of the total portfolio, a positive improvement from the ~81% previously; that said, the combination of automobiles and related components continues to stand out as the key source of industry concentration at 36.3%.

In line with the Indxx India Consumer Index's 30-stock cap, the INCO portfolio only maintains 30 holdings at any given time. The largest single-stock exposure remains automotive manufacturer Mahindra & Mahindra ( MAHMF ), though its weightage has declined by more than 2% to 5.5%. Food & beverage giant Nestle India ( NSZTY ) is the biggest gainer this time around, with a 5.5% allocation, along with jeweler Titan Co., Ltd ( TQTQY ) at 5.4% and two-wheeler manufacturer Bajaj Auto at 5.1%. Diversified Indian conglomerate I.T.C. Ltd. ( ITCTY ), formerly the second largest holding, has seen its weightage decline to 5.1% (down from ~7% prior), with food company Britannia Industries ( BRTQY ) and Indian consumer goods company Hindustan Unilever also dropping down the list. Following the reshuffle, the concentration of INCO's top five holdings has declined to ~6pts to ~27% of the portfolio. Given the limited number of holdings, the INCO fund is fairly spread out from a single-stock perspective.

Fund Performance – Exceptional Compounding Track Record

The ETF has been on a tear over the last month, driving its YTD return to +7.4% and annualized return since inception to an impressive >9% (in market price and NAV terms). By comparison, the iShares MSCI India ETF ( INDA ) has lagged YTD at down 1.5%, while over longer time frames, INCO has outperformed by a wider margin. At a ~1.6%pt delta to the index over the fund's life, however, the tracking error is fairly wide - even after accounting for the expense ratio.

The annual distribution payout isn't as attractive. While the trailing twelve-month yield stands at >10%, most of this was due to the realization of capital gains. Filtering out the recurring income portion of the yield, INCO would have only yielded <1%, so income investors should probably look elsewhere. Growth investors, on the other hand, will find a lot to like about INCO, given its portfolio companies' proven ability to deploy excess cash into high ROI opportunities (reinvestments or M&A). Another area where INCO will divide investors is on the valuation – the portfolio comprises best-in-class consumer names with extensive runways, but this is reflected in the 39.5x trailing P/E (weighted harmonic average) and 6.5x P/B (weighted average), both multiple turns above the MSCI India Index constituents.

Invest in the Most Populous Nation Via the Indian Consumer

India is set to take the 'most populous' nation crown from China far earlier than most had expected; if the current trend sustains, its lead could even double in a few decades. Having a big population doesn't necessarily translate into economic prosperity, however, particularly with the Indian population still largely less educated and concentrated in rural areas. On the other hand, the relative youth of the average Indian means the economy will benefit from a 'demographic dividend' at a time when many developed markets are at the opposite end of the demographic cycle.

Plus, Indian companies understand their markets very well, particularly on the consumer side. As a result of their vast distribution channels and ability to connect with a diverse range of consumers (e.g., North and South Indian consumers tend to have very different needs), companies like Nestle India and Hindustan Unilever have built huge economic moats that translate into sustained double-digit percentage ROEs through the cycles. In the near term, the Q1 earnings season is off to a good start as well, with management commentary suggesting an improved rural demand outlook, as well as input cost tailwinds from a deflationary commodities backdrop. As always, the catch with investing in India is the valuation – at >30x P/E, the INCO portfolio isn't cheap by any stretch, and more value-conscious investors may want to wait for a pullback. Relative to the sustained double-digits percentage ROEs and earnings growth offered by best-in-class Indian consumer stocks, though, investors should still come out ahead at these levels.

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