The Tantallon India Fund closed 2.69% higher in May as markets sought to handicap the outcome of the recently concluded elections in the face of higher-for-longer inflation, increasingly confrontational geopolitics in Ukraine, Gaza and the South China Sea, and benchmark-focused investors being “herded” out of India into the “China hope” trade.
Anchored by our bottom-up stock-specific convictions, we have stayed locked in on trying to manage interim volatility while positioning the portfolio for policy continuity despite Prime Minister Narendra Modi securing a much weaker-than-expected mandate; sustained land, labour, tax, agricultural sector, and foreign direct investment reforms; and more development/social spending.
After three months of intense media coverage, high-decibel campaigning, thousands of AI-generated deepfakes and endless “gaming” of possible election outcomes and potential stock market implications, we can all breathe a sigh of relief with the election results in the bag and allow ourselves to re-centre on fundamentals
We were wrong. The Modi government has taken office for a record-third time; but, contrary to our expectations of a clear mandate, the electorate delivered Modi a functional coalition government which, while likely to be stable, will now certainly require the “management” of disparate coalition priorities and greater social spending.
Over 44 days, 642 million out of 968 million eligible voters exercised their prerogative at the ballot box. We do need to acknowledge and celebrate that India remains a very noisy, functional, vibrant, secular and rational parliamentary democracy.
The fevered handwringing in the media over the last year, bemoaning the “tilt” towards authoritarianism and more assertive Hindu nationalism, completely missed the point. Give voters who did make an active choice the credit, displaying great maturity in retaining the country’s secular fabric and the constitution’s inherent checks and balances.
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Voters showed up in vast numbers across the country, braving a debilitating heatwave, to be counted, casting a vote for continuity, continued fiscal and policy reforms, and job creation, while explicitly acknowledging Modi and the BJP are far from perfect, and messaging their intent on potential constitutional reforms with an empowered and effective opposition, given starkly uneven job creation over the last decade, stagnant real incomes and persistent inflation eroding purchasing power, exacerbating the rural/urban divide.
Looking past the market’s near-term “disappointment” over the coalition outcome, we would reiterate the point that India’s economic fundamentals remain robust. Real GDP growth of +8.2% for the fiscal year ended March 2024, well ahead of market expectations, was fuelled by fixed asset investments growing 9%.
We anticipate real GDP growth continuing to surprise on the upside at more than 7.5% for FY2025, and compounding at more than 7% over the next three years.
We expect La Niña conditions to be supportive of a normal monsoon and a recovery in rural spending/consumption bolstered by greater social spending to close the gap between urban/rural consumption; an acceleration in private and public fixed asset capital formation and construction given the focus on enabling infrastructure, manufacturing, and low-cost housing; and the export economy to continue to sustain global market share gains.
We expect the Reserve Bank of India (RBI) to start a shallow easing cycle in the second half of the calendar year. Modi’s commitment to fiscal discipline has “managed down” both inflationary expectations and the government’s borrowing needs, providing the RBI with greater flexibility as headline inflation starts to moderate.
We expect government revenues to surprise on the upside providing a buffer for the greater social spending now required. The fiscal deficit has narrowed to 5.6% of GDP buoyed by personal income tax revenue growth of +25% in FY2024 (+20% in FY2023, and +43% in FY2022), and strong growth in corporate taxes and GST revenues.
We do not expect a coalition government to compromise macro stability. A significant uplift is the dividend paid out by the RBI to the government. The wild card, of course, remains the risk of higher energy prices, and the impact on headline inflation and inflationary expectations.
We are modelling a stable rupee in a “stronger for longer” US-dollar world, reflecting both stable/improving current and fiscal accounts, significant FX reserves, and our expectation of continued inflows into rupee-denominated fixed-income assets given that India goes into the JP Morgan Emerging Market Index at the end of June.
How is the portfolio positioned currently?
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- We have been carrying a “higher than normal” cash position given our concerns about the inherent unpredictability of a democratic election process with a third of the electorate having never voted before. In hindsight, we should probably have been carrying an even higher cash buffer.
- We do expect markets to remain extremely volatile in the near term as investors digest the uncomfortable implications of a coalition government, and the uncomfortably high level of retail leverage in the markets, in particular, in the small- and mid-cap stocks, and in domestic industrial, infrastructure and public sector companies where stock market “narratives” are likely to be challenged by the dynamics of coalition politics.
- We continue to tune out the noise and will look to take advantage of market volatility and uncertainty over coalition politics to build exposure to what we believe will be Modi’s priorities in the third term:
- (1) job creation through industrialisation, indigenisation, and policy/subsidy support for exports, semiconductor, electric vehicle and solar module supply chains;
- (2) infrastructure development with a particular focus on rail, ports, airports, roads and water;
- (3) indigenisation of India’s defence requirements;
- (4) improving energy security by accelerating investments in thermal, renewable and nuclear power, in large-scale battery energy storage systems, and in upgrading the grid;
- (5) expanding affordable housing programmes;
- (6) accelerating capital investments in the agrarian economies of Uttar Pradesh, Bihar, Madhya Pradesh, Tamil Nadu and Telangana.
Notwithstanding the near-term disappointments for most market participants on a weaker-than-expected Modi mandate, the 2024 General Elections delivered a vote for policy continuity and welcome checks and balances.
The high-frequency data we track underpins our conviction in India’s macro stability, the business cycle, investment-led GDP growth compounding at around 7% over the next three years, and the visibility of our portfolio companies delivering on sustained earnings/cash flow growth.
We are prepared for and are looking to take advantage of the volatility to build on our exposure to long-runway, idiosyncratic growth opportunities in infrastructure development, industrialisation, energy security, indigenisation, sustained job creation, and affordable housing and consumer discretionary stocks where we have strong conviction in volume/mix driven operating leverage, and strong earnings/cash flow growth.
Stock highlight of the month
The stock we would like to highlight this month is Cipla, a leading Indian pharmaceutical company with a long track record of delivering on the founding family’s commitment to providing affordable, R&D-driven, generic therapeutic solutions across the developing world in India, Africa, the Middle East and Latin America. Our conviction is that the company is on the cusp of yet another inflection, leveraging its core process chemistry skills, scale, and the substantial free cash flows being generated to invest in biologics, gene therapies, mRNA therapies and oligonucleotides.
We expect Cipla’s revenue to experience a CAGR of over 15% over the next three years while consensus estimates are seen modelling growth in the high single-digits.
Cipla is a clear beneficiary of pricing stability being restored in US generics. Given the upcoming launches of gAdvair, gAbraxane and a strong line-up of peptides, our conviction is that Cipla is poised to exceed current market expectations on revenues, mix, and margins.
The domestic portfolio is focused on cardiac care, diabetes, urology and CNS, and positions Cipla as a strong No 2 behind Sun across the specific therapeutic segments, underpinning good visibility on revenues and margins.
We expect the consumer wellness segment to provide an additional growth impetus on the back of strong anchor brands, new products and differentiated channel strategies.
We conservatively expect Cipla to deliver on earnings compounding at more than 20% over the next three years; consensus estimates expect about 10% growth.
On a standalone basis, we expect operational and scale efficiencies (especially once the Goa facility comes back online) to drive margin accretion of more than 100 bps (basis points) over the next three years.
Further, we expect the US opportunity for gAdvair, gAbraxane, and the four approved peptides, and a higher share of chronic therapies in the domestic portfolio will be strongly margin/mix accretive.
The businesses in South Africa and Brazil are back on an even keel; however, we have yet to build in any margin improvement, given the risk of near-term foreign exchange volatility.
The Tantallon Asia Impact Fund SF is a fundamental, long-only, Asia-focused, total return opportunity fund. The fund invests with a horizon of three to five years in a concentrated portfolio (30–35 positions without leverage), market cap/sector/capital structure agnostic but with strong conviction on the structural opportunity, scalable business models, and data-driven analysis of sustainability, innovation, societal trends, and material environmental and governance initiatives to drive profitability. Tantallon Capital Advisors 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
