The Tantallon India Fund closed 5.44% lower in September as markets struggle to internalise the US Federal Reserve Board’s commentary on reining-in inflationary expectations and the unprecedented strength in the US dollar even as corporate earnings continue to surprise on the upside and the government’s implementation of structural reforms builds momentum on the ground.
We expect markets to remain extremely volatile. The current investment environment is challenging, perhaps the most challenging environment since the 1997/1998 Asian Financial Crisis and Russian Currency Crisis. Causes include the war in Ukraine and deteriorating geopolitics on many fronts, central banks belatedly tightening in the face of persistent inflation, long Covid in China, political ineptitude across multiple geographies, a global food and energy crisis compounding Opec+’s intransigence and mounting recession risk.
Lessons from the past
Digging through our old journals, we found a particular note to self from March 1999 that resonates strongly: “If you are ‘short’, beware of being squeezed by regulators and politicians jawboning and actively intervening in currency and rate markets, squeezing equity short positions. (Malaysia’s currency controls and the Hong Kong Monetary Authority buying domestic equities, squeezing shorts, come to mind) If you are ‘long’ on strong, fundamental conviction, will your clients allow you to be right, enabling you to look through painful, short-term, mark-to-market drawdowns, and ‘buy and hold’ compelling investment opportunities?”
We are intensely aware that sharply higher interest rates globally and unprecedented strength of the US dollar are feeding into significant volatility across all asset classes. As liquidity tightens, the risk of nascent financial stress across credit markets morphing into a significant market “accident” have risen.
Do not be tempted to revisit what had “worked” in the post-Global Financial Crisis cycle just because stock prices are down a lot. They are just unprofitable growth companies which benefitted from “cheap” money, globalisation and irrational optimism that led to absurd valuations in both public and private markets.
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However, bear markets are not permanent, drawdowns tend to be indiscriminate and volatility does create significant investment opportunities. That said, having actively invested through the past 30 years of market cycles, we sound so much “wiser” being bearish, as opposed to trying to identify and invest with compelling valuation created by market volatility or high-quality companies with strengthening business moats and improving visibility because of internally-funded market share gains, and sustainable earnings and free cash flows.
As Opec+ attempts yet again to prop up energy prices and political regimes in Hurricane Ian’s immediate aftermath, we remain focused on identifying and investing in structural beneficiaries of de-carbonisation and energy security and transition, de-globalisation, higher-for-longer inflation and interest rates, shrinking labour pools (especially in geographies hostile to immigration), domestic consumption, and more rational competitive intensity across sectors.
For India specifically, we want to be clear in reiterating our investment conviction:
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The Indian stock market’s relative outperformance is predicated upon years of intentional policy efforts to:
- Build the enabling policy and physical infrastructure supporting industrialisation and job creation for the 20 million youth turning 20 years old each year;
- Systematically implement structural tax and labour reforms to encourage re-investments in domestic industry and a sustained private sector capex cycle;
- Reduce subsidies and ensure fiscal discipline, preventing government borrowing from crowding out the private sector;
- Encourage strong FDI flows to reduce the historical balance of payment stress in the face of higher energy prices and periodic foreign institutional investor panic;
- Encourage domestic equity savings through systematic investment programmes, allowing for a sustained domestic bid for domestic stocks.
We remain more constructive than consensus and are looking to take advantage of the volatility to build our exposure to Indian equities.
We believe that the market is underestimating the inherent operating leverage as corporate India leans into a new capex cycle, industrialisation, infrastructure spending, and new job creation and consumption.
India’s inclusion in the global bond indices has been delayed again. However, we remain convinced that India’s inclusion in the indices in the next 12 months will see substantial flows into the market seeking rupee-denominated fixed income and real assets, reducing stress on the balance of payments and currency from elevated imported energy prices.
The domestic bid for Indian equity assets has been sustained by the systematic investment programmes for retail investors (analogous to the decades of retail flows into 401K and superannuation accounts) and by the increase in permissible equity allocations for domestic retirement funds.
Our key concerns remain: The drag on corporate earnings from a prolonged, deep recession in the US and Europe; the risk of elevated energy and commodity prices from the war in Ukraine; and the risk of elevated correlations between Indian and global equities as global central banks are forced to continue to tighten in the face of stubbornly high inflationary expectations.
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Stock of the month
The company we would like to highlight this month is Indian Hotels, the country’s largest hotel operator with a pan-India presence and with 20,000+ rooms operating across multiple brands/categories, spanning marquee properties in the luxury segment to business travel, affordable hotels and homestays. The international business currently accounts for about 15% of room inventory and 25% of revenues.
We expect Indian Hotels to compound revenues at a 30%+ CAGR over the next three years, well ahead of the ~20% growth rate pencilled in by Main Street.
Significant pent-up demand, US-dollar strength and residual post-Covid challenges with international tourism have seen domestic tourist traffic drive both occupancy levels and average room rates to above pre-Covid rates. Our view is that given the lack of newbuild over the last decade, and the recovery in business traffic, occupancy rates and average room rates in India will sustain well above market expectations over the next three years.
Based upon our interaction with global travel agents and reviewing the data and the commentary from the major airlines with regular flight schedules into India, our view is that foreign tourists are set to return to India this Christmas, with pre-bookings extending well into Spring. We sense there is a significant upside to even our current average room rate projections.
Domestic business traffic and domestic mid-end tourism in the two- and three-star segment, represent significant opportunities. Covid saw a significant decline in available inventory as standalone hotel properties were forced into closure. We are enthusiastic about the branding and the product positioning under the “Ginger” flag and feel that it is an opportunity that the market is currently ignoring.
We believe Indian Hotels is poised to deliver on earnings compounding at 30%+ over the next three years versus the market’s significantly more modest expectations of mid-teens growth.
On the back of improving utilisations, higher room rates and improving mix (as fees ramp up from the managed properties), we expect ebitda margins to average 30% over the next three years (versus the markets projecting 20%-ish margins after posting 13% in the last financial year).
The market remains extremely sceptical regarding a turn-around in the New York, Boston and London properties. We are reassured by the quarterly reporting on reduced corporate overheads, improving labour costs, and more direct marketing/sales to end customers.
Conclusion
We expect equity markets to remain volatile and are mindful of the risk of market “accidents” given deteriorating macro and geopolitical data points, mounting global recession concerns and second-derivative earnings downgrades, and the push/pull of investor leverage and positioning.
We continue to validate our conviction in the Indian economy growing sustainably in the 6%–7% range, anchored by structural reforms, and we are patiently building positions in the highest-quality financials, capital goods, and consumer-facing companies where we have a conviction on earnings and cash flow visibility, and where the recent market action has provided us with compelling expectations or a valuation reset.
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 to 30 positions that are unlevered), market cap/sector/capital structure agnostic, but with strong conviction on the structural opportunity, scalable business models and 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
