SINGAPORE (May 20): The Tantallon India Fund closed down 1.89% in April weighed down by the rupee and another bout of risk-off as crude prices spiked on US President Donald Trump’s decision to further limit Iranian oil exports and the Druzhba pipeline debacle. On the ground, corporate earnings for the small- and mid-cap universe continue to surprise on the upside, well ahead of the more muted performance out of the large-cap index heavy-weights. Market participants are in “wait-and-watch” mode, however, as the Indian general election (the largest democratic electoral exercise in history, with 900 million registered voters potentially casting a vote) draws to a close; a Modi victory would be a clear positive for sentiment and the market.
Despite positive flows (US$3.5 billion [$4.8 billion] from foreign institutional investors and US$3 billion into domestic equity funds), the US Federal Reserve’s and the Reserve Bank of India’s (RBI) messages on being “comfortably patient”, and a visible pickup in domestic corporate activity (M&A, and both equity and debt issuance), equity market participants have been largely apathetic through April. Risk assets have rebounded off the October 2018 lows; at this point, it would seem that the markets are “cashed-up”, in rotation/consolidation mode, and “waiting” for certainty in three weeks vis-à-vis the outcome of the general election.
Effects of general election
We are well aware of how poorly the markets have projected election and referendum outcomes in the last five years. [Market declines ahead of an election sometimes imply that the governing party loses. Since April 16, the BSE Sensex Index has fallen 5.5%.] A “loss” for Prime Minister Narendra Modi would be a short-term market dampener. Our view remains that, irrespective of the election outcome, Modi’s structural reforms have been institutionalised and will sustain a decisive new investment cycle.
Benign outlook for oil
Crude price volatility is the ultimate arbiter of risk appetite and flows into Indian equities, given the implications for the fiscal and current account and, ultimately, the rupee. We have absolutely no idea what the price of oil will be at the end of next week — let alone at the end of the year.
Geopolitical uncertainty and Trump posturing on the grand stage, and potential supply disruptions from sanctions and civil war, are likely to weigh on crude price volatility in the short term.
In the longer term, however, we have conviction that:
• The spikes we have seen in energy prices over the last couple of years have had no fundamental growth-demand underpinnings;
• There is abundant new supply coming onstream — conventional fossil fuel resources, as well as shale and grid-parity renewables — and the Warren Buffett- backed bid by Occidental Petroleum Corp for Anadarko Petroleum Corp is as clear a signal as we should expect on the deep commitment to further upstream development capex and to significant new supply being commissioned over the next decade; and
• Disruptive new electric vehicle/battery storage technologies and increasingly targeted policy measures to reduce carbon emissions could set crude and other fossil fuels down a path of longer-term, structural demand declines.
The bottom line is that, in the medium to long term, we do have a benign outlook on energy prices — and that is, ultimately, very, very good news for India and investors in Indian risk assets.
Key risks to be continuously assessed
• Domestically: (i) continuity to the reform process, and to Modi’s anti-corruption platform if he is not re-elected or is hamstrung with an unwieldy coalition government; (ii) fiscal constraints limiting government spending; (iii) impaired transmission of RBI’s monetary easing; and (iv) un(der)-employment, given that India’s demographic opportunity demands the creation of about 20 million new jobs annually; and
• Externally: (i) potential supply-side constraints driving crude prices higher in the short term (which remain our major concern); (ii) completely unpredictable geopolitics, protracted trade conflicts, and customs-union breakdowns negatively affecting global growth and risk appetite; and (iii) the sustainability of Chinese stimulus measures, and sundry central banks endeavouring to maintain an “easing” bias to enable the global economy to navigate the current growth air-pocket.
Future Lifestyle Fashions a proxy for Indian consumer
The stock we would like to highlight this month is Future Lifestyle Fashions, the flagship fashion business of the Future Group. FLFL is India’s largest fashion retailer, with more than 300 stores in 90 cities spread over six million sq ft of retail space. Its target audience ranges from the mass market to premium segment. The company looks to explicitly fulfil the Indian consumers’ varied brand aspirations in clearly defined distribution channels (Central, Brand Factory). An interesting fact in the context of the group’s chequered history and comfort with leverage is that FLFL is the only dividend-paying company in the group, testimony to excellent working capital management and the ability to secure attractive long-term rental leases.
We expect FLFL to deliver on consolidated revenues compounding at 25% annually over the next three years, well ahead of consensus expectations.
• We have good visibility on new store openings, with long-term rental leases having been signed. We expect FLFL to add at least 30 discount-channel Brand Factory outlets and four to five very large, higher-end department store Central formats annually for the next five years;
• We are conservatively building in 10% same-stores-sales growth for the discount channel and 7% same-store-sales growth for the higher-end department store format; we might well be surprised on the upside by the strength of the aspirational brands and, importantly, the ability to engage customers through digital and social media outreach, and the ability to convert store footfalls into sustained spending patterns; and
• We have limited expectations of expansion into Tier-3 and -4 cities at this point; as Indian consumers continue to gravitate to aspirational brands, however, these smaller cities could represent meaningful upside to our estimates over the next three to five years. We expect FLFL’s earnings to compound at a compound annual growth rate of more than 50% over the next three years, versus much more muted consensus expectations. 2• Scale economics in both Central and Brand Factory formats will drive strong operating leverage;
• A structurally improving mix on the back of significantly higher revenue contribution from private label and licensed brands;
• Thoughtful category expansion into accessories, luggage and footwear will further improve the margin profile; and
• Sustained revenue growth, strong working capital management and sustained free cash flows will translate into significant deleveraging and interest cost savings over the next three to five years.
Rural consumption trends to rise
The markets are fixated on the outcome of the general election. On May 23, we will know whether Modi will be re-elected to another five-year term. Expect the markets to be “anxious” in the interim.
• On the ground, we have renewed conviction in strong rural consumption trends, in a nascent capex cycle, and in policy reform continuity/momentum; we believe that India’s idiosyncratic growth opportunity is intact;
• We would urge investors to take the long view and continue to increase their allocation to Indian equities;
• Irrespective of the election outcome, India’s structural reforms and domestic economy stand poised to deliver on sustained real GDP growth compounding at more than 7% annually over the next three to five years;
• We expect our portfolio companies to deliver on earnings and cash flows compounding at more than 15% annually over the next three years; and
• We find valuations and the risk/reward compelling (especially in the small- and mid-cap space), given the prospects of sustained revenue and earnings growth, and the likelihood of further easing by RBI.
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 (25 to 30 unlevered positions), market cap/sector/capital structure agnostic, but with strong conviction on the structural opportunity and scalable business models and in management’s ability to execute. Tantallon Capital Advisors, an advisory company, is a Singapore-based entity set up in 2003. It holds a Capital Markets Service Licence in Fund Management from the Monetary Authority of Singapore.
