The Tantallon India Fund closed 6.47% higher in February despite significant intra-month volatility as the markets internalised the risk of sharply higher US Treasury yields weighing on discount rates and terminal “values” for the crowded pandemic “winners” in e-commerce, FinTech, BioTech, renewable energy, e-mobility, e-gaming and cryptocurrencies.
Buffeted by increasingly high-decibel market action amid rising inflation/real yield expectations, our views stand.
The price action in commodities, US Treasuries and the TIPS spread suggest that markets are projecting diminished tail risks and a “more or less” synchronised global economic recovery in the second half of the year.
That said, we should expect much higher volatility across asset classes as rising US Treasury yields reflect expectations of economic revival.
The negative real yield narrative for the US Dollar (USD) will likely be maintained by the Fed’s uncompromising policy and liquidity support, Biden’s stimulus package and his ambitious legislative, social, infrastructure and climate change agenda.
As the normalisation and reflation narrative takes hold, we should seek to take advantage of the current market volatility to build exposure to high-quality moats with self-sustaining growth capital.
The markets have inflected positively in India, reflecting both consistent flows into non-USD risk assets as well as the positive feedback loop with Prime Minister Narendra Modi’s February Budget and its reform-oriented industrialisation, infrastructure development, privatisation, and rising employment/rural income narrative.
We are pleased to note that our portfolio companies, in aggregate, delivered very strong revenues (+14% y-o-y) and earnings (+36% y-o-y) in the December quarter. Even accounting for pent-up demand as the economy reopens, the market has been positively surprised by domestic consumer and industrial demand, market share gains, operating leverage, and structural cost rationalisation efforts bearing fruit.
The high-frequency data that we have monitored over the last year has consistently pointed to the “normalisation” of industrial production, employment, and consumption. As we expected, the December quarter delivered positive growth although not as the market expected. We believe that the real economy is poised to revert to its historical 7%+ growth trajectory.
Having maintained sound fiscal discipline over the last year, Modi has intentionally supplemented a national Covid-vaccine roll-out with a strong counter-cyclical fiscal and monetary policy booster shot, a high-quality mix of infrastructure spending and manufacturing incentives, and reasonable budgetary math thanks to a pro-active growth and privatisation agenda. We anticipate an accelerating private sector capex and industrial investment cycle in India as global supply chains look to diversify away from their dependence on Chinese manufacturing.
Modi’s clear policy goals lend themselves to structural investment and opportunities for Indian equity investors: industrialisation; rising rural incomes, brand awareness and propensity to consume; de-carbonisation; affordable housing and healthcare; consolidation and self-sustaining profitability in financial services; digitisation; infrastructure; and logistics.
The pandemic has been extraordinarily disruptive although, at the same time, new digital technology introduction timelines have been significantly compressed, while effecting real behavioural and societal change.
The Covid-19 convergence of demand, an enabling policy framework and an aggressive digital infrastructure build-out have set the stage for a genuine multi-year opportunity in the digital economy encompassing e-commerce, data analytics, blockchain, the Internet of Things, cloud migration, healthcare, automation, robotics, AI, electricity and traffic grid management, working from home, streaming entertainment content, and online education.
More than 750 million fixed and mobile broadband users in India have forced a surge in data consumption rate to 8.5 exabyte/month, or an increase of 50 times over the last four years, at the scarcely believable low price of US$0.15/GB ($0.20/GB). We expect data usage to increase by 2.5 times over the next three years underpinned by the recently auctioned spectrum, increasing affordability of smartphones and data, and significantly higher acceptance and ease of online engagement, fulfilment and entertainment options.
India’s digital opportunity is substantially larger than the market’s conventional focus on electronic gaming, e-commerce, e-fulfilment and electronic payment gateways.
We are most excited about investing in the blockchain, structural cost savings, and digital consumer conversion opportunities driving sustainable earnings/cash flow growth for the traditional industrial, manufacturing, and consumer companies who are set to reap the benefits of the digital assets they have incubated.
The key challenges we are carefully evaluating at this point include data privacy and security issues, digital infrastructure bottlenecks, and evolving government regulations impacting social media, e-commerce, FinTech and logistics platforms.
What are we most mindful of?
Firstly, crude prices are well off their lows and India’s fiscal account vulnerability to high crude prices remains, as do latent inflationary expectations.
Secondly, Taper Tantrum II and regulatory “intervention”. We expect the Fed to persist with its asset-purchase programme and retain the toolkit to effectively address “disorderly conditions or persistent tightening” as it pursues its twin goals of higher inflation and employment. However, expect significant market volatility and regulators (the PBOC in particular) jawboning over elevated asset prices.
Thirdly, Covid-19 resurgence. Given the vaccine roll-out programme is underway, we do not anticipate another extended national lockdown; however, localised lockdowns are still possible and will be disruptive.
Higher realised volatility notwithstanding, the continued buoyancy in the high-frequency indicators we track bodes well for our outlook on the Indian economy and the markets.
We expect India’s real economy to re-establish a sustainable 7%+ GDP growth trajectory over the next two to three quarters on the back of the roll-out of the vaccine programme, supportive monetary and fiscal policy, strengthening domestic and external demand, and sustained private sector investments into infrastructure, urbanisation, industrialisation, and the consumer and digital economies.
Earnings for the December quarter has surprised positively on both the top line and operating leverage. We believe our portfolio holdings will deliver on earnings and cash flows compounding at 15%+ annually over the next three to five years on the back of sector consolidation and sustained market share gains, operating leverage, and mix/margin improvement.
We expect that market valuation multiples will be sustained: The vaccination programme will reduce tail risks and the economic reset is being manifested in greater consumer and business confidence. Do take advantage of market volatility to invest in Indian equities.
Company highlight
The company we would like to highlight this month is GMM Pfaudler (GMM-P), a global medical and chemicals consumables company that has recently concluded a reverse takeover of its private equity controlled German parent. Following the acquisition of the parent’s IP, product portfolio, and existing customer relationships, GMM-P is in an excellent position to leverage its low-cost Indian manufacturing base, to grow its global footprint in the speciality pharmaceutical and agro cum industrial chemicals space.
We expect GMM-P to compound revenues at a minimum of 15% CAGR over the next three years versus consensus estimates modelling single-digit growth.
Triangulating end-demand from both the pharmaceutical and chemicals sectors, our conviction is that the market is under-estimating sustained demand growth opportunities from existing clients.
The government’s incentives to boost exports will translate to further structural cost competitiveness for GMM-P’s Indian facilities relative to the global peer group, allowing for new client “wins”.
New product launches from the parent’s portfolio will be a significant revenue and mix improvement opportunity over the next three to five years.
We expect GMM-P to compound earnings at a 40%+ CAGR over the next three years versus the market’s expectations of low double-digit growth.
This is due to a fast-improving export mix that will be mix/margin accretive. The market has yet to calibrate the revenue/mix/cost synergies and the strong operating leverage that will accrue to the merged entity. We anticipate operating margins to improve by more than 100 basis points annually over the next three years.
Investments in de-bottlenecking existing capacity and new gas furnaces will drive additional operating efficiencies.
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
