(May 15): The Tantallon India Fund closed 8.23% higher in April, with the broad market narrative focused on looking beyond the current economic meltdown towards an eventual recovery.
The stark disconnect between economies in “lockdown” and equity markets rallying sharply off the March lows, reflect “relief” at global central banks seemingly committed to back-stopping risk assets through massive liquidity interventions, domestic investors anticipating further fiscal, monetary, and policy support, and a sense that Prime Minister Narenda Modi’s early decision on a national lockdown had allowed India to hopefully escape the worst.
However, there is extremely limited earnings visibility in the current environment. In the absence of a viable and scalable vaccination programme, trying to project demand, supply, revenues and margins over the next two to three quarters is a largely futile exercise.
Outlook for the Indian economy
Given the expected fiscal stimulus and the slump in tax revenues, the fiscal deficit is expected to be close to 5% versus the budgeted 3.5%.
A prolonged shutdown would take heavy toll given mass unemployment, weighing most heavily on leveraged SMEs and on household consumption and debt-servicing capacity.
Balance sheet stress will be ruthlessly exposed by demand destruction, collapsing revenues, and negative operating leverage.
Businesses are prioritising cash generation and balance sheet resilience, delaying investments, evaluating equity issuance, and dividend cutbacks.
The dislocation in the global economy and the national lockdown will weigh on India’s growth outlook over the next two to three quarters.
Tantallon has spent the past month engaging virtually with dozens of Indian companies across the market cap spectrum. We expect a short, sharp recession, followed by a strong recovery, for the reasons below:
• India is a significant beneficiary of the correction in energy prices, arguing for modest inflationary expectations, further monetary easing, and a stable currency.
• Surplus domestic liquidity and significant policy/fiscal stimulus to revive growth and earnings cycle with clear focus on rural and middle class employment and consumption.
• Further structural reforms and infrastructure investments encourage global supply chains to relocate to India.
We have dramatically scaled back our growth expectations for the fiscal year ended March 2021 to +0.5%, before reverting to a +7% run-rate in FY2022–FY2025.
Compelling valuations
To be sure, valuations are compelling relative to asset values, replacement costs, and the strength of the underlying cash flows.
About 70% of the Indian equity market is already selling at a discount to 10-year average P/BV, P/NAV, and P/CF multiples, despite structurally lower inflation/interest rates, modest fiscal/current account deficits, and modest aggregate corporate leverage.
Longer term, we retain conviction in fundamentals for our portfolio companies, and in earnings and cash flows compounding at 15%+ annually over the next three to five years.
We are currently modelling a 350bp deterioration in operating margins for our portfolio holdings for the fiscal year ended March 2021, before rebounding strongly into 2021/2022. We expect to see two to three quarters — through the end of September 2020 — of delayed consumption, down-trading, and some outright demand destruction — so, both mix deterioration and negative operating leverage. We also expect to see optimised efficiencies of “just in time” manufacturing and delivery devolving to “just in case” stocking and supply chain stress, structurally increasing working capital requirements.
We are most conflicted about our long-held convictions in the highest quality, well-capitalised private sector financials. We expect that well-capitalised financials with strong deposit franchises, strong branding, and a strong suite of digital products will take disproportionate market share through this crisis, and will be poised for years of very profitable growth.
However, the reality of a sharp economic contraction, job losses, eroding commercial real estate values, and the near certainty of rising corporate and personal default rates in the short term, even as the massive injection of central bank liquidity compresses net interest margins, would suggest a period of below-trend growth and potential stock multiple de-rating. We have significantly reduced our exposure to the sector in the last six weeks.
Anticipating significant policy/fiscal support, we are mapping the nuances of a path to recovery over the next 12–18 months. We are diligently stress-testing our assumptions in pharmaceutical stocks, chemicals, telecoms, agricultural and rural beneficiaries, construction and building materials, and financials. Over the next quarter or so, we expect to reduce our current significant cash position.
Monthly stock highlight
The stock we would like to highlight this month is CCL Products (CCL), the leading manufacturer of instant coffee globally, with private label customers in 60 countries purchasing its spraydried, freeze-dried, and liquid concentrate variants of instant coffee. CCL currently has 35,000 metric ton (MT) of capacity globally (70% of which is in India).
The significant opportunity in the medium term is in establishing its own brand “Continental” in the domestic market to compete with the current duopoly between Nestle and Unilever.
We expect CCL’s consolidated revenues to conservatively compound at 12%+ annually over the next three years versus more sedate market expectations of a 9% CAGR.
Despite short-term challenges in managing logistics/supply chain through the Covid-19 shutdowns in India and in Vietnam, demand for end product remains robust, and customer indications would suggest very strong re-stocking demand over the next six months globally. Perhaps, “stay at home” translates to a structural uptick in coffee demand globally.
Management’s short-term goal is to rampup global capacity to 50,000 MT over the next three years, providing us good visibility on volume growth.
We are excited about the traction being established through the organised retail channels and the on-premise consumption in mom-andpop coffee shops for the Continental brand domestically, and in particular, in the premium filter coffee segment. Our belief is that consensus is underestimating the mix improvement upside that we are currently modelling.
We expect CCL’s earnings to compound at 20%+ annually over the next three years versus consensus expectations modelling sub-12% growth.
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 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
