Shifting ROCE attitudes are sparking role reversal in China and India markets, says Samir Mehta of JOHCM Asia ex Japan.
Businesses are commercial opportunities, spotted by risk-taking entrepreneurs with access to capital and other resources. Traditionally, companies need competitive ‘moats’ to deliver sustained high returns on capital employed (ROCE).
But, like much else in the world, these moats are no longer stable. The internet, strident monetary actions by central banks, government policies and ideological competition have drastically modified the way moats are built, and more importantly, destroyed.
These momentous changes can be encapsulated by the mantras of world-leading entrepreneurs:
• Deng Xiaoping’s astute strategy: “Hide your strength and bide your time;”
• Jeff Bezos’ simple focus: “Your margin is my opportunity;” and
• Masayoshi Son’s bold declaration: “In our industry, winner takes all.”
China directed its state apparatus to foster industries from scratch. Amazon became laser-focused on the long-term with nary a care for short-term losses. Softbank invested copious amounts of capital in one industry player with an explicit directive of killing competition and emerging as a winner through the carnage.
What triggered the rise of a bull market in Chinese stocks while at the same time the start of a bear market in India? Was it just foreign investors shifting interest from India to China? Or Mr. Xi Jinping recognising the folly of his ideology and having a change of heart? A ‘DeepSeek’ moment? Or because in President Donald Trump’s world, perceived allies are worse than avowed enemies, and thus provided India with an escape from harsher tariffs?
While one can never be sure of the root cause, we believe one thing is clear: There has been a big role reversal in the attitudes of managements toward profits and ROCEs in the two countries.
Up until the pandemic, China Inc. epitomized the three mantras above. A heady mix of abundant low-cost capital, regulatory help (including subsidies), strong appetite for scaling business, and a priority for market share over profitability defined most business. Despite many ambitious, talented entrepreneurs with varied opportunities, few companies achieved the sort of haloed status Mr. Warren Buffett might enjoy.
India Inc. was the opposite. Companies were over-burdened by high capital costs, complex governmental regulations, and entrepreneurs with softer ambitions, including those prioritizing high ROCEs above all else.
Since 2021, China’s economic growth has slowed as a result of regulatory crackdowns, a housing market bust, and geopolitical headwinds. Venture capital investments slowed to a trickle; several businesses, including start-ups, shut down. The stock market tanked, and foreign capital withdrew. A deflationary slowdown prompted local investors to buy more bonds and to shun equities.
Following the pandemic, India became the rising star, benefiting from the ‘China plus one’ strategy, with global companies diversifying away from China to minimise supply-chain risks. A production-linked incentive scheme (tax benefits) in India also encouraged large-scale incremental manufacturing. Soon, confidence was growing that India could achieve GDP growth of 7-8% pa over the next decade. If China had reached this milestone in the past, why not India?
India’s downdraft
India’s stock market boomed. Corporate earnings grew while China struggled. Equity valuations skyrocketed, trending closer to twice the mean valuations compared to the past decades. Retail investors, global asset allocators, venture capitalists, even China-focused hedge funds wanted to invest in India.
What went unnoticed was a loosening of financial discipline under this illusory guise of assured growth. High ROCEs in many industries attracted new entrants as conglomerates, nimble start-ups, and medium-sized firms backed by venture capital, chose to attack incumbents. High equity valuations, cheap and plentiful venture capital and unfettered ambition became a heady cocktail.
In India, the paint industry was a cozy oligopoly led by Asian Paints. Decades of steady growth, high margins and sustained high ROCEs meant even its smaller competitors thrived. While some international companies attempted to build a business and break through, they struggled to break up the oligopoly.
Grasim, part of the Aditya Birla group, a manufacturer of viscose staple fiber and chemicals, was unphased. They invested upwards of Rs100b (US$1.25b) over three years, setting up six manufacturing plants. For context, Asian Paints invested approximately Rs.97.2b over the past decade.
Source: Bloomberg. Data as of 13 March 2025.
Another example is Zomato, which started out as a restaurant aggregator and grew into a formidable food delivery platform. Following an acquisition of Blinkit, the company expanded into quick commerce to deliver groceries and goods to consumers within 10-15 minutes, via ‘dark stores’ or warehouses.
Swiggy (recently listed; venture backed firm), Zepto (unlisted; venture backed), Reliance Industries, Flipkart (owned by Walmart) have already committed several millions in investments chasing this opportunity. Other potential competitors, Tata Neu and Amazon Fresh could also enter the fray.
Elsewhere, Ultratech Cement announced its entry with a US $200 investment in manufacturing cables and wires, another oligopolistic sector. Shares of Polycab and KEI Industries promptly fell 25-30% in less than a week. And Reliance Industries has begun expanding into carbonated soft drinks through its brand, ‘Campa,’ at a much cheaper price, threatening ROCEs of Pepsi bottler Varun Beverages.
There are numerous other examples.
Source: Bloomberg. Data as of 13 March 2025.
Meanwhile in China, years of competition have now shifted to serious consolidation. In the electric vehicle space, just six to eight serious competitors, out of the roughly 80-100 start-ups and brands over the past two decades have survived.
Build Your Dreams (BYD), the clear winner, has achieved scale through cost and technological leadership; BYD’s ROCE has increased from 7-12% pre-pandemic to 25-30% over the past three years.
Source: Bloomberg. Data as of 5 March 2025.
In music streaming, Tencent Music is nearly a duopoly with Netease Music, though Bytedance remains a marginal player. Despite slashing their marketing and sales spend by 75% from its 2019-20 levels, the platform has gained subscribers and substantially increased gross margins.
Source: Bloomberg. Data as of 5 March 2025.
Full Truck Alliance, similar to an Uber for logistics, has emerged from the downturn to become one of the strongest competitors matching shippers and truckers of cargo. Its ROCE has risen from negative levels pre-pandemic to 9-11% and could potentially double over the next three to five years as they gain scale and operating leverage.
Bull or bear in the East?
Capital and competition go through phases.
While we don’t suggest that these changes in China are permanent, India’s corporate ROCE’s are waning, while those for China are ascending.
When structural changes in industry dynamics (higher ROCEs) merge with investor apathy (low valuation multiples), the resulting profit growth and valuation for stocks can surprise on the upside over the long-term.
In our view, this bull market in China — in many stocks — has legs. If the Chinese authorities provide additional stimulus, or if President Trump agrees to a tariff deal, we could present arguments for capital to chase what appears to be a structural pivot.
RISK CONSIDERATIONS: The strategy invests in international and emerging markets. International investments involve special risks, including currency fluctuation, lower liquidity, different accounting methods and economic and political systems, and higher transaction costs. These risks typically are greater in emerging markets. Such risks include new and rapidly changing political and economic structures, which may cause instability; underdeveloped securities markets; and higher likelihood of high levels of inflation, deflation or currency devaluations .
The views expressed are those of the portfolio manager as the date of posting, are subject to change, and may differ from the views of other portfolio managers or the firm as a whole. These opinions are not intended to be a forecast of future events, a guarantee of future results, or investment advice.
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