The Tantallon India Fund closed 0.71% lower in September amid significant global market volatility triggered by a spike in US bond yields with the Fed’s messaging on tapering, a spike in energy prices and the Evergrande liquidity crisis.
These issues exacerbated worries over supply chain disruptions, higher input commodity prices, and the likelihood of a structural slowdown in China given its ageing population, the regulatory crackdown on private enterprise, and the implications of global supply chains relocating away from the country.
In India, we are most concerned about energy prices remaining at elevated levels, the attendant drag on the current and fiscal accounts, and, crucially, the constraints imposed on the Reserve Bank of India by stubbornly high inflationary expectations. High oil prices also hurt.
Selldown in low volatility sectors
Intriguingly, the “risk-off” trade over the last month in India has diverged from the historical patterns we have seen over the last three decades of being invested in the market.
The selldown has been in the historically low-beta sectors like IT services, FMCG and telecoms, reflecting the stop-start dynamics of the services economy constrained by an extended Covid drag, demanding valuations and passive asset allocation flows.
Domestic cyclicals in the power, energy, real estate, consumer durables, metals and infrastructure sectors continued to outperform. While valuations for “old economy” stocks are a lot more forgiving, our sense is that the market is actually actively rewarding pockets of resilient and visible growth, underpinned by favourable commodity pricing tailwinds, and government spending and incentives for manufacturing and infrastructure.
Helping this along perhaps is the resilience in domestic retail flows into the equity markets and the preference for more domestically-oriented stocks with good revenue and earnings visibility, as opposed to the traditional foreign institutional investor “favourites”.
The high-frequency data we track suggests that the economy is on the cusp of a strong cyclical recovery anchored by government reforms and infrastructure spending, the revival in the private capex cycle, and pent-up consumer demand. There are also other positive signs:
- We are encouraged by the daily Covid vaccination rate tracking at 7.7 million/day through September: 260 million people having been fully vaccinated; 70% of the adult population has had at least one vaccine; and the country is on track to have half the country fully vaccinated by the end of the year. We are keeping a wary eye on the daily new infection data as we head into the festive season.
- GST collections in September came in at INR1.17 trillion ($21 billion), boosting the two-year CAGR for GST collections to 12.8%, validating President Narendra Modi’s commitment in implementing GST.
- Manufacturing PMI rose to 53.7 in September, up from 52.3 in August. • E-way bills rose to a six-month high, clocking a two-year CAGR of 13.8%. • Air passenger traffic for September is tracking at 82% of February levels.
- The Centre for Monitoring Indian Economy’s (CMIE) weekly unemployment rate declined to 6.1% in September, the lowest in 20 months.
On the negative side, we would point to the services PMI contracting to 55.2 in September (vs 56.7 in August) given the mobility restrictions in some cities, chip shortages weighing on automobile and commercial vehicle production and sales, and coal shortages weighing on power production/consumption.
We have continued to interact virtually with company managements, regulators, local bureaucrats and the sell-side.
We are particularly encouraged by the traction we see of high quality, well-capitalised, over-provisioned private sector banks executing on profitable digital and customer acquisition.
Commodity price inflation and supply chain disruptions (from computer chips and coal to coffee and cocoa) will weigh on reported revenues, margins and earnings in the near term — across sectors.
At this point, the markets seem inclined to look through these shortterm disruptions; we are not as sanguine, and are trying to sift through the noise to focus in on companies with pricing power and scale benefits to potentially offset structurally higher input costs without compromising long- term volume/growth targets.
- Rural demand remains resilient, underpinned by higher agri-commodity prices.
- Discretionary consumption appears to be recovering as new hiring picks up in the IT Services and manufacturing sectors, and as banks start to lend again.
- The property sector seems primed for a structural revival given improving affordability in key urban centres and attractive mortgage rates. The July-September quarter marks the first five years.
- Optimism on festival demand: Given the extremely subdued festival season last year, expectations are building for a significant revival in festival spending.
To recap, high energy prices are a spoiler, and does create a shortterm overhang for investor sentiment and the markets. That said, the economy is on the cusp of a strong cyclical recovery anchored by government reforms and infrastructure investments, the revival in the private capex cycle, and pent-up consumer demand.
We remain invested in the idiosyncratic opportunities in financial services, industrialisation, infrastructure and logistics, and the consumer and digital economies.
Stock of the month
The stock we would like to highlight this month is Aarti Industries, an entrepreneur-driven bulk and speciality chemical company operating across the benzene/toluene value chain, supplying product to over 20 sectors globally. Aarti is a key beneficiary of global supply chains looking to actively diversify away from their dependence on Chinese-domiciled capacity. We are particularly focused on the significant revenue/ margin opportunity ahead as Aarti invests in new chemistries in the chloro-toulenes value chain.
We expect Aarti’s consolidated revenues to compound at around 30% annually over the next three years versus the market projecting a more modest 18%–20% run-rate.
The new capex programme involving INR50 billion over five years across 40 new agrochemical products and 50 new pharmaceutical products will transform Aarti into the primary non-Chinese supplier globally for its key products. The timely commissioning of the new capacity, and the strong end-user demand we see from their global pharmaceuticals and agro-chemical clients underpins our assumptions on volume-off take and revenue growth.
The investments in new chemistries in the chloro-toulenes value chain will allow significant cross-selling opportunities to their existing customer base and encourage import substitution for new customers, driving revenue and cost synergies, and giving them the ability to improve mix.
We expect Aarti to commercialise the Dicamba molecule over next two years and are currently modelling a 70% utilisation rate on the capacity that has been built.
We believe that Aarti will compound earnings at a 35%+ annual run-rate over next three years, versus market’s current expectations of profits compounding at 20% annually.
On the back of the new specialty chemicals capacity coming on stream, scale benefits, and operating leverage, we are modelling sustained mix/margin improvement over the next three years. E 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
