SINGAPORE (July 17): The Tantallon India Fund closed 7.73% higher in June, in another volatile month as markets oscillate between bouts of anxiety over surging Covid-19 infections potentially requiring prolonged “shutdowns” and hopes that massive liquidity infusions by global central banks would sustain asset values and anchor a look-through to “normalisation” in 2021.
Falling equity volatility, a revival of animal spirits in Chinese equities, and cautious positioning have driven a sharp rebound in global risk appetite and equity valuations for Big Tech, broadly for Chinese index heavyweights Tencent and Alibaba, and for a host of renewable energy stocks headlined by Tesla.
Juxtaposed against equity market optimism is more circumspect bond investor positioning with 10-year US Treasury yields stuck in a narrow range reflecting misgivings on the sustainability of the global recovery and employment, and the exposed fault lines on global trade and geopolitics as we head into a contentious election season in the US, exacerbated by growing concerns over Chinese territorial intent in Hong Kong, the South China Sea, and along the border with India.
Our view remains that it is simply too soon to be sketching the parabola of an economic recovery and that we should be wary extrapolating the bounce-off of lockdown-impaired global economic activity. Further “localised lockdowns” will likely be the “tool of choice” in managing resurgent infections as economies re-open; and the pandemic will likely have a lingering drag on employment, and on consumer business confidence and spending.
Therefore, rather than trying to agonisingly “project” a path to normalcy/recovery, we are laser-focused on identifying business models with sustainable moats, resilient balance sheets and cash flows, disciplined capital allocation policies, and the opportunity to take permanent market share away from weaker competitors.
Activity rebounds across the board
On India specifically, the various high frequency indicators we track suggest that economic activity has rebounded sharply from the April “lows”. However, it remains below pre-Covid-19 levels as the different states continue to enforce varying degrees of restrictions on non-essential businesses.
However, rural India is in remarkably good shape with a lower incidence of infections, the government’s prioritisation of agrarian stimulus and rural employment programmes, and tailwinds from a very good spring harvest carrying over into the summer planting cycle given the early onset of the monsoons.
Meanwhile, industrial activity has rebounded sharply in the last two months. PMIs improved further in June versus May, with manufacturing PMI recovering faster than services PMI to 47.2 in June from 30.8 in May, well ahead of market consensus expectations of 37.5.
Exports are at 85% of pre-lockdown levels, rail freight is tracking at 90% of pre-lockdown levels, and intra-state freight traffic in June reached 80% of the average of the preceding financial year.
Employment and labour force participation improved markedly in June with unemployment now down to a 14-week low, primarily because rural agricultural employment rose 11% q-o-q.
Reflecting on the Sino-Indian border skirmish, we are quite frankly at a loss to clearly explain why decades of studied diplomacy suddenly evaporated.
Yes, there is a decade-long pattern of China flexing its military muscle to resolve border/island disputes. Yes, China’s ambitious Silk Road project highways linking the mountain passes skirting Kashmir are suddenly exposed to India’s decision last summer to abrogate Kashmir’s special status and to cross the Line of Control to bomb terrorist camps on the Pakistani side of the border.
Bottom line, our sense is that, notwithstanding the potential for more social media-fuelled
jingoism, extremely harsh weather conditions and snow-blocked passes at extreme altitude for six or seven months in the year, should limit the potential for debilitating hostilities. The incident should also set the stage for deeper economic, commercial, technology and military ties between the US and India given the now-obvious reality of a common foe.
Stock focus: Biocon
The stock we would like to highlight this month is Biocon, a speciality pharmaceutical company with strong bio-chemistry skills.
On July 13, Biocon announced it had secured approval from the Drugs Controller General of India (DCGI) for its plaque psoriasis drug Itolizumab for emergency use in Covid-19 patients.
Indeed, Biocon has successfully transitioned from being a small molecule-formulation manufacturer to being an R&D-driven bio-similar and biologic manufacturer. Having carefully tracked the successful launches of their bio-similar products (Trastuzumab, Adalimumab, Glargine, Pegfligrastim) in developed markets, we believe that the market is structurally under-appreciating Biocon’s opportunity to scale up market share globally, its strategic relationships with Mylan and Sandoz to help mitigate development, distribution, financial and legal risks, and the upside inherent in its custom R&D business and its pipeline of new products.
We expect Biocon to compound its revenues at close to a 30% CAGR over the next three years versus market expectations of a more pedestrian 18% CAGR.
We are most encouraged by the Sandoz commitment to underwrite 50% of the development costs for Biocon’s novel molecule and bio-similar R&D programme post-2025.
Over the next 18 months, we expect Biocon to launch eight new biosimilar products, underpinning our optimism that revenue growth will be well ahead of market expectations.
Having ramped-up capacity, we expect the market will also be surprised by the revenue run-rate in the small molecules biologics business as the company launches new products and enters new markets
We expect Biocon’s earnings to compound in excess of 35% annually over the next three years, versus the market’s projection of 20% annual run-rate.
Margins are also expected to expand by 500bps+ over next three years as bio-similars drive significant revenue/margin mix improvements, we start to see scaling benefits from its novel molecule discovery and development business, and good operating leverage from higher capacity utilisation in the new small molecules plants.
The Tantallon India Fund is a fundamental, long-biased, India-focused, total return opportunity fund, registered in the Cayman Islands and Mauritius. The fund invests with a three- to five-year horizon, in a portfolio (25–30 unlevered positions), market cap/sector/capital structure agnostic, but with strong conviction on the structural opportunity, scalable business models and in management’s ability to execute. Tantallon Capital Advisors, the advisery company, is a Singapore-based entity, set up in 2003, and holds a Capital Markets Service Licence in Fund Management from the Monetary Authority of Singapore.
