The Tantallon India Fund closed 4.44% higher in June as markets quickly digested the disappointment over the elections, which resulted in a coalition government for Prime Minister Narendra Modi. Concerns had arisen about potential delays in anticipated land, labour and tax reforms.
We have been surprised by the quick snap-back. With markets up 13% from the post-election lows, the cash reserves we had maintained as a buffer against market volatility have been a drag over the last few weeks.
Looking ahead to the upcoming annual Budget and beyond, we are optimistic regarding the continuity demonstrated by Om Birla’s re-election as Speaker of the House and the re-appointment of key ministerial positions. Despite Modi’s weaker-than-expected mandate, coalition concessions give hope for sustained reforms in land, labour, taxes, agriculture, and foreign direct investment.
While coalition partners will seek their share of benefits, this will likely manifest as financial aid to states for accelerating local infrastructure projects such as irrigation, roads, rail, power generation, and ports, along with budgetary incentives to spur industrialisation.
Expectations are that Modi will maintain fiscal prudence, with an anticipated increase in social spending balanced by a commitment to macroeconomic stability and support for the private sector. This approach is expected to give the Reserve Bank of India confidence to gradually reduce interest rates in the coming months, as inflation and inflationary expectations moderate.
Regarding budgetary priorities, we expect to see a specific focus on affordable housing, renewable energy, the electric vehicle supply chain, semiconductors, tourism, retail, and additional export-oriented manufacturing incentives.
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We expect to see more targeted infrastructure development and welfare/social spending, particularly in the Hindi-speaking heartland, Maharashtra, Haryana, Jharkhand and Andhra Pradesh.
As in the 2003–2007 cycle, we expect sustained growth in government and private sector capital expenditure (compounding at 8% over each of the next three years versus 6.5% over the last couple of years) underpinned by Modi’s commitment to industrialisation and sustained job creation by accelerating the building up of infrastructure and explicit support for “Make in India” manufacturing policy, import substitution, and developing an export economy.
We expect to see recovering consumption growth (compounding at 6% over each of the next three years versus the 4% growth registered over the last couple of years), driven by both structural (improving job creation and higher wage growth) and cyclical (moderating inflation and improving agricultural output and incomes) drivers.
Tracking rural revival closely
Rural incomes and consumption trends have lagged expectations due to two consecutive poor monsoons, lower agricultural yields, and lower agri-commodity support prices. This lag is exacerbated by high inflation, which is eroding purchasing power at the bottom of the pyramid.
Post-election analysis holds rural distress primarily responsible for the BJP’s relatively poor showing in the recent elections. The party won only 44% of the rural seats it contested, as opposed to a 58% “success rate” in the 2019 polls.
Not surprisingly, we expect to see more explicit policy support for the rural economy through higher fertiliser subsidies, higher minimum support prices for grains and cereals, and an expansion in the rural employment guarantee programmes.
We are positioning our portfolio for a revival in rural sentiment/consumption, given the data from the Meteorological Department portending a more “normal” monsoon post-El Niño and an increase in policy and financial support for the rural economy.
We retain firm conviction in India’s industrialisation and capex cycle and the multi-year tailwinds for our core positions in the industrials.
We expect gross fixed capital formation (GFCF) as a percentage of GDP to remain north of 35% over the next three years. The visible government commitment to building infrastructure and additional manufacturing sector incentives will encourage private entrepreneurial risk capital to commence a nascent industrial investment cycle.
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Our key focus areas have been the opportunities in indigenising India’s defence capabilities, developing India’s energy security (through new thermal, renewables, and nuclear power capacity), developing India’s electric grid, rail, road, and port infrastructure, and identifying and investing in key “sunrise” sectors such as data centres and semiconductors.
However, stocks have done very well, and valuations are rich relative to history and the market. Mindful of the sector’s history of periodic disappointments in execution and on margins (operating leverage and raw material price volatility), we seek to take advantage of the market strength to scale back some of our long-held portfolio convictions.
Stock of the month
The stock we would like to highlight this month is VA Tech Wabag (VATW), a Chennai-based global water and sewage treatment company with a portfolio of patented water, desalination, zero liquid discharge, and sewage treatment solutions. Thanks to its low-cost India-based design and engineering capabilities and an asset-light business model where it outsources construction activity to a local partner, VATW is the low-cost global provider of turnkey solutions in water management and waste treatment.
We expect VATW to compound its consolidated revenues at a 20%+ run rate annually over the next three years, versus consensus expectations of revenue growth compounding at sub-15% annually.
We are certainly more optimistic than the market about India’s capex cycle. We expect meaningful order inflows from the domestic market over the next five years, fuelled by strong central and state government budgetary support for irrigation, water and sewage treatment, and desalination plants.
Our expectations for the international order book may well be much too conservative. Significant tenders are being floated in the Middle East and Northern Africa, backstopped by strong multi-lateral agency support for industrial-scale desalination, water treatment plants, and sewage treatment.
We are not building any upside to the order book from the multi-year green hydrogen and semiconductor opportunities in India and abroad, which require large quantities of pure and desalinated water.
We expect VATW to compound earnings at a 30%+ CAGR over the next three years; current consensus expectations are anchored to 20% growth.
We are conservatively modelling operating margins to improve by 50 bps annually over the next three years based on operating leverage and a higher proportion of operation and maintenance (O&M) contracts in the mix.
We are more constructive than the market about the higher-margin international order book sustaining improvements over the next two to three years.
We expect the pivot towards an asset-light model, focusing on revenue-to-cash conversion and tighter working capital management, to yield significant debt reduction and interest expense savings.
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.
