The Tantallon India Fund closed 4.09% lower in October, the largest drawdown since March 2020. Markets had to price in a massive rotation by foreign portfolio investors out of India into Chinese risk assets, new domestic equity issuance, geopolitical fracture points in the Middle East being reflected in higher crude oil prices, mounting uncertainty over the US presidential election and its implications, local regulators actively curtailing retail participation in speculative options and futures trading strategies, and a tepid earnings season.
At the risk of sounding Pollyannaish, we would simply make the point that this is exactly the volatility we have been anticipating and writing about over the last several months. It provides us with an opportunity to finally buy into high-conviction names whose valuations on a three-year-plus view are now compelling.
The US election has been front and centre of every conversation over the past month. It is finally over, and with Trump slated to take office as the 47th President of the US on Jan 20, 2025, at 30,000 ft, we would highlight the following:
• Trump’s win was largely expected, with the Republicans securing control of the Senate and the House. However, what was not expected was higher interest rates and a stronger US dollar. A surging US budget deficit (if Trump follows through on his proposed tax cuts) and stubborn inflationary expectations (additional import tariffs and disruptions to already-tight labour markets are inherently inflationary) are likely to demand higher real interest rates (irrespective of what the Fed might do), which would then, make the case for a stronger US dollar.
• Lower energy prices. While remaining bellicose on Iran, Trump has frequently alluded to Ukraine’s need to “concede and negotiate”, his ability to call a halt to the war in Gaza and Lebanon, and China’s mercantilist impulse minimising the risk of open conflict in the South China Sea. Given elevated political risk premiums embedded in current crude oil prices, we should reasonably expect lower energy prices to sustain.
• Protectionist trade and tariff barriers remain core to Trump’s messaging. We should expect (the threat of) higher tariffs on Chinese exports imposed through executive fiat, which would be a positive fillip for manufacturing in India (and other China+1 beneficiaries) as an increasingly urgent alternative to supply chains currently embedded in China.
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Tantallon argues for a transient slowdown
The sharp market correction over the last few weeks has pundits “searching” for a narrative. The consensus seems to be extrapolating the most recent high-frequency data points to “flag” a broad-based, sustained slowdown. Having collated data and inputs across sectors and from across the country, we fundamentally disagree.
We would make the case that the transient “slowdown” is a consequence of (i) explicit Election Commission restrictions on government spending programmes ahead of national and state elections over the past three months, (ii) heavy flooding in several states during an extended monsoon season negatively impacting both industrial and agricultural output, and (iii) the “timing” (based on the astrological calendar) of the inauspicious “Shraadh” period (when discretionary spending is almost completely curtailed) and the Hindu festival season, which “shifted” the traditional consumer festival-related spending to October (from September last year).
The fundamentals of the investment-driven expansion we have been tracking and modelling over the past two years remain intact. We see government spending and consumer confidence rebounding strongly.
We are reassured by October’s high-frequency data rebounding strongly off the August/September trough, with GST collections up 8.9% y-o-y to INR1.9 trillion ($30 billion) in October, manufacturing PMI recovering to 57.5 (after softening to an eight-month low of 56.5 in September), services PMI recovering to 58.5 (from 57.9 in September), and two-wheelers (+32% in October vs –5.6% in September) and passenger vehicle (+25.9% in October vs –6% in September) sales rebounding.
The earnings releases and commentary from the fast-moving consumer goods (FMCG) and automobile companies point to a healthy monsoon sowing season and a revival in rural spending due to higher farm output and agricultural prices.
Prime Minister Narendra Modi’s fiscal discipline and the Reserve Bank of India’s “inflation targeting” have created an adequate buffer to allow for intentional monetary and fiscal easing into the second half of the current fiscal year, which will support accelerating private sector capex.
Key risks to flag include geopolitical crises, higher energy prices and greater trade/tariff restrictions.
Given the “slowdown”, the July-September quarter delivered disappointing earnings.
About 40% of the BSE500 reported earnings that lagged consensus expectations and consensus estimates for 60% of the BSE500 have been cut.
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Parsing the numbers, the disappointments/haircuts are attributable to delays in government procurement contracts and ordering, weaker urban consumer spending, weather-impacted manufacturing shortfalls, and negative operating leverage.
Interestingly, management commentary at the results’ briefings remained broadly upbeat, indicating a revival in urban consumer spending after the Shraadh period, a recovery in rural consumption trends following the sowing season, and, importantly, a strong recovery in government spending and new orders.
The industrials stood out given their positive outlook on industrialisation broadly and more granularly, including infrastructure spending, electrification, energy security, indigenisation and scaling China+1 opportunity.
The pharmaceutical companies flagged significant domestic opportunities in chronic therapies and the long runway in the US for complex generics and speciality pharmaceuticals, given the political imperative to reduce drug costs and the dependence on China-centred supply chains.
The rural-facing consumer and industrial companies flagged a revival in sentiment and spending — for the first time in six quarters — offsetting an unexpected contraction in urban-centric consumption trends.
The financials were rather “downbeat”, focusing on managing margins and balance sheet risk and the new regulatory constraints on unsecured consumer lending.
IT services companies remained “hopeful” of a 2H2024 recovery in banking, financial services and insurance (BFSI) spending in the US and Europe while highlighting limited “visibility” of new orders and margin trends.
The commodity companies — from chemicals and mining to energy and cement — reflected volume/pricing disappointments, exacerbated by negative operating leverage and higher financing expenses.
Stock highlight of the month
The stock we would like to highlight this month is Aditya Vision (AVL), a consumer electrical products retailer with a dominant presence across the Hindi-speaking heartland in Uttar Pradesh (UP), Bihar and Jharkhand. We believe that AVL’s commitment to bricks-and-mortar shops, a well-trained sales force, and a vernacular-and-local community-centric in-store customer experience is crucial in converting first-time footfalls into an organised retail format into actual sales. AVL’s catchment area represents 30% of India’s population, and given the current low single-digit consumer electrical penetration levels and minimal competition from national retail chains (who continue to steer well clear of Tier 2 and Tier 3 cities given relatively low incomes and complex local supply chains), offers us a long growth runway.
We expect AVL to deliver on consolidated revenues compounding at a 30% CAGR over the next three years. The stock is not well covered by the Street.
We have good visibility on new store openings in key urban and semi-urban locations across UP, Bihar and Jharkhand, and we expect AVL to add about 30 stores annually for the next three years.
We are conservatively building in 12% same-stores-sales growth for the channel, in line with nominal GDP growth in the catchment area; we are probably under-estimating rising real incomes and aspiration levels for branded consumer electronics in Tier 2 and Tier 3 cities in the Hindi heartland.
We expect AVL’s earnings to compound at a 40%-plus CAGR over the next three years.
We expect mix improvement and scale economics to drive strong operating leverage.
We expect ROE/ROCE to improve by 500 basis points (bps) over the next three years, exceeding 30%.
Despite re-investments in expanding the network, building product awareness and expanding the stock-keeping unit (SKU) mix, we expect margin uplift and strong working capital management to sustain strong free cash flow growth, supporting a higher dividend payout.
Conclusion
The sharp stock market correction over the last month has given voice to concerns over a broad-based slowdown in the real economy.
Having carefully collated data and inputs from across sectors and the country, we expect the investment-driven expansion to remain intact and government spending, consumer confidence, and high-frequency data to rebound strongly.
We want to take advantage of the volatility to buy into high-conviction names with compelling valuations on a three-year-plus view.
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
