India to Foreign Retailers: Not So Fast!

Developing nations such as China have helped the global economy eke out marginal growth amid the worst financial crisis in a generation. These markets have rewarded investors with significant gains for decades and rapid urbanization, low levels of sovereign and household debt, and a rising consumer class will spur growth for another decade.

But it’s no a cakewalk for investors. In addition to strong growth prospects, developing nations also come with political instability, rampant corruption, and low levels of corporate transparency. Investors who want to tap this growth without developing an ulcer often choose to invest in multinational firms with extensive operations in these developing nations. They sacrifice some of the growth they would get from an investment in a pure emerging-market stock, but in return they receive some peace of mind.

News from India last week demonstrated one of the challenges of following this strategy. Indian lawmakers abruptly backtracked on plans to liberalize its $450 billion retail market and allow foreign retailers greater freedom to operate in this potentially lucrative market. The surprise move demonstrates mounting political paralysis in India and a growing sense that India, despite its democratic leanings, remains far less hospitable to foreign business than ostensibly Communist China.

India continues to grapple with rising inflation and the country’s finance minister recently reduced the country’s growth forecast amid an uncertain outlook for the global economy. India will release a bevy of economic data this week, but slowing exports are expected to result in a 0.5 percent year-over-year decrease in industrial output in October. Even with these economic headwinds, India’s mid-year review calls for growth of 7.25 percent to 7.75 percent for the fiscal year ending in March, enviable economic growth, though this is down from an original forecast of 9 percent.

Multinational retailers such as Wal-Mart Stores (NYSE: WMT), Carrefour (Other OTC: CRRFY.PK) and Tesco (Other OTC: TSCDY.PK) are retooling their strategies for India. But the recent decision by Indian policymakers demonstrates the challenges these companies will face cracking this market. Here are two US-listed Indian companies that should benefit from India’s continued growth.

HDFC Bank (NYSE: HDB), India’s second-largest lender, recently announced plans to add four million credit card users in the next two years, bringing the number of credit card customers to 10 million. The company has grown its profit by at least 30 percent each year for the past decade and has added almost two million customers per year, according to recent comments by the firm’s managing director, Aditya Puri. The firm boasts deep penetration in India’s rural markets with more than 2,000 branches and about 6,000 ATMs in more than 1,000 Indian cities. The bank’s success has not gone unnoticed by investors, leaving the stock reasonably priced at a forward price-to-earnings ratio of 17.5 and a price-to-book ratio of 4.1.

Tata Motors (NYSE: TTM) controls 62.7 percent of India’s market for commercial vehicles. Tata Motors is also the third-largest producer of passenger vehicles in India, a segment that’s grown by a compound annual growth rate of 17 percent over the past five years–this growth is a secular trend supported by a low car density rate of 8 cars per 1,000 people in India. To fend off rising competition from domestic and foreign rivals, Tata Motors has released the world’s smallest and least expensive car, the Nano, which sells for under $3,000. Early reviews and sales of the Nano have disappointed, but the company has embarked on an aggressive marketing campaign to combat flagging sales.

Tata Motors in 2008 bought the beleaguered Jaguar-Land Rover brand of luxury cars from Ford Motor (NYSE: F). Jaguar-Land Rover sales have been strong in China and Russia, two key markets for future auto sales. The stock’s forward price-to-earnings ratio is only 6.3 (i.e., cheap valuation) and its return on equity for the 2011 fiscal year is a sky-high 47.5 percent (i.e., very profitable).