Tantallon India Fund closed 4.39% higher in August with a strong set of earnings results and global equity managers reallocating away from Chinese Internet stocks and into laggard large cap stocks in India.
Taking a step back, we would acknowledge the stark polarisation of market “views” over the last several weeks as media talking heads, strategists and buy-side analysts have become increasingly strident on the imminent demise of the private entrepreneur in China, the persistent pandemic drag on global supply chains, inflationary expectations, fading fiscal stimulus, and tapering and its implications for the US$, and by extension, for commodities, crypto assets and non-US stocks.
Trying to keep things simple, we would make the following points:
Pricing trends and management commentary affirm rising inflationary expectations — not just “transitory” supply-side bottlenecks. Our view is that the Fed will commence tapering bond purchases by the end of the year and that the US 10-year will be closer to 2.5% by year-end 2022.
The de-rating of Chinese Internet stocks as Xi aggressively “re-engages” with the private sector in pursuit of “common prosperity” will continue to support flows into large cap stocks across the region and into India in particular, given the relative growth dynamics.
Covid-19 and its mutations are not “going away” despite vaccination rates and booster shots picking up globally. We should expect persistent supply chain disruptions, higher input costs, periodic localised lockdowns and intentional localisation of manufacturing and assembly capacity — potentially, at the expense of scale benefits and margins.
Economic data shows positive momentum
India is now vaccinating more than 8 million people every day and with 12% of the population or 160 million people having been fully vaccinated, the country is on track to have half the country fully vaccinated by the end of the year.
- PMI manufacturing dipped to 52.3 in August from 55.3 in July as chip shortages forced production cutbacks in autos and auto ancillaries.
- After contracting for three months on the back of localised lockdowns and mobility restrictions, the services PMI rose to its highest level since March 2020, accelerating to 56.7 in August.
- Air passenger traffic for August averaged 76% of February levels, improving from 56% of February levels in July.
- Passenger vehicle sales continue to grow at double-digit levels on a two-year CAGR basis in August.
- Export growth registered its third consecutive month of two-year CAGR in double digits.
- India’s unemployment rate has decelerated and is range-bound near pre-pandemic levels.
- Agriculture was the only spoiler with monsoon activity having deteriorated and a rainfall deficit of 9%, which translates into a 2% y-o-y decline in sowing activity.
We have continued to engage virtually with dozens of our contacts across the corporate sector, domestic market participants, financial journalists and policy-makers. They say the new capex cycle that we have been writing about for several months is upon us.
Unlike the FY2009–FY2013 capex cycle that was driven by capital-intensive core sectors like power, metals and infrastructure, our conviction is that the current capex cycle will be focused on digital eco-systems, manufacturing, decarbonisation, renewable energy, electrification, logistics and infrastructure.
The revival in manufacturing and specific government incentives are explicitly focused on job creation and import substitution. Our growing conviction is that we need to be incorporating a view on a more balanced current account as a sustainable anchor for economic growth in India, stabilising the currency, reducing imported inflation, and encouraging both foreign direct and portfolio investments.
We want to be invested in industrialisation broadly and would highlight a rich and varied investment opportunity set. This ranges from industrial gases and factory automation to the upgrade of the electricity grids and from enabling infrastructure and logistics to export hubs leveraging low-cost Indian engineering talent.
Stock of the month
The stock we would like to highlight this month is Divis Labs, a company that over the past three decades has built a reputation as the preferred supplier to both domestic and global pharmaceutical companies of active pharmaceutical ingredients (API) and Contract Research and Manufacturing Services (CRAMs). Management has continued to systematically invest in backward integration and in scaling-up manufacturing, allowing the global pharmaceutical value chain to reduce its dependence on China.
We expect Divis to compound revenues at close to 25% annually over the next three years, well ahead of market expectations of revenues compounding at sub-15% annually.
- Over the next three years, we are excited about the potential US$10 billion-plus ($13.5 billion-plus) pipeline opportunity with close to 20 molecules that Divis has been working on going off-patent.
- Given the capacity ramp-up over the last 18 months, we have good visibility on improving utilisation rates as Divis builds global market share given cost competitiveness and superior product portfolio vis-àvis the Chinese competitors.
- We see an opportunity for strong mix improvement given the focus on green chemistries and more complex APIs.
- Additionally, we are optimistic over Divis plans to invest INR25 billion ($460 million) in capex over the next three years to augment its capacities for custom synthesis and nutraceuticals.
- We expect Divis to compound earnings at 30% annually over the next three years although consensus estimates seem to suggest earnings compounding at 18% annually.
- We expect strong operating leverage on the back of higher utilisation rates as the new capacity is rampedup and mix improvements to drive 150bp+ of ebitda margin improvement annually over the next three years.
- We expect the investments in de-bottlenecking and backward integration to further improve yields, reduce wastage, and drive significant efficiency and cost gains.
In conclusion:
- We are maintaining a wary eye on the Covid-19 variants and the rate of daily new infections and hospitalisations. We are not out of the woods by any stretch and the upcoming festival season is certainly cause for anxiety.
That said, as India’s vaccination programme is ramping up nicely and the high frequency data we track points us towards pent-up demand, a strong private sector capex cycle, government reforms and infrastructure spending, and new manufacturing incentives, we would anticipate the underlying strength in the industrial and services economy to sustain.
- We are most focused at this point on trying to identify and invest in the structural opportunities in industrialisation, infrastructure and logistics, and the consumer and digital economies.
The Tantallon India Fund is a fundamental, long-biased, India-focused, total returns opportunity fund, registered in the Cayman Islands and Mauritius. The fund invests with a three-tofive-year horizon, in a portfolio (25 to 30 unlevered positions), 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 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
