The Tantallon India Fund closed up 3.38% last month with June quarter earnings releases and management commentaries surprising positively in the face of stark economic contraction and spiking Covid-19 infections.
The path to “normalisation” is in the resilience of the Indian rural and semi-urban economies, sector consolidation, and tailwinds from accommodative global monetary and fiscal policies, targeted domestic stimulus, low energy prices, and a weaker US dollar.
The US Federal Reserve has moved the goalposts, guiding for “lower for much longer” and a “new” inflation-targeting framework to ensure sustained labour market gains. The negative real yield narrative for the US dollar, and committed, accommodative global central bankers will drive the rerating of non-US-dollar risk assets, and perhaps, the market’s focus moving beyond Big Tech and e-commerce to the more traditional reflation beneficiaries.
Localised “lockdowns” to try and manage resurgent Covid-19 infections globally, structural underemployment, and cynical geopolitical and antitrade rhetoric and confrontation in the build-up to the US elections in November, will remain short-term overhangs.
The big companies are getting bigger with product and service differentiation and balance sheet strength driving sector consolidation globally. However, beware of more aggressive cross-border regulatory scrutiny and oversight, and knee-jerk political “intervention”.
On India specifically, the 24% contraction in real GDP for the June quarter was worse than consensus expectations of about a 20% contraction, reflecting the realities of a stringent national lockdown with capital formation, construction, manufacturing, hospitality, and education services contracting by about half y-o-y.
That said, national lockdown measures have been eased and sequential improvement over the last eight weeks in the high frequency data we track is very encouraging: The broader economy is now tracking at around 85% of pre-Covid levels.
We highlight improving GST collections (now at 85% of pre-Covid peak), rail freight traffic (+7% y-o-y), e-way bill generation (+13% y-o-y), e-toll collections (–5% versus pre-Covid peak), and two-wheeler (+5% y-o-y) sales.
The resilience in reported June quarter corporate earnings and increasingly confident management commentaries were the real positive surprise, with rural and “digital” being the standout performers.
With a structurally weaker outlook for the US dollar, sustained capital flows, and forex reserves at a record US$540 billion ($738 billion), the Reserve Bank of India has seemingly decided to “allow” the rupee to appreciate.
After three straight months of declines, banking sector loans to SMEs have registered a significant recovery in the last six weeks, as did mortgages, auto and personal loans.
On the negatives, new Covid-19 infections are tracking at 70,000 per day as lockdown restrictions have been eased so we expect localised lockdowns to be reimposed to contain the community spread of the virus.
Chinese territorial and military ambitions along the borders in Ladakh and the Galwan Valley will likely remain a distraction for policy makers and the markets.
Sector consolidation and corporate bankruptcies will drive redundancies and potentially, risks to banking sector capital and risk appetite.
We have continued to virtually “visit” dozens of listed and private companies. Over the last few weeks, we have observed a resurgence in business confidence with managements signalling that the recovery over the last three months is “more than just restocking demand”, and that business broadly is tracking at more than 80% of pre-Covid levels on the back of sustained demand coming out of rural and semi-urban India.
Management have cut discretionary spending and operating expenditure to offset negative operating leverage from collapsing volumes and revenues during the lockdown while shifting quickly into maintenance capex mode.
The switch to “digital” to drive brand marketing and product penetration, the explosive growth in ecommerce, and the wealth-creation and discretionary spending in rural India have been bright spots.
Agrochemical stock in focus
The stock we are highlighting is Rallis India, a Tata Group agrochemical formulations, seeds and crop protection company with a strong brand portfolio and a pan-India sales and distribution network. A new management team plans to better leverage brands, its distribution network and balance sheet strength to develop a stronger, more diversified product portfolio to address the structural uptick in demand for both the spring and the summer crop cycles.
We expect Rallis to compound consolidated revenues at 18% annually over the next three years, with market consensus modelling a much more sedate 11% CAGR.
The more than 20% increase in acreage under cultivation over the last three years and the multi-cropping cycles that have become possible given the investments into rural irrigation projects and created a sustainable demand driver for agricultural inputs, including seeds, fertilisers, and crop protection.
Explicit government support for the rural and agricultural sectors, and consecutive good harvest seasons have seen a significant boost in rural incomes through the pandemic. We expect that Rallis’ branded agri-product portfolio will be a key beneficiary.
We also expect the clampdown on cheap Chinese imports through the agrochemicals supply chain will drive significant market share gains for Rallis.
We expect Rallis to compound earnings at 25% annually over the next three years versus market expectations of 15% CAGR, and for ROE and ROCE (Return on Capital Employed) to track north of 20%.
The new product launches focusing on the winter crop will drive both mix and margin improvement. We expect significant scale benefits and the various cost savings initiatives put in place by the new management team to sustain operating margins improving by about 150bps annually 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 Singapore-based entity, set up in 2003, and holds a Capital Markets Service Licence in Fund Management from the Monetary Authority of Singapore.
