Market traveler

We visited India and saw a transformingeconomy. Industries from grocery retail to finance are evolving.

The markets often focus on India’s short-term consumer activity. However, there’s more to the story.

Policy, tech disruption, and structural shifts are key factors in India’s journey. Here’s our first-hand look.

India up close: A transformation storyUpon stepping off the plane from our recent trip to India, one thing was clear to me: There’s no shortage of color. You see it in how consumers dress, blending Western garb with vibrant local apparel like saris. You see it in how consumer brands package their goods to attract the consumers. Of course, outer packaging only tells part of the story—true in life and in retail.

Playing off that theme, we believe India’s economy is about more than surface-level impressions of consumption. Yes, it’s a major economic driver. But we don’t judge India’s investment space by short-term consumer activity. Rather, we’re interested in the stories behind the consumer:

• Companies’ moves to capture shifting demand

• Government reforms that can enable growth

• Structural improvements for living and business conditions

In this piece, we’ll recount what we saw firsthand in June on the streets of India, in its shopping malls, and in a convening of institutional investors where attendees forecasted tech-driven disruption and the need for government reform.

So where should we start? The mall. In our jobs as emerging market investors, we can gain insights through research in our offices. But it’s more enlightening to wander around stores in the countries we invest in to gauge the retail experience and see how brands compete for market share.

—A. Shimada

Alison ShimadaSenior Portfolio Manager, Head of SF Global Emerging Markets Equity Team

Mandeep Manihani, CFA®Analyst, Wells Fargo Asset Management

September 2019

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How India’s brands and grocers are evolving to meet new demandOn the top floor of Mumbai’s Atria Mall, we browsed the Indian supermarket retailer Big Bazaar’s grocery store. Our goal: Get an in-person look at the region’s consumer staples sector. The industry is among the strongest of India’s structural growth stories, but at existing valuations of 40–60x price/earnings, we’ve struggled to see much value. Our biggest takeaway: The grocery retail experience in India is shifting with modern trade.

International and India-based consumer giants had a strong presence across all major product categories at the store. They commanded shelf space and offered goods that cater to all aspects of daily life. Big Bazaar, which started as an everyday low-price store, appeared to be taking on an increasing premium strategy. Three trends were clear:

• A wide range of products geared toward consumers with busy lifestyles

• Storewide, more health-focused and natural offerings at a higher price point

• A variety of ayurvedic, or holistic healing products, geared toward the mind, body, and spirit

Is the strategy working? For starters, the convenience of finding practically all of one’s grocery needs under one roof is a compelling value proposition. This is especially relevant for the Indian middle class, who are embracing the modern retail format. In fact, I ran into my friend from graduate school and his wife in Big Bazaar who, while shopping, confirmed the modern format’s practicality and rising popularity among consumers—especially India’s young professionals.

Historically, India’s consumers have shopped daily for fruits and vegetables at small neighborhood shops …

It was intimate and rooted in tradition: Customers could pay their bills to the shop owners at month-end.

However, the experience was inconvenient. People would visit several shops in one trip to prepare for meals.

Enter the modern supermarket retail format:

25%Supermarket growth in 20181

375Stores Big Bazaar parent company

Future Retail aims to open by 20222

700 millionMillennials and Generation Z consumers in India by 20303

Sources: 1. Nielsen India, 2. Nikkei Asian Review, 3. Bain & Company

India’s market is willing to pay a premium for companies that run the right product portfolios. This is especially clear given the potential of India’s massive consumption economy. However, as we moved from aisle to aisle, it was evident that competition across products is extreme. Building brands and innovating go a long way. Here, major staples brands shined and had the fastest-moving products.

For example, domestic giant Marico’s Saffola “FITTIFY Gourmet” sub-brand aims to capture the rising health focus of consumers with a busy lifestyle. Marico extended its portfolio to offer ready-to-eat meals, from breakfasts to dinners. The meals occupied substantial space in the health food aisle and resonated with me the most. We don’t know if these innovative products will one day become consumer brands’ revenue drivers. But long term, we believe the reward for getting it right will be huge.

—M. Manihani

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The macro story: Modi 2.0 and structural reformsStrategic moves can help Indian brands seize opportunities in the consumer economy—but for the economy itself to grow, significant reforms must take place.

As our plane descended in New Delhi, our optimism about India’s economy was high. Mr. Narendra Modi had just had a thumping reelection victory, which meant we as investors could expect continuity of his pro-reform policy agenda. There had been some lingering concerns related to the liquidity crisis at nonbank financial companies (NBFCs) and the ensuing growth slowdown. However, investors like us hoped the government would address the issues and pass a fiscal stimulus for ailing sectors.

These hopes quickly began to dampen.

On the first day of our trip, we attended “Macro Day” at the Citi Conference in New Delhi. The event set a somber mood for the trip, which was only reinforced in the coming days. The idea of bailing out troubled NBFCs (see page 4) was an unpopular one, as the government doesn’t want to be seen as a supporter of “private gains, public losses.” Indeed, three issues were clear:

1 There was no quick fix to the problem.

2This was not fully appreciated by the market, especially considering banks had little confidence in the quality of NBFCs’ books.

3Fresh off a massive election victory, there was little urgency to quickly prop up the economy.

It’s fair to say Mr. Modi is working with longer-term structural objectives. His team did a commendable job in its first term with sanitation, connecting villages with roads and electricity, and providing cleaner cooking fuel to the poorer strata of the society. As people in India move into the middle class—still small at less than 100 million out of 1.35 billion—their concern over health and well-being for their families only grows.

These infrastructural achievements explained why Mr. Modi’s election results surpassed investors’ expectations, despite passing tough reforms. This includes a goods and sales tax (GST) that’s proved logistically difficult for businesses to adapt to while creating winners and losers among smaller and larger brands.

—A. Shimada

Cooling off versus consuming

Baskets might have been full at Big Bazaar, but not so much at other mall retailers.

From the minute we arrived in India, our senses were greeted by the smell of air conditioning units working overtime in a very hot climate (that, with a side of air fresheners and, of course, delicious-smelling food). The same was true at Pavilion, the high-end shopping complex where we studied the retail experience. I’ve always argued that brick-and-mortar retailers would face disruption. But the category seems to have more staying power in India than in the West. Why? The role of air conditioning in the consumer experience.

We saw crowds of window-shoppers as we passed by clothing shops, smartphone stores, and car showrooms. But relatively few were purchasing. Instead, they came for comfort. In India, people need a place to escape the regular 85- to 100-degree heat. In early June, a countrywide heatwave pushed temperatures up to 115 degrees in some parts of India. In response, people visit malls to eat with friends, watch movies, and shop—if not purchase.

Case study:How India’s goods and sales tax (GST) affects the competitive landscape

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About 30 of us investors gathered in the basement of a high-end jewelry store in New Delhi. That’s where we learned how a new tax system helped the retailer leapfrog past its competitors.

We visited Tanishq, a high-end jewelry retailer under which Indian consumer goods company Titan operates over 270 stores across 160 Indian cities. The New Delhi location was huge, showcasing two levels of collections. On the walls: life-size posters of Tanishq’s brand ambassador, a Bollywood actor, donning Tanishq wares. A long line formed, as staff greeted and engaged incoming customers.

Why wasn’t this store as affected by the current slowdown of India’s consumer economy? In our basement Q&A session, the store manager and staff explained the structural drivers.

Smaller regional players and family

jewelers dominatedIndia’s jewelry retailindustry for years.

However, the advent of GST—which,

logistically, has been challenging for

smaller businesses to adapt to—also

made it difficult to avoid a tax on gold.

Meanwhile, a few jewelry industry scams dried up

financing for smaller, unorganized players.

These factors prompted Indian

consumers to gravitate toward

established, trusted brands like Tanishq—in turn, accelerating smaller competitors’ exit from the market.

Titan has been the biggest beneficiary of these changes while leveraging its brand strength and financial position. However, vanishing competition can only get you so far. Brands still need to make money. The store manager explained Tanishq is launching 250 new collections every quarter and making the consumer-purchasing journey easier from strong exchange terms to special offers. Titan sees large upside potential in the bridal jewelry market. With another full week of wedding days in fiscal year 2020 (39 days) versus 2019 (32 days), the store manager was hopeful that more wedding vows would give way to more revenue.

—M. Manihani

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Why NBFCs matter and financial reform is keyPrime Minister Narendra Modi has his work cut out. He must solve a crisis that’s partially due to not addressing financial system weaknesses in his first term. The issue: nonbank financial companies. In recent years, NBFCs proliferated to occupy the space vacated by badly run state-owned banks that ran out of capital and struggled with bad loans. NBFCs rose quickly among ineffective oversight.

NBFCs form over 20% of India’s financial system credit, and the economy is feeling the impact of slower credit growth. Two NBFCs have failed, and many in India are raising accusations of corruption and poor corporate governance.

We believe the government needs to ensure the stress is contained, while regulators need to ensure tighter rules on NBFCs’ risk concentration and asset-liability management. It goes without saying they must also reverse the tide of sluggish credit. The property sector is at the core of NBFCs’ stress. Government efforts to lift the property sector should help normalize the sentiment and lending. The jury is still out on economic growth, which is facing the fallout of demonetization and GST.

Modi’s government needs to ensure the teething problems of GST are gone and that the bankruptcy court is working efficiently.

Start-up disruption fueled by private investment and data usageAt the Morgan Stanley India Summit, the local heads of Bain Capital, TPG, and other private equity firms articulated a big theme they see developing in India: funding consumer technology start-ups amid a data consumption boom. The private equity firms see a marketplace for new e-commerce delivery platforms, ranging from grocery delivery services to digital payment platforms. These ideas may be a given in developed markets—but remember, in some emerging markets, digitization of older business models is still in early stages.

Are economic conditions in India conducive for building a start-up marketplace? Consumer spending on goods may be sluggish. But data usage is skyrocketing in India with consumers’ growing internet and mobile use. This was a major topic in the summit’s analyst meetings and presentations. More than ever, people in India are online watching videos, using social media apps, and searching with Google.

In 2016, there were only 20 Indian YouTube channels with greater than 1 million subscribers.

Now, in 2019, there are 600 India YouTube channels with more than 265 million monthly active users.

This makes India the site’s largest and fastest-growing audience in the world, according to YouTube.

Consumption of high-data video content on mobile devices is now 85%, with 60% of the viewing time originating from outside of India’s six largest metro markets.

Source: YouTube

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We think data usage is likely to continue at a fast pace. India currently has the cheapest mobile data in the world, at $0.26 per 1 gigabyte of memory. And this proliferation of cheap data rates has led to a marked increase in internet access.

How cheap is India’s data for consumers?

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6

8

10

12

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abyt

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mem

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Source: Cable.co.uk (a price comparison website for consumer telecom services)

Will low-cost data be sustainable? Not likely. India’s telecom sector is highly concentrated, with three major players controlling over 90% of the market share in subscriber and revenue terms. These firms are underpricing data as they fight for subscribers—but that won’t last. When the war for subscribers nears an end, telecoms would be in a sweet spot to leverage data-hungry customers. We believe that—even when data costs rise—Indian consumers will prioritize mobile phone expenditure as an important area of discretionary spending. It’s hard to give up one’s ability to pay for services by phone, contact friends and relatives easily, share information, and of course watch YouTube.

—A. Shimada

How data and disruption can enhance India’s financial sectorIn the realm of India’s technology story, you may have noticed that we aren’t talking about businesses that outsource services to developed economies. Instead, we’re focusing on the theme of inward transformation—companies small and large that can elevate technology to become a driver of the country’s domestic economy.

Certainly, this includes start-ups. India’s digital ecosystem is supporting new business ideas that are helping independent tech start-ups mushroom and turn into unicorns at a fast clip. But it also includes large, established players seeking to launch internet-related businesses or use the internet to transform themselves. For example, India’s move to a data-driven economy has implications for its financial sector. While almost 80% of the population has a bank account, about half of these accounts are inactive, according to the World Bank. Meanwhile, a significant number of Indian consumers do not take advantage of formal credit facilities.

To us, this indicates the Indian financial sector has a long way to go in ensuring real financial inclusion among India’s citizens—and it has an opportunity to penetrate underserved markets.

A shift to online banking could help in two ways. Indian banks view digitization as an increasingly important driver of cost efficiency. SBI, India’s largest bank by asset size and branch network, has already moved 80% of its transactions outside of physical branches to the digital route, helping lower costs. Digitization is also a tool that, with adequate infrastructure in place, could bridge the financial inclusion gap—for instance, as a way to engage those with lack of logistical access to bank branches.

We believe online banking adoption among India’s consumers should accelerate with rising smartphone penetration. This can make it easier for banks to reach and engage customers about financial products and services.

Indian banks also have a chance to penetrate the market of small and medium enterprises (SMEs). Historically, India’s organized financial sector hasn’t served SMEs appropriately, due to an inability to accurately assess their risk. Here, technology and government reform are converging to create opportunity. Banks can better engage and serve SMEs through the trifecta of digitization, data collection, and GST (helps increase transparency of SMEs’ financial statements).

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Case study:A financial brand grows with use of data-driven technology

Bajaj Finance (BAF) is a leading NBFC in India’s consumer space. The firm has been adding close to 2 million new customers each quarter, with a current customer base of 37 million customers.

At the Morgan Stanley conference, the rooms were packed for BAF CEO Mr. Rajeev Jain’s presentation and group meeting with investors. He described how his company is using data to grow its business, gain competitive advantage, and manage risks.

The firm has been adding close to 2 million new customers

each quarter, with a current customer base of

37 million customers.

Amid other well-known issues around NBFCs, they have a significant information gap about consumers compared with India’s banks. So, BAF is using technology to close that gap and improve its business, focusing on:

• Enhancing customer acquisition

• Improving underwriting and collections

• Lowering costs

BAF has been building capabilities around collection efficiencies, which have consistently improved from below 80% in recent years to 99% today. This is an important driver of profitability. Despite the sharp growth, BAF has maintained strong asset quality with healthy coverage ratios.

Mr. Jain made it clear that BAF’s focus on technology is only expanding:

• BAF is the lar gest user of the Salesforce platform in that part of the world with 60,000 licenses.

• It’s the first company in India to transfer its enterprise data warehouse to Azure cloud.

• The company is now actively investing and deploying capabilities in AI, machine learning, facial recognition, and natural language processing.

• T oday, BAF has about 2,500 data variables on each customer, but all are structured, and these technologies would enable data mining on semi-structured and unstructured data, fueling further gains in efficiencies.

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Final takeaways: As India develops, we see growing opportunitiesTo recap, we believe investors should focus more on the longer-term structural story in India rather than just consumer trends and short-term cyclical changes. In Mr. Modi’s second five-year term, he can now work on tackling some of the larger development issues beyond financial reforms.

His administration’s net target is to see the Indian economy grow to $5 trillion by as soon as 2024. Is this possible?

Today, India is not on the map of obvious winners from the ongoing trade spat between the U.S. and China. What’s more, in the World Bank’s Ease of Doing Business Index, India continues to lag at 77th place worldwide. Still, the country is up from its 142nd ranking in 2014. And breaking into the top 50, as the Modi government aspires to do, would go a long way in improving India’s investment climate.

Reforms on our radar include:

Water conservation and management: Building upon his progress in improving water sanitation, Mr. Modi plans to ensure piped water to every rural home by 2024.

Agriculture: Mr. Modi wants to improve farmers’ livelihoods through better investments, logistics, and market support. The end goal: double farmers’ income by 2022 and reduce their dependence on government bailouts.

Land and labor: Looking ahead, we envision India’s government applying serious deliberation to big-ticket land and labor reforms, likely in late 2020 or 2021.

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We see promise in these infrastructural improvements. The development of India that we’ve witnessed reminds us of Southeast Asia’s development stage in the 1990s:

• Public infrastructure mainstays such as subways are now underway in major cities that increase efficiency and alleviate major traffic jams

• Roads being upgraded and modern airports that are now operational

• The formation of the middle class, who will continue to drive greater consumption of travel and leisure, financial services, and telecom services

• A segment of the population that is young, educated, and upwardly mobile

• Exposure to growth sectors such as health care and information technology

Having been on the ground in India enables us to envision how all of this can take place. As we boarded our flight home, we traded notes and ideas. The macro story in India is indeed full of challenges. But we like the prospects of how a reform-minded government might help business. It could take time before those reforms bear fruit for everyone, and in the meantime, we appreciate how certain businesses are capturing market share in a time of uncertain but hopeful socioeconomic change.

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The views expressed and any forward-looking statements are as of September 18, 2019, and are those of Alison Shimada, portfolio manager; Mandeep Manihani, analyst; and/or Wells Fargo Asset Management. Discussions of individual securities, or the markets generally, or any Wells Fargo Fund are not intended as individual recommendations. Future events or results may vary significantly from those expressed in any forward-looking statements; the views expressed are subject to change at any time in response to changing circumstances in the market. Wells Fargo disclaims any obligation to publicly update or revise any views expressed or forward-looking statements.

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