Between 1870 to 1940, America became the world’s most industrialised economy. During this period, with the emergence of railroads, the telegraph, cars and roads, the American economy was ‘networked’. This joining up of America helped efficient, well capitalised companies with competitive advantages to consolidate entire industries. After a decade of pathbreaking structural reforms, India is going through a similar phase. Massive improvements in transport & communication networks, in the banking system, in the tax regime and in the way social security benefits are dispensed have allowed enterprising companies to capitalise on these changes and create mouth-wateringly valuable franchises.

India’s rise today echoes America’s ascent

The year 1870 represented modern America at dawn. Over the subsequent six decades, every aspect of life experienced a revolution. By 1929, urban America was electrified and almost every urban dwelling was networked, connected to the outside world with electricity, natural gas, telephone, clean running water, and sewers….More than 80 percent of urban homes in 1940 had interior flush toilets, 73 percent had gas for heating and cooking…In short, the 1870 houses were isolated from the rest of the world, but 1940 houses were ‘networked’, most having the five connections of electricity, gas, telephone, water and sewer…Networking inherently implies equality. Everyone, rich and poor, is plugged into the same electric, water, sewer, gas and telephone network.” – Robert Gordon in ‘The Rise and Fall of American Growth’ (2016).

The networking on the US economy in the half a century prior to World War II transformed how business & industry functioned in that country. The emergence and completion of railroad networks by the 1880s, the advent of the telegraph at the turn of the century, the arrival of the Model-T Ford in 1908 and the creation of a tarmac road network by 1940 joined up an economy which until then was a cluster of rural and regional economies. As a result, giant American companies emerged with superior R&D capabilities and with national sales & distribution networks. These companies were increasingly funded by a booming stockmarket and the first generation of investment banks (JP Morgan, Lazard, Goldman, etc).

India today is in a similar situation today as USA was between 1870-1940. The Economist, in its 14th May editorial, said “…a novel confluence of forces stands to transform India’s economy over the next decade, improving the lives of 1.4bn people and changing the balance of power in Asia…As the country emerges from the pandemic, however, a new pattern of growth is visible. It is unlike anything you have seen before…. These changes…help explain why India is forecast to be the world’s fastest-growing big economy in 2022 and why it has a chance of holding on to that title for years.” – The Economist, 14th May 2022 (source: https://www.economist.com/leaders/2022/05/13/the-indian-economy-is-being-rewired-the-opportunity-is-immense).

The four structural changes which have transformed India

As the pandemic recedes, four pillars are clearly visible that will support growth in the next decade: the forging of a single national market; an expansion of industry owing to the renewable-energy shift and a move in supply chains away from China; continued pre-eminence in it; and a high-tech welfare safety-net for the hundreds of millions left behind by all this.” (source: The Economist, 14th May 2022, https://www.economist.com/briefing/2022/05/14/india-is-likely-to-be-the-worlds-fastest-growing-big-economy-this-year).

So, what exactly has changed in India over the past decade for The Economist to take such an optimistic view of the country’s economic growth? We believe four distinct sets of structural changes are interplaying with each other very effectively to give contemporary India its growth story:

1. Change in Transport and Communication Networks: Not only has India’s highway network doubled over the past decade, air passengers have tripled, and freight corridors have reached 1,110 km by March 2021 (from zero a decade ago; source: Investec). Furthermore, the proportion of the population using the internet has risen from 8% to 43% from 2010 to 2020 (source: https://bit.ly/3O2lmtD) whilst the cost of using data has fallen sharply as evidenced in the following exhibits. In fact, India today uses more data than any other country in the world.

Just as importantly, over the past decade, retail payment settlements have shifted from being predominated by paper clearing to almost 100% electronic clearing – see exhibit 3 below. A critical driver of the digitisation of payments has been Unified Payments Interface (UPI). UPI, transactions have risen from ~USD 1 billion in FY16-17 to ~USD 560 billion by FY20-21. To put this in perspective, BHIM UPI (which is a free UPI app) transactions accounted for 15% of GDP in FY19-20 (source: https://bit.ly/3xKmkoq).

2. Tax Reforms and the Formalization of the Economy: Over the past decade India has witnessed non-stop tax reforms (both on indirect and direct tax regimes), improved enforceability, compliance and hence collections. Both, direct and indirect taxes, as a percentage of GDP, have risen materially as evidenced in the exhibit below.

As evading taxes becomes increasingly difficult, we are seeing a steady decline in the share of the ‘unorganised’ i.e., tax evading part of the economy. For example, in the plastic pipes sector, the market share of unorganised sectors has fallen very significantly over the past decade (see exhibit below).

3. Clean up of the Banking system: As is well known, bank loans to the power and infrastructure sector went sour from 2011 onwards, and by 2015, the Indian banking sector as a whole was in serious trouble. The sector has been nursed back to health in the last six years on the back of the Asset Quality Review by the RBI in 2015, the promulgation of the Insolvency & Bankruptcy Code (IBC) in 2016, and recapitalisation of some stricken public sector banks which were then merged with each other (so as to create financially viable banks). This triple punch has been very effective both in reduce the level of stressed assets in the Indian banking system and in establishing strong (in fact, record) capital adequacy – see exhibits below.

4. Jan Dhan, Aadhar, and Mobile (JAM) plus the India Stack: The unique confluence of 330 mn bank accounts set up under the Jan Dhan Yojana, the linking of the same to the unique identification number (Aadhar) and the seeding of that into app-rich smartphones which are now ubiquitous in India has led to the creation of a digitised social security network (JAM). JAM in turn has allowed the Government to make Direct Benefit Transfers or DBT with reduced leakage (to intermediaries) and with less duplication (i.e., the same person cannot claim benefits multiple times). The impact of this is far-reaching – almost a third of India’s 300 million households qualify for around USD 70 billion worth of DBT, translating to approximately USD 250 per year per household. This has in fact helped India keep poverty at bay even during trying times like the pandemic (see exhibit below).

Impact of structural changes – on the country and on smart companies

These four sets changes have had a tangible financial impact. On the macroeconomic front, financial savings as a percentage of GDP has doubled over the past 5 years.

Furthermore, the Current Account Deficit (CAD) has shrunk from 5% a decade ago to 1.5% today. This in turn has meant that the pace of INR depreciation to the USD has reduced materially over the past decade (3% vs long term average of 4%).

To the extent, current account deficit and INR depreciation are both a function of the inflation differential between India and the developed world, the structural reduction in India’s inflation rate (see Exhibit below) also bodes well for India.

All of this has obviously translated into robust real GDP growth (ten year average of 6%) despite the painful structural adjustments that the country has had to live through.

Investment Implications

At the corporate level, well managed companies have capitalised on these structural changes by: (a) improving their Asset turnover (revenue per unit of asset employed), (b) improving their EBITDA margins (operating efficiency), and (c) improving their working capital cycles (the time it takes to go from purchase of raw material to getting the customer’s cash in the bank). Such improvements have helped the companies generate more Free Cashflow and reinvestment of the same has allowed these companies to grow the scale of the business by 4-5x over the course of the past decade. We have highlighted below a few such businesses from our portfolios.

Case 1: GMM-Pfaudler

GMM-Pfaudler, with access to best-in-class technology, longstanding relationship with customers, smart capital allocation skills, and massive benefits from achieving economies of scale, has garnered massive dominance in the glass-lined reactors segment, so much so that its nearest competitor in India is just 2/3rd its size.

This has primarily been possible due to the virtuous cycle of generating far higher cashflows than peers and redeploying them to further increase its dominance by GMM and has led to capacity growth of almost 3x in the last 5 years. Furthermore, due to the better cashflow generation, GMM was able to buy out the India unit of De Dietrich, its only other MNC competitor in India, and acquire Pfaudler International. GMM-Pfaudler’s asset turnover, as a result, has kept rising from 2.31x in FY13-16, 2.53x in FY16-19, and 2.98x in FY19-22 period (source: Marcellus Investment Managers, Ace Equity).

Case 2: Dr. Lal PathLabs

Dr. Lal PathLabs, over the last 7 years, has invested heavily in technology for supply chain optimization and for upgrading the consumer interface, like live tracking of samples and AI/ML enabled recommendation engine.

This has helped company grow its collection network at a CAGR of 22% (from ~1759 to ~4731) in the last 5 years, jump in asset turnover of more than 15%, and a ZERO working capital cycle, making its turnaround time to process test samples and deliver reports to customers one of the best in the organized pan India diagnostics industry.

Case 3: Page Industries

Page Industries had invested in ERP back in 2008 when it was USD 30 million company, which helped it grow rapidly for a decade without compromising on efficiency. However, Page did not adequately invest in technology as compared to their growth subsequently, which made them face some major challenges, especially in the post GST (post FY17) period.

In the last 3 years though, Page has ramped up its investment in technology (notably employing ARS, Salesforce Automation, Blue Yonder software), leading to efficiencies in multiple layers of the production and distribution process. As a result, their working capital cycle reduced rapidly from 90 days to 70 days.

In fact, there are a number of companies in our portfolios who have benefited from these structural changes. In the exhibit below, it is noteworthy how working capital cycles have shrunk continuously for such firms, how operating margins have risen continuously for such firms and how ROCE has stayed in the mid-twenties (well above the corresponding metric for the Nifty) implying that our investee firms are generating significantly more Free Cashflow than the Nifty.

In fact, if we look at all the companies in the BSE500 and sort them each year for the past 16 years basis: (a) above average Return on Capital Employed (RoCE) and (b) above average reinvestment rate vis-à-vis all other companies (see exhibit below), we see that:

  1. Above average companies over a ten year cycle generate Free Cashflow growth of 22%. In contrast their share prices have risen by only 17% implying that there is a ‘free lunch’ of 5% per annum available to investors in such high quality companies.
  2. For the rest of the market i.e., for below average companies, the opposite is true – these companies’ share prices have compounded 5% FASTER than their Free Cashflow growth implying that such firms are being overvalued by the Indian market.

We recently conducted a webinar as well on this subject which can be accessed here: https://bit.ly/3bmQOnQ.


Nandita Rajhansa and Saurabh Mukherjea work for Marcellus Investment Managers (www.marcellus.in). Marcellus’ clients, its staff and their relatives have invested in all the stocks mentioned in this note through Marcellus’ PMS offerings.


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