The Tantallon India Fund closed 1.87% lower in January as markets picked apart narratives on vaccination rollout delays, mutating Covid virus, further lockdowns, the Reddit message boards triggering an epic short squeeze, the PBOC signalling their concerns with speculative excesses, and a rash of executive orders by US President Joe Biden, and much navel gazing and partisan rhetoric on a US$1.9 trillion ($2.5 trillion) stimulus package.
However, filtering the noise, our investment framework stands.
Firstly, as vaccine rhetoric is expected to contextualise risk flows in the short term, markets should remain to remain volatile.
Secondly, global policymakers seem committed to “protecting” asset values, and the price action in commodities, US Treasuries and the TIPS spread would suggest that markets are projecting diminished tail risks and a probable synchronised global economic recovery in the second half of 2021.
Thirdly, the negative real yield narrative for the USD and the continued rerating of non-USD risk assets will likely be sustained by the Fed’s unambiguous liquidity support and Biden’s legislative, social and climate change agenda, and additional Covid-relief programmes which will demand further fiscal expansion.
Finally, watching the surreal GameStop saga unfold in real time across social media raises some uncomfortable questions on risk, regulatory oversight, and consequences of retail trading platforms providing transparency to algorithm-driven high-frequency traders.
Pro-consumption Budget
In India, as we had expected, the Budget presented on Feb 1, 2021, marks a reset for both the market, as well as for growth expectations.
Firstly, having maintained stoic fiscal discipline over the last year as a national Covid vaccine rollout finally gets underway, President Narendra Modi has delivered on a strong counter-cyclical fiscal policy push. These include a high-quality spending mix emphasising growth, targeted infrastructure spending, and new manufacturing capacity and job creation; forgoing the path of least resistance and higher taxes, and committing instead to a more pro-active growth and privatisation agenda. As a result, the market has been positively surprised.
Secondly, the Budget introduces progressive reforms to augment the transformational September 2019 corporate tax rate cuts and the tax incentives for setting up new manufacturing capacity. These include setting up an asset reconstruction company (ARC) to take over distressed assets in order to free up bank capital; a development financial institution to help finance long duration infrastructure projects; a small depositor-guarantee programme; the focus on ensuring adequate liquidity in the domestic corporate bond market; and additional incentives for affordable housing and export-oriented manufacturing capacity.
Secondly, the Budget is also pro-consumption. We would highlight that the further rationalisation of the personal tax slabs; continued efforts to boost rural and agrarian incomes; increase in the food-subsidy programme for those at the bottom of the pyramid and in the MNREGA allocations, the programme that benchmarks national minimum wages; further incentives for affordable housing mortgages; and additional social security and healthcare benefits for migrant workers and employees in the gig economy.
More importantly, the Budget math is reasonable. While the domestic bond market has groused over the short-term increase in borrowing requirements with a projected fiscal deficit of 9.5% in FY2021 ended March, declining to 6.8% in FY2022, given the excess liquidity in the banking system, reasonable revenue projections, and credible privatisation targets, our sense is that Modi has struck a good balance between fiscal consolidation and a forward-looking investment agenda.
Having studiously tracked multiple high-frequency data points over the last year, we continue to highlight the positive data points validating our expectations of a decisive growth reset. These include:
- The Composite PMI recorded a fifth consecutive month of expansion, with both Manufacturing (57.2) and Services (52.8) PMI higher than December levels.
- GST collections in January rose to an all-time high of INR1.2 trillion ($21.9 billion), 8.1% higher y-o-y.
- Rail Freight traffic growing at 8.8% y-o-y is consistent with the data over the last three months.
- Credit growth in January is tracking at a nine-month high of 6.6% y-o-y.
- Unemployment rates declined to a four-month low, even as active Covid cases fell 80% from the September peak.
Modi continues to deliver on de-regulation and growth supportive reforms. He has an aggressive infrastructure programme that dovetails well with sustained private sector investments into infrastructure, urbanisation, industrialisation, and the consumer and digital economies.
The return to pre-Covid business activity levels is also at hand, thanks to the government having ensured adequate domestic liquidity and SME viability, the resilience of rural/agrarian India, innovative e-commerce outreach, and an investment and export led industrial recovery. We expect the real economy to re-establish a sustainable 7%+ GDP growth trajectory over the next two to three quarters.
We are half way through the December quarter earnings season and surprised by strong top line growth and operating leverage while consensus earnings estimates play catch-up. 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. We expect that the vaccination programme will reduce tail risks, and as the economic reset is manifest in greater consumer and business confidence, domestic and foreign flows into Indian equities will be sustained.
Stock of the month
The company we would like to highlight this month is Jubilant Foodworks, the master franchisee for Dominos in India, Bangladesh, Sri Lanka and Nepal. The Quick Service Restaurant (QSR) category has expanded significantly through the pandemic, as lockdowns and restrictions on indoor dining, and customers focus on hygiene and social distancing, have seen a significant erosion of market share for the unorganised sector.
Within the QSR space, Jubilant stands out given its branding, its distribution presence which is three times larger than its closest peer, and sustained profitability and cash flows, allowing management to intentionally invest in new products, formats, cuisine and a slew of digital initiatives that will underpin visible growth over the next five years.
We believe that Jubilant will compound its revenues at a 20%+ CAGR over the next three years versus consensus estimates modelling growth at a 10% run rate. This will be due to significant market share gains at the expense of the unorganised sector and smaller regional players will translate to accelerating same store sales growth as the economic recovery gets underway. In addition, its expansion into Tier 2 and Tier 3 cities and the commitment to augment the existing network will see 120-odd new store openings over each of the next three years.
We are also excited about initiatives expanding into new formats, cuisines, and premium food categories, which includes plant-based protein, backed by a digital strategy leveraging a food super app, and its existing centralised kitchen and home delivery network.
We expect Jubilant to compound earnings at a 40% CAGR over next three years, well ahead of market consensus. This is due to new products and a gradual recovery in dining-in will see an improvement in mix. The expected significant reduction in competitive intensity, aggressive rental renegotiations, and economies of scale and strong operating leverage also underpin our base case expectations of 150bps–200bps of margin accretion annually.
In addition, management has been proactive in closing unprofitable stores, and in tweaking formats to enable quicker breakeven on new store openings.
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.
