The Tantallon India Fund closed 11.29% higher in November with markets hopeful over the prospects of “successful” vaccine intervention, reassured by the prospects of a Biden-reset with the rest of the world, and crucially, enthused by the prospects of a Powell/Yellen combination anchoring extended policy and liquidity support as a buffer against collateral damage from resurgent Covid-19 infections globally.
On India specifically, we remain more positive than consensus. We expect real GDP growth to actually turn positive in the December quarter on the back of the resilience in the rural economy, accommodative monetary policy, recovering business and consumer confidence, and a strong recovery in manufacturing and exports.
Reflecting on our virtual meetings
We have continued to carefully map our anecdotal inputs from months of virtual interaction with companies and policymakers on the ground, against the empirical data on steadily improving economic activity. Managements highlighted that the return to pre-Covid business activity levels across sectors has been much faster than anticipated.
- E-commerce channels currently account for about 8–10% of consolidated revenues — a two times increase over the last 12 months.
- The deliberate measures put in place to rationalise costs and “right size” organisations are likely to be durable, driving a sustained uptick in margins as operating leverage kicks in.
- Improved access to domestic liquidity thanks to various government measures to ensure SME viability.
- A nascent private sector capex cycle has been bolstered by renewed expectations on government infrastructure spending.
Growth has certainly surprised on the upside but so too has inflation, primarily that of food and commodities. The hike reflects pent-up demand and supply-side bottlenecks as the economy reopens.
In the short term, we expect monetary policy to remain accommodative. But we should expect the Reserve Bank of India to start to articulate an “exit” in spring and will likely proactively sterilise excess liquidity through open market operations and the reverse repo window.
In addition, manufacturing in India is at a positive inflection point — thanks to Modi’s focus on deregulation and implementing key land, labour, tax, agricultural and power sector reforms, and the development of manufacturing special economic zones, dedicated road and rail freight networks and shipping infrastructure. This means India is stacking up as an increasingly attractive alternative for MNCs looking to reduce their dependence on China-domiciled supply chains.
We anticipate that the recently announced extension of the Production Linked Incentive (PLI) programme to 10 manufacturing sectors will provide additional impetus to augment globally-competitive local manufacturing capacity, creating employment and boosting exports. Conservatively, mapping the sectoral breakdown in committed private sector capex plans for the next three years, we expect that India’s manufacturing output will treble over the course of the next decade, providing a significant boost for SMEs.
Key concerns include commodity price inflation; a sustained increase in Covid-19 infections that might require aggressive quarantine or lockdown measures; and productivity shortfalls given social distancing requirements at manufacturing locations.
We remain extremely constructive on Indian risk assets: We expect real GDP growth to actually turn positive in the December quarter due to sector consolidation, operating leverage, and mix-margin improvement to anchor strong earnings visibility, and for global liquidity and a weaker US$ outlook to be supportive of Indian equities.
We expect the real economy to re-establish a sustainable 7%+ GDP growth trajectory over the next two to three quarters.
We retain strong fundamental conviction in our portfolio holdings delivering on earnings and cash flows compounding at 15%+ annually over the next three to five years, underpinned by sustained market share gains, improving earnings and cash flow visibility, and compelling asset values.
We would urge investors to take advantage of any near-term market volatility to increase exposure to Indian equities.
Stock of the month
The company we would like to highlight this month is Intellect Design Arena (IDA), a technology services company designing customised cloud-based digital financial products for global banking and financial services companies.
We expect IDA to compound consolidated revenues at 15%+ annually over next three years, with consensus market estimating a more modest 10% CAGR.
Having carefully tracked the investments over the last five years in building deep domain knowledge and unique IP-driven product suites, and the investments made in building out a comprehensive global sales and marketing network, we believe that the market is structurally underestimating IDA’s potential to both win new clients, as well as to increase wallet share from their existing clients.
Our base case is for the current US$45 million/quarter ($60.2 million/quarter) revenue run-rate to accelerate to US$70 million/quarter over the next three years given our conviction in the specific opportunity in the consumer and insurance verticals.
We expect IDA to compound profits at 150%+ over the next three years and for ROCE/ROEs to track at 20%+, not forgetting this is a bit of a statistical aberration given the depressed earnings cycle over the last two years, but substantially ahead of market expectations.
IDA’s management highlighted that the return to pre-Covid/normal business activity levels across sectors has been much faster than anticipated. E-commerce channels currently account for about 8–10% of consolidated revenues, doubling over the last 12 months.
On our base case assumptions, we expect operating margins to improve from 9% to 25%+ over the next three years on the back of the acceleration in revenue recognition, higher licensing fees driving mix improvement and earnings visibility, and strong operating leverage as utilisation rates improve meaningfully
Importantly too, having turned net cash in the current fiscal year, and with moderating incremental capex and working capital requirements, we expect significantly higher free cash flow conversion, anchoring our expectations of a higher dividend payout.
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.
