The Tantallon India Fund closed 3.44% higher in March with the markets blindsided by dramatic margin calls, mounting anxiety over China aggressively resetting the terms of engagement geopolitically, concerns over higher US Treasury yields and resurgent Covid infections even as mass vaccinations hold out hope for a “return to normal” by the end of the year.
Reflecting on the challenges of trying to map higher market volatility against the ebb and flow of vaccine optimism, fiscal stimulus, US green economy aspirations, rising Treasury yields, geopolitical stress points from the South China Sea to Crimea, gridlock in the Suez Canal, and crowded trades being margin-called, we would simply reiterate our view at 30,000 feet.
We are reassured that credit markets have largely stabilised. We remain comfortable projecting diminished tail risks and a “more or less” synchronised global economic recovery in the second half of 2021 as the pace of vaccinations pick-up.
Market volatility allows us to build exposure to high-quality businesses with superior product/service/balance sheet differentiation that will take disproportionate market share from weaker competitors as economies reopen and stabilise.
Surge in infections as India ‘reopens’
Over the last four weeks, we have seen a spike in Covid-19 infections in Mumbai, Delhi and Bangalore, lulled perhaps by a false sense of security and lockdown fatigue.
We acknowledge the risks of elevated infection levels but we do not anticipate another national lockdown and instead expect that there will be a reimposition of local lockdowns in the Covid hotspots, temporarily restricting mobility, public gatherings and local businesses until the rate of new infections is brought back under control, boosted by the country’s accelerating vaccine programme.
The current localised restrictions are primarily in the contact-intensive services sector. The agricultural and manufacturing sectors have not been impacted, minimising the potential economic drag.
We should certainly expect the markets to be volatile in the short term given expectations of a speedy “return to normal” have already been built-in. We remain focused on the structural reforms underpinning the growth runway over the next three to five years.
Business confidence continues to recover strongly
The high-frequency data tracked would continue to point to a robust recovery in economic activity headlined by manufacturing PMI posting its eighth consecutive month of expansion, industrial capacity utilisation exceeding pre-Covid levels, very strong GST collections, and continued strong growth in exports, electricity consumption and consumer durable sales.
Urban consumption is inflecting positively, reflecting pent-up demand and rising discretionary spending even as rural consumption has remained resilient.
Accommodative monetary policy, growth-supportive labour, tax reforms and healthy private sector corporate balance sheets put the country on the cusp of a sustained private sector capex cycle.
Digitalisation, financial inclusion and mobile telephony have provided significant, sustainable opportunities in e-banking and e-commerce, rationalising supply chains and payment systems while helping minimise the drag from wasteful subsidies and crony middlemen.
Of concern are spikes in input commodity prices that will depress margins, rising inflationary expectations that might force pre-emptive tightening, the risk of higher reported non-performing loans in the banking system and the risk of resurgent infections forcing local governments to adopt more restrictive lockdown measures.
Stock of the month
Deepak Nitrite, a speciality chemicals company, finds itself in a sweet spot, benefitting both from import substitution as well as from global supply chains looking to aggressively diversify away from their dependence on Chinese-domiciled capacity.
Deepak’s products find their way into colourants, rubber processing, pharmaceuticals, explosives, refineries, agrochemicals, fuel additives, paper, textiles and detergents. Deepak is a global top-three player in speciality chemicals like xylidines, cumidines and oximes, especially phenol/ acetone which is a key driver of revenues and earnings visibility over the next three to five years.
We expect Deepak’s consolidated revenues to conservatively compound at a 15%+ annual run-rate over the next three years versus the market projecting a significantly more modest 8% CAGR.
Strong end-user demand from global pharmaceuticals and agrochemicals companies provides good visibility on volume-off-take and revenue growth.
The recent commissioning of the new phenol/acetone capacity and the new isopropyl alcohol capacity coming online over the next three months will be a significant new revenue driver.
We are also excited by the new product pipeline focusing on clean technologies and a global client base but as we have yet to model the new products, our current revenue assumptions are probably understated.
We expect Deepak’s profits to compound at 25%+ annually over the next three years versus the market’s current expectations of profits compounding at 15% annually.
Given the recent/imminent commissioning of phenol/acetone and isopropyl alcohol capacity, we expect significant mix/margin improvement and strong operating leverage over the next three years.
The investments made over the last five years to backwards integrate across chemical chains and the intentional increase in domestic sourcing of raw materials will translate to a structural uplift in operating margins.
Given robust generation of free cash flow as new capacities are ramped up, we expect further deleveraging of the balance sheet and a higher dividend payout over the next three years.
As India’s vaccination programme ramps up, we expect diminished tail risks, Modi’s structural reforms, digitalisation and a manufacturing sector reset to translate to sustained growth.
Take advantage of volatility
We continue to urge investors to take advantage of market volatility to increase exposure to Indian equities.
Mindful of the potential economic drag from a prolonged resurgence in new infections, we would expect markets to be volatile in the short-to-medium term as India ramps up its vaccination programme from the current 3 million+ vaccinations/day run-rate.
We believe India is on the cusp of re-establishing a sustainable 7%+ GDP growth path.
We have a strong conviction in industrialisation, infrastructure development, urbanisation, and consumer and digital economies. We expect earnings for the March quarter to surprise as positively as the December quarter did, on both the top line and operating leverage. We believe our portfolio holdings will deliver on earnings and cash flows compounding at 15%+ annually over the next three to five years on the back of sector consolidation and sustained market share gains, operating leverage, and mix/margin improvement.
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
