The Tantallon India Fund closed 6.22% higher in May with very strong corporate earnings for the March quarter. This significantly exceeds market expectations, nudging the focus towards peaking new Covid infection rates and falling hospitalisations as local lockdowns seemed to have brought India’s second Covid wave under control.
Amid higher volatility over the last six weeks, global markets are struggling with the dissonance between rising inflationary expectations, elevated stock market multiples and risks to corporate earnings.
In addition, the central banks’ narrative of “transitory” inflation is at odds with the narrative of pent-up demand, sticky commodity prices, strained supply chains, prospects of an explosive economic recovery and a “new” Cold War rhetoric that is threatening fragile geopolitical detente and global supply chains.
Second Covid wave is close to peaking
Reported daily new Covid infections in India have fallen to one-third of the recent peak in the middle of May and several states have announced a limited relaxation of the strict mobility restrictions imposed in early May.
About 175 million Indians have received at least one dose of a Covid vaccine with 45 million being fully vaccinated and about 40% of the population over the age of 45 having received at least one dose.
The high-frequency data that we track would suggest that economic activity contracted by an average of 15% m-o-m in May and 7% m-o-m in April when Covid infections spiked across the country.
The current localised restrictions are primarily for the contact-intensive services and transportation sectors. The agricultural and manufacturing sectors seemed to have been minimally impacted by the mobility restrictions, minimising the potential economic drag.
We are carefully monitoring rising delinquencies for banks and finance companies given renewed stress on SMEs and retail borrowers, and parts in rural India where the pace of the vaccination roll-out has lagged.
The markets are clearly building up expectations of a speedy “return to normal” with heightened retail equity investor participation and reopening beneficiaries on a tear.
It has been an extraordinary 12 months given the pandemic, national lockdowns and unprecedented economic contraction. However, robust corporate earnings have reflected resilient demand, disciplined cost and working capital management, and focus on balance sheet deleveraging.
The BSE-200 stocks are on track to deliver 19% operating profit growth for the fiscal year ending March with 60% of the BSE-200 constituents actually growing their top lines.
In terms of stock price performance post-results, financials seemed to have delivered the biggest “positive” surprise while healthcare, infrastructure and utilities “disappointed” despite handily exceeding consensus estimates.
Interestingly, unlike the first wave a year ago, the second wave coincides with a 5% increase in consensus earnings estimates for the BSE-200 for the fiscal year ended March 2022.
Management has been decidedly more upbeat than the handwringing by opposition politicians, the heart-wrenching threads on social media and relentless “India-bashing” by the local and international press.
The efforts to rationalise fixed costs over the last year are structural and will yield durable margin uplift, even as recovering utilisation rates and scale benefits will see the BSE-200 likely continue to deliver on strong earnings over the next two to three years.
Digital and technology innovation will differentiate operational and financial efficiencies across sectors, creating durable business moats.
The focus is on assessing the new goodwill amortisation schedule that was introduced in February. Back-of-the-envelope calculations estimate a 20% charge of the value of the goodwill incurred in recent M&A transactions, and potentially, therefore, a disincentive for future M&As.
Stock focus of the month
The stock we would like to highlight this month is Linde India, the listed Indian subsidiary of Linde, a global leader in industrial gases.
Industrial gases are an excellent proxy for industrial growth. Given the significant consolidation in the industrial gases sector globally and as domestic capacity ramps above contractual demand from anchor customers, we would make the case for Linde India delivering on sustained top-line growth and significant margin accretion over the next five to seven years.
We conservatively expect Linde India to compound revenues at more than 20% over the next three years. At this point, there is virtually no sell-side coverage on the company.
We expect Linde India to compound volumes at more than 15% annually for the next decade. After the Linde-Praxair merger, Linde India commands close to a 60% market share of the Indian industrial gases market and is a beneficiary of India’s focus on ramping up industrial and export manufacturing capacity, and the significant new investments being made in infrastructure, metals and mining, medical gases and healthcare, and renewable energy.
Linde India is a key enabler in India’s evolving clean energy strategies through its de-carbonisation and carbon sequestration technologies, its proprietary hydrogen liquefaction technology, and its unique presence along the green hydrogen value chain from production to storage and distribution, to conversion and utilisation.
Given the new business/technology opportunities that we have assessed, we suspect that our current 5% annual mix/pricing assumptions might be too conservative. We expect Linde India to compound earnings at 50% over the next three years.
On the back of strong volume growth and mix improvements, we expect significant operating leverage and margin accretion above 150bp annually over each of the next three years.
The divestment of non-core assets has resulted in a net cash balance sheet, yielding significant interest expense savings and given strong free cash flows, we are comfortable projecting that Linde India’s growth capex will be funded through internal accruals.
Focus on normalisation versus focus on reforms
The markets seemed to have anticipated the peak in new Covid infections and are focused on “normalisation” of economic activity as local lockdowns are lifted and as India ramps up its vaccination programme.
We have stayed focused on parsing the structural reforms underpinning a sustainable growth runway over the next three to five years. We have a strong conviction in industrialisation, infrastructure development, urbanisation, and the consumer and digital economies.
We believe our portfolio holdings will deliver on earnings and cash flows compounding at more than 15% annually over the next 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 advisery 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
