The Tantallon India Fund closed 5.64% higher in July as market sentiment and risk aversion waxed and waned between heightened concerns over further Covid-19 outbreaks and potential lockdowns compromising the real economy, buffered by expectations of even more aggressive policy relief and stimulus that would be supportive of underlying asset prices.
The tug-of-war being played out in real-time captures the re-rating of tech, e-commerce and the new “green” superstars on one hand, against the palpable weakness in the US dollar on the other. The weakness is, in part, due to the policy actions of the US Federal Reserve, but primarily due to markets starting to internalise concerns on rampant Covid-19 infections in the US; myriad policy mis-steps by Congress; the White House and China indulging in cynical brinksmanship ahead of the elections in November; a burgeoning deficit as the spending spigot remains open; and falling real bond yields juxtaposed against the tailwind for gold.
For the Covid-19 pandemic, our top-down view remains that localised lockdowns will likely be employed to manage resurgent infections globally, creating a lingering drag on employment, consumer and business confidence, and spending. We believe a sustained global economic recovery is several quarters away, that we should not extrapolate the “re-stocking bounce” off lockdown-impaired economic activity, and that the structurally weaker outlook for the US dollar and accommodative central bankers globally will likely sustain the rerating in non-US dollar risk assets.
Monetising Reliance Jio
Over the last 12 weeks, Reliance Industries has diluted 33% of its stake in telco Reliance Jio for an astounding US$20 billion ($27.4 billion). Reliance Industries has intentionally deleveraged its balance sheet, and put a valuation marker in the sand as a precursor to a listing of Reliance Jio. A range of investors, from industry buyers, Facebook, Google, Intel and Qualcomm, to private equity and sovereign wealth funds, have certainly placed their chips on the table. As it is, geopolitics between the US, China, and India presents Silicon Valley and US Big Tech an opportunity to finally stymie Chinese Big Tech’s Indian ambitions. For instance, 18 of India’s current 30 unicorns have been funded by Chinese strategic investors.
To be sure, the Jio opportunity can leverage technology and a digital ecosystem for half a billion paying subscribers to ubiquitously connect with “India’s 60 million micro, small, and medium businesses, a 120 million farmers, 30 million small merchants, and millions of small and medium enterprises in the informal sector”.
The unique combination of Reliance’s current 400 million-odd subscribers and its digital plus physical ecosystem; Facebook’s platform monetisation track-record; and Google’s ambition to drive 5G data usage and to monetise its Android operating system, anchors its projections for Jio’s growth and cashflows. Conservatively, we expect valuation for Jio to be higher than US$100 billion over the next two years.
A path through Covid-19
We have been fortunate to be able to continue to engage virtually with dozens of Indian businessmen, local technocrats and politicians, and industry consultants. Despite anticipatory provisioning by private sector financials, we would highlight “better than expected” corporate profitability for the June quarter — almost entirely on the back of tight cost controls and disciplined working capital management. In the quarter, revenue declines for companies in BSE500 are tracking at about –25% y-o-y, while Ebitda margins (ex-financials) in aggregate have actually expanded by about 250bps y-o-y.
We are most encouraged by companies pointing to sequential demand recovery between April and July (albeit, remaining concerned about the impact of further intermittent lockdowns on industrial production, employment and consumption); migrant rural labour returning to urban centres, allowing industrial capacity and infrastructure development to be ramped up; and loans under “moratorium” (where interest was not being serviced) declining from about 40% of aggregate system lending in April to about 15% in June.
While questioning the robustness of the data on Covid-19 testing, reporting and tracing, it is worth reflecting that 70% of the current active cases in India are from the five states with the highest urban densities — Maharashtra, Andhra Pradesh, Karnataka, Tamil Nadu, and Uttar Pradesh — while none of the other states account for more than 5% of total active cases, with the rural hinterland largely insulated thus far.
As in other global equity markets, retail participation is very high. Over the last quarter, retail volumes are tracking at about 70% of average daily cash volumes.
The key risks to remain mindful of include: confirmed Covid cases and hospitalisations continue to rise, forcing further intermittent lockdowns; sector consolidation and corporate bankruptcies driving redundancies and rising unemployment levels; and rising delinquencies eroding banking sector capital and risk appetite.
Flavour of the month
The stock we like to highlight this month is Mahindra & Mahindra (M&M), India’s dominant tractor manufacturer with a growing export footprint for their line-up of SUVs, pickups, small sedans, tractors, and agricultural equipment.
We expect M&M to compound revenues at close to a 12% annual run rate over next three years, well ahead of consensus estimates compounding in the 5%-plus range.
We anticipate sustained demand for M&M’s core tractor and agricultural equipment portfolio, well ahead of market expectations, given a very successful Spring harvest season, a very good monsoon season replenishing reservoirs to record levels, and the government’s significant new agricultural reforms announced at the end of May.
The recently announced Ford JV on sedans, light commercial vehicles and SUVs will fill significant gaps in M&M’s portfolio while allowing its low-cost manufacturing and engineering capacity to support Ford’s developing market expansion strategy. In addition, M&M’s push into electric vehicles is a significant differentiator among competing Indian OEMs and represents a compelling option value as Indian policymakers look to embrace “green”.
We expect M&M to compound earnings at 20%-plus annually over the next three years; twice what market consensus is currently modelling. We anticipate ramping utilisation rates on the back of three new tractor models, several SUV model refreshes, and the new Ford JV will drive very strong operating leverage.
Actions investors should take
We at Tantallon will continue to focus on business models with sustainable moats, resilient balance sheets and cash flows, disciplined capital allocation policies, and provide the opportunity to take permanent market share away from weaker competitors.
We urge investors to take the long view and to look through near-term market volatility to increase exposure to Indian equities.
We retain strong fundamental conviction in our portfolio holdings, with earnings/cash flows compounding at 15%-plus annually over the next three to five years.
Over the last three months, we have systematically increased our exposure to agricultural and rural beneficiaries, telcos, construction and building materials companies, and chemicals and pharmaceutical stocks, where we see opportunities to sustain significant market share gains at the expense of weaker competitors.
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
