The Tantallon India Fund closed 3.33% higher in December, bringing another tumultuous year to a close. We are pleased with the Fund’s performance, 23.92% higher for 2021. As we look ahead to what is likely to be an equally volatile and frequently confounding year in the markets, we are trying our best to filter the “noise” and stay focused on the fundamentals driving our convictions in individual stocks.
On markets globally, here are some thoughts to share:
The increased volatility across markets over the last several months has fuelled an uncomfortably nagging sense that equity markets are being whipsawed by “narratives” to explain “positioning” rather than reflecting “investment conviction” on any number of factors, from Covid resurgence and China angst to geopolitics and crypto havens, and from the Fed messaging versus actions on tapering to the longer-term implications for the yield curve and fiat currencies. Buckle your seat belts. In contrast to equities, it has been far more straightforward to acknowledge (i) the trifecta of strong growth, persistent inflation and expectations of higher US interest rates weighing on global bonds that is down 4.7% for 2021, and (ii) the substantial under-investments in exploration and production, dove-tailing with a more belligerent Opec that is driving a 59% increase in crude prices in anticipation of “normalising” demand.
Given persistently high inflation prints, it was also anomalous to reflect on precious metals ending the year in the red: gold (–3.6%), silver (–11.7%) and platinum (–9.6%). Ironically, physical demand for gold has remained stable with central banks globally maintaining disciplined gold purchase programmes, ostensibly as an inflation hedge. China’s largely self-inflicted wounds to rein in their tech tycoons, property speculation and corruption, while simultaneously pursuing a fraught zero-Covid strategy, and a much more aggressive geopolitical stance, almost certainly guarantees below-trend growth and a more accommodative fiscal and monetary policy regime to ensure “stability” in the build-up to the 20th Party Congress, “a major event in the political life of the party and the country”. Perhaps, emboldened by the stark polarisation across the US political and ideological spectrum, the escalating geopolitical fracture points from Crimea and the Persian Gulf to the South China Sea, are explicitly designed to test post-Brexit/postTrump/post-Abe/post-Merkel resolve in holding together fragile post-war alliances that have “maintained the peace”. The “peace dividend” from the fall of the Berlin Wall has been fully franked.
Expect some volatility
On India specifically, mindful of the risks of significant near-term market volatility, we remain extremely constructive on India and Indian equities.
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First, yes, given India’s outperformance over the last 18 months or so, we should be preparing ourselves for a volatile few months. Foreign portfolio flows will remain fickle, looking to arbitrage (perceived) valuation disconnects and reversion-to-mean trades as Fed-tapering is baked into the cake, while domestic investors will continue to rotate between laggard sectors, taking their cues from the domestic elections calendar.
Our view is more nuanced though. Modi is back in election mode, with all eyes for now on the outcome of the state elections in Uttar Pradesh, India’s largest state, with elections scheduled in phases commencing Feb 10, with the outcome to be announced on March 7.
We expect continuity and discipline in terms of monetary and fiscal policies, with an even greater focus on industrialisation and job creation.
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We expect real GDP growth to compound at 8%–9% over the next three years, underpinned by accommodative monetary policies, a strong private capex cycle, government spending on infrastructure, strong exports, and strong domestic consumption.
The strong earnings recovery/growth narrative remains intact. Our view is that the market is structurally under-estimating the Indian corporate profit pool: on our estimates, corporate profitability is poised to exceed 4.5% of GDP in the next 12 months on the back of strong pent-up demand, pricing power, operating leverage, and improving asset quality for the banks.
Our growing conviction is that India is likely to be added to the global bond indices in the next 12 months. Inclusion in the global indices could trigger as much as US$200 billion ($269.48 billion) in passive bond flows into India over the next decade, with India potentially representing 9%–10% of the JPM GBI-EM Global Diversified Index and meaningfully positive implications for India’s balance of payments, the yield curve, cost of domestic borrowing, investment cycle, and currency.
India’s evolving equity culture is poised to drive a further re-rating of market multiples. With merely 7% of domestic savings currently in equities, our conviction is that the Indian retail investor will be the marginal buyer of Indian equity assets over the next decade.
Flows apart, pausing to reflect on our more fundamental concerns, we would highlight (i) potential nearterm earnings volatility given the Omicron-drag and the significant volatility in input commodity costs, (ii) India’s current account vulnerability to substantially higher crude prices and (iii) the Reserve Bank of India wrestling with its natural inclination to signal higher policy rates (potentially, with a reverse repo hike in February) in the face of the Omicron speed bump.
Stock highlight
The stock we would like to highlight this month is Maruti Suzuki, India’s largest passenger vehicle manufacturer, with a well-differentiated, mass-market product portfolio, leveraging the Suzuki-Toyota collaboration on hybrid and battery electric vehicle. With improving chip supply, and given significant pent-up demand as the economy “reopens” post-Covid, Maruti’s portfolio refresh and new product line-up anchors our conviction on Maruti’s sharply improving growth and earnings profile, setting the stage for a potential stock multiple re-rating as well.
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We expect Maruti to compound revenues over 25% CAGR over the next three years versus the market pencilling in a more modest 15% run-rate. Maruti is on the cusp of a significant new product cycle: Five new SUVs, a slew of hybrid offerings, and facelifts for the existing Baleno, Brezza, Alto and Swift models. Having spoken with several Maruti, Honda, Hyundai and Toyota dealerships across the country, including in Tier 2 and Tier 3 centres, we are encouraged by the positive body language on dealer inquiries. We expect that the market will be surprised by the pent-up demand as supply normalises, and given the investments in a comprehensive national dealership network, Maruti is primed to benefit.
We expect Maruti to more than double its compressed natural gas (CNG)-fuelled volumes over the next two years, with the company offering more base variants with CNG as the fuel option.
We are particularly enthused by the tie-up with Toyota to deliver several hybrid alternatives over the next three years, with the combination of lower emissions and higher fuel efficiency providing a cost-effective solution for India to meet its aspirational emissions goals.
We expect Maruti’s profits to compound at a 40%+ CAGR over the next three years, well ahead of consensus modelling 20% run-rate. We believe that the market is structurally under-estimating volumes/mix uplift over the next two to three years as well as the inherent operating leverage in the business as volumes recover sharply off the Covid-and-chip-shortage-induced malaise.
The collaboration with Toyota and Suzuki on developing new powertrain technologies, coupled with low-cost local production will see Maruti enjoy significant scale benefits with minimal incremental investments in R&D and plant and facilities.
In conclusion
We expect the markets to remain volatile and are looking for opportunities to increase our exposure to Indian equities.
India’s growth/earnings trajectory is likely to continue to surprise positively given Modi’s focus on structural reforms and infrastructure investments, the increasingly visible private sector capex cycle commitment, and significant pent-up consumer demand with India on course to achieve full vaccination rates for the adult population of 75% over the next three months.
We are invested in idiosyncratic opportunities in financial services, industrialisation, infrastructure and logistics, and the consumer and digital economies, where valuations are attractive relative to the visibility on earnings and cash flows compounding at 15%+ over the next three years.
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 concentrated portfolio, 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 advisory company, is a table Singapore-based entity, set up in 2003, and holds a Capital Markets Service Licence in Fund Management from the Monetary Authority of Singapore
Photo: Bloomberg
