The Tantallon India Fund closed up 2.96% higher in August, underpinned by a visible recovery in the domestic economy, strong earnings reports and growing confidence in structural reforms being sustained.
However, US Federal Reserve chairman Jerome Powell says the board is committed to doing whatever it takes to reining inflation and inflationary expectations, even at the expense of a recession.
Our view is that we should expect another more than 100bps in interest rate hikes over the next six months, bringing the policy rate to more than 3.5%.
Meanwhile, the more orderly bond market action seemed to have internalised the Fed’s most “hawkish” policy stance since the 1980s and be more willing to tolerate a period of below-trend economic growth and some softening in labour market conditions to set the stage for achieving maximum employment and stable prices over the longer-term.
We continue to expect that equity markets remain extremely volatile over the next few months until the Fed signals that they are close to “being done” in their efforts to restore policy credibility and achieve more durable price stability.
Known ‘unknowns’ on our radar screen
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How much uncertainty lies ahead for corporate profitability? Given falling PMI, excess inventory in global supply chains, hiring cutbacks and profit warnings from technology companies, and discretionary spending being ratcheted back, we do worry about a prolonged economic slowdown translating to significant earnings headwinds.
Also, how much further policy-easing, currency “weakness” and corporate “restructurings” lies in the cards for China? China is in near recession thanks to President Xi Jinping’s zero-Covid adherence, rising unemployment amid a slowing economy, property sector woes, and a climate crisis where record heatwaves and drought have severely comprised hydro-electric output, industrial production, and access to key river ports on the Yangtze River. Our growing sense is that Xi will kick the can further down the road and will be forced to ease monetary, fiscal, and regulatory policies.
Putin’s war in Ukraine is not going well for Russia but we are already past the stage where we can articulate rational risk/reward outcomes. The risks of unintended consequences are real and go beyond us trying to model supply constraints in energy and food supplies.
Indian economy on the right track
India is an idiosyncratic growth pocket amid the significant slowdown that we have seen globally:
• Topdown, the policymakers seem to have gotten the mix just about right, having:
- “Normalised” and hiked interest rates and policy rates at 5.4% are currently above pre-pandemic levels;
- Surplus interbank liquidity has dropped from US$89 billion ($125.5 billion) in January to US$21 billion in August; and
- The government seems to be on track to deliver on its commitment to reduce the fiscal deficit in the current financial year to 6.4% of GDP despite government spending on infrastructure and capital projects being budgeted to grow more than 25% y-o-y.
• We expect another 50–100 bps of policy tightening over the next six months. Despite the moderation in energy and food prices, and hence, a moderation in headline inflation, we expect the Reserve Bank of India to remain vigilant in managing inflationary expectations, particularly given the rupee’s historical vulnerability to higher energy prices.
• Gross fixed capital formation (GFCF) has rebounded for six consecutive quarters, accelerating sharply in the latest two quarters. Stripping out outlying Covid comparisons, we would point out that private consumption expenditure in the June quarter (1Q23) was 9.9% higher than the pre-covid quarter (1Q20) while total fixed investment spending in 1Q23 was 6.7% higher than in 1Q20.
• The high-frequency data we track continues to be growth affirmative: continued traction in services-led consumption; unemployment levels tracking close to pre-pandemic levels; credit growth accelerating to its highest level since March 2019; a sustained recovery in new homes, and passenger and commercial vehicle sales; and robust mobility and travel data, and tax collections.
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• The headline trade deficit numbers are a source of concern, reflecting both the spike in imported energy prices, as well as a slowdown in external demand for India’s exports. As the trade deficit have widened to an all-time high of US$30 billion in July, the trade deficit is tracking about 10% of GDP. Excluding imported commodities, the deficit is tracking at around 3.3% of GDP.
The significant heatwave in the northern and eastern parts of India and the unevenness of the monsoons, have impacted the sowing season and are likely to be an overhang on rural consumption over the next few months.
Stock focus
The company we would like to highlight this month is Fortis Healthcare, a pan-India, multi-speciality hospital franchise with a dominant National Capital Region (NCR) footprint.
Fortis is a turnaround story with IHH Healthcare, the new controlling shareholders with a 31% stake, focused on improving utilisation rates and operating metrics, while addressing bloated overheads and a sub-optimal cost structure.
The IHH open offer which has been put on hold while the courts review the litigation between the erstwhile promoters, Daiichi Sankyo and the Singh brothers, does represent interesting option value for investors. We are much more focused at this point, on the improvement in operating fundamentals over the next three years, which should allow the stock to close the significant valuation gap relative to Fortis is well on track to deliver an additional 1,500 hospital beds in brownfield capacity expansion over the next 24 months. This is simply not factored into consensus estimates and will allow Fortis to systematically expand its market share in NCR given the visible industry capacity constraints.
- As serious Covid hospitalisations abate, thanks to vaccines and boosters, the ramp-up in urgent and preventive surgical procedures will be a significant positive driver in the mix, improving utilisation rates, and revenue growth.
- We are starting to see the first signs of a recovery in medical tourism, and are conservatively modelling a 30% CAGR in medical tourism revenues off a very depressed Covid-base, with obviously positive implications for mix and revenues. We expect Fortis to deliver on consolidated revenues compounding at more than 15% annually over the next three years, twice the current consensus expectations. We expect Fortis to deliver on earnings compounding at more than 30% CAGR versus consensus estimates projecting flat earnings over the next three years.
- Over the next three years, we expect more than 100 bps of annual margin expansion on the back of strong operational efficiency gains, operating leverage, and improving mix.
- Given the measures already put in place, we are comfortable projecting a small cash profit at the Chennai Hospital over the next two years, versus the current annual INR400 million ($7.07 million) loss being incurred at the ebitda level.
- Given the industry-wide capacity constraints, we are starting to see a shift towards cash-paying patients, with obviously positive implications for profitability and cash generation.
- The market is under-appreciating the focus on margins and sustained profitability in the diagnostics division, as patients opt for the convenience, speed, and reliability of in-house diagnostics testing (as opposed to price-shopping across the various diagnostics chains) at the hospital they are actually being treated at.
In conclusion
- Corporate India continues to demonstrate resilience in margins, profitability, and free cash flow generation. The positive surprises have been in consumer staples and discretionary, capital goods, and financials while the disappointments have been in energy, healthcare, utilities and technology.
- We expect equity markets to remain volatile given macro and geopolitical uncertainties exacerbating global recession concerns, the second derivative of earnings downgrades, and the push/pull with investor leverage and positioning.
- As the Indian economy settles into a sustainable more than 6%–7% growth trajectory, we are patiently investing in high-quality financials, capital goods, and consumer-facing companies, when we have a conviction on earnings and cash flow visibility, and the recent market action has provided us with compelling expectations and valuations.
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 positions without leverage), market cap/sector/capital structure agnostic, but with strong conviction on the structural opportunity, scalable business models and 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
