MNC valuations lower than historical average: Kotak MF

INTRO: In a world where business increasingly spans borders, companies with a global footprint are proving to be some of the most resilient players in the market. That’s the premise behind the Kotak MNC Fund — a fund dedicated to multinational corporations known for their strong global brands, advanced tech, and solid financials. Harsha Upadhyaya, Chief Investment Officer and Fund Manager at Kotak Mahindra Asset Management Company, talks about the fund’s strategy and how it plans to tap into the strengths of these global giants.

Do MNCs represent a distinct and compelling category within public equity markets, significant enough to justify an NFO? What are the specific opportunities?

We have defined multinational companies (MNCs) as companies where there is a foreign promoter holding more than 50%, essentially subsidiaries of foreign companies. That's the first segment. The second segment is a company where there is a joint venture between a foreign promoter and an Indian promoter. The third category that we would be looking to invest in is an Indian-owned, Indian-listed company; however, having more than 50% of turnover coming from exports. Or with manufacturing as a base, being located outside India, accounting for more than 50%. So, that's how we have expanded the list of multinationals. Indian companies doing significant business outside India also have a chance to be included in the portfolio.

Now, why this approach? The first two categories are well-known. They have been in India for decades, and we know how they have built their businesses. They come with experience across different geographies and cycles. Obviously, their balance sheets are a lot more resilient compared to other companies in the country. Generally, over the cycle, they have demonstrated that, because of their stronger brand equity, technological superiority, and marketing strength, they have consistently grown their respective businesses.

The third category that we have added is likely to see a lot more companies joining over the next few years. In our opinion, given that many Indian companies have started to view global trade and commerce as significant opportunities. With supportive government policies and some years of export experience, companies are more inclined to increase their focus on international markets. Similarly, companies have now reached a reasonable size, comparable to global peers, where M&A activity could also take place. If they buy something outside India, then, by that definition, they can also be classified as multinationals.

We believe this universe will expand, and as for the first two categories, the fact is that many foreign companies have invested in India and are looking to list their companies here, which means that list will grow as well. And in terms of track record, there’s a lot of confidence in this basket.

Thirdly, in any market, one needs flexibility for the portfolio manager to get in and out of certain stocks and sectors. So, if you launch a narrow theme or a single-sector theme, it becomes riskier. If anything happens to that sector, you can’t simply move out. But with MNCs, if you don’t like a certain industry segment, either because of valuations or business concerns, you have the flexibility to shift to something else.

In our opinion, there are about 15 different large industry sectors available for investment. It’s essentially a subset of the Indian market, with opportunities across large, mid, and small segments. Of course, large caps dominate because most of these businesses are very large. And at this point in the market, valuations are at an elevated level. A bit of a large-cap tilt is something we would have advised our investors even in other funds where the market allows. And in MNCs, because of the way the universe is constructed, you will naturally have a tilt towards large-cap. That’s another advantage.

It seems that MNCs no longer view the Indian market as favourably as they did two decades ago, particularly in sectors such as pharma, cement and infra. Would you agree?

While that perspective may hold true for certain companies, there are also new MNCs looking to list in India. In fact, we have an MNC listing this week, with others in the pipeline. It’s not a uniform trend where all MNCs want to either enter or exit India. Each company’s decision depends on its objectives and financial situation. If parent companies are under financial strain, they may decide to leverage higher valuations in India and cash out. However, many Indian-listed MNCs continue to command premium valuations, a trend that has persisted over the years. The growth trajectory in India is different from that of mature markets, so you can’t directly compare valuations. Some may view India as an expensive market and choose to exit, while others see long-term growth potential and want to maintain a listing here. Ultimately, it depends on how they perceive valuations and what their strategic objectives are.

Over the past couple of years, it’s the industrial and capital goods MNCs that seem to be capitalising on the India growth story. Do you observe a cyclicality within MNCs, with industrials currently having their moment?

Not exactly. Each business opportunity is unique and will play out differently. Capacity growth isn’t necessarily the main driver anymore. While some industries have recently seen significant growth, making current growth in other sectors seem more subdued, these cycles can vary widely depending on the sector. Each segment's performance and growth trajectory is influenced by specific industry dynamics, so the growth trends among MNCs in various sectors will not always align cyclically.

How would you reconcile the rise of domestic Indian FMCG brands, which are capturing incremental market share from traditional FMCG companies? Are we witnessing a “new India” where FMCG companies, especially in the food sector, may not see the same kind of growth they did two decades ago?

Every company will experience its own cycle. For industrials, the cycle tends to be more pronounced compared to the more stable FMCG sector. In FMCG, fluctuations in market share and profit margins are generally less extreme. Industrial growth is currently in the spotlight because, for a good 10 to 15 years, little happened in many sectors. Now, with the investment cycle picking up, we’re seeing a significant shift in growth trajectory over the past couple of years.

FMCG, however, is not inherently cyclical, so it may not appear as attractive as industrials today simply because its growth trajectory hasn’t changed as dramatically. But when the economy moderates, industrials will likely decline faster than FMCGs, which have more resilience on the downside. During the Covid period, FMCG companies performed well, not because of explosive profit growth, but because they are viewed as resilient, lower-risk investments. Each market phase is different, and valuations will fluctuate accordingly. Today’s valuations may look very different in a few years. That’s the nature of markets—if it were predictable, we’d all be using Excel sheets to set ceiling and floor valuations. So, while the environment for FMCG may not be as dynamic as it once was, it remains a stable sector, especially in periods of uncertainty.

So, we’re not necessarily entering a cycle where industrials will overshadow FMCG and that the era of strong growth for FMCG is over?

No, we can't conclusively say that. We may see one or two quarters of sluggish profit delivery from FMCG, but a few quarters down the line, market sentiment may shift. People might feel that it’s time to move from industrials back to FMCG. After the elections, for instance, there was some movement in that direction—industrials had high valuations, so investors shifted toward consumption-driven sectors, hoping for a strong rainy season and better performance in agriculture, for example. These are normal market reactions and outside of anyone’s control. Both sectors have significant opportunities in a growing economy like India. FMCG will generally be more stable, with less extreme swings. It won’t see 50% growth or a 50% decline. In contrast, certain industrial companies could experience that kind of volatility. The key difference is that FMCG operates within a narrower band, offering resilience, while industrials may show higher growth but with greater cyclicality.

Another aspect of MNC investing is that, for certain sectors such as mobile phones, there are no major mobile phone brands available for direct investment, so you’re left with proxy plays, such as contract manufacturers. Does the limited depth of proxy play in MNCs constrain you to a subset of companies, giving you very few choices? Is that why you’ve created a new subset of Indian-owned companies with significant international business?

Creating the third subset isn’t due to restrictions; it’s because we see a growing opportunity for Indian-listed entities to expand internationally. In the early 2000s, outside of IT, very few companies focused on exports. Today, however, we see more industries, such as electronics and auto components, positioning India as a potential global trade hub. As industries like electronics grow, India can follow the path of other Asian economies. However, India hasn’t historically had the same manufacturing ecosystem as places like Taiwan. It takes critical scale to compete globally, but we believe many sectors are approaching that level. Some already have, and others are moving in that direction. That’s why I said that while today’s universe might be limited, it’s likely to grow as Indian companies with international ambitions increase in number.

Do you think the premium that India has traditionally held is widening? At the overall market level, valuations have increased. Specifically for MNCs, would you say the current valuations are still comfortable?

Yes, if we look at the long-term average price-to-earnings ratio for MNCs, it used to be around 36 times one-year forward earnings. Today, MNCs are quoting at about 31x one-year forward, which is lower than the historical average. In contrast, many non-MNC companies have performed exceptionally well in recent years, pushing their valuations up significantly.

This current valuation level reduces the risk for new investors looking at MNCs, especially compared to other segments. That’s also one reason we considered this a good time to launch a fund focused on MNCs. We wanted to ensure an attractive valuation for investors while also focusing on the resilience of these businesses. So, from both a resilience and valuation perspective, MNCs are appealing in the current market environment.

Do you see the Production-Linked Incentive (PLI) scheme eventually driving the growth of companies in sectors such as high-end electronics, potentially leading to more public listings across the manufacturing sector?

Definitely. Just look at the semiconductor space, where close to one lakh crore rupees are being invested in facilities in Gujarat by prominent players. Tata, for example, has earmarked a significant portion of this investment. With that level of investment, over time, there will also be ancillary businesses setting up around it. If you consider how Pune and Chennai evolved into major auto hubs, or how Maruti and Hero Motors helped create an automotive ecosystem in the Manesar-Gurgaon belt, a similar trend could emerge in the semiconductor and electronics sector. Currently, India doesn’t have a mature semiconductor industry, but three to five years down the line, we could see the growth of not only semiconductor companies but also their supporting industries. This should lead to more public listings, although it’s difficult to predict what shape these companies will take or how they’ll be valued at that time.

When comparing growth opportunities between MNCs and homegrown companies, do you still see MNCs as having a distinct advantage, or is it more nuanced, with growth potential varying across different sectors?

It’s definitely more nuanced; the market isn’t homogeneous. MNCs include industrials as well as more stable businesses, and each industry represented within MNCs will have different growth dynamics and valuation profiles. The advantage of this investment product is that I’m not restricted to a single segment. For example, if you only invest in FMCG, you’re tied to that industry regardless of changes in consumption patterns or valuations. With MNCs, I have access to nearly 15 different segments with reasonable depth, giving me flexibility across industries. We currently have a universe of close to 190 companies, which is sufficiently large to allow diversified opportunities within the MNC space.

Do you see a longer runway for growth in industrials, especially with expectations that private capex will eventually pick up?

In the medium to long term, industrials definitely have a strong growth trajectory. However, the entire sector has already seen substantial re-rating over the past three years, along with other parts of the market. Moving forward, I don’t believe we’ll see uniform performance across the sector, as investors will increasingly seek fundamentals to justify valuations. There will likely be some correction in valuations at some point, though it’s hard to predict exactly when. I think that, rather than seeing sector-wide growth, we’ll move toward more stock-specific performance. The focus will shift to individual companies with strong fundamentals, rather than the sector as a whole continuing to hog the limelight.