The Tantallon India Fund closed down 0.76% in October as markets largely ignored earnings for the quarter substantially exceeding expectations but focused instead on the risks posed to the real economy by elevated energy prices and the implications for inflationary expectations, monetary policy and the currency.
We would point to significant volatility across all risk markets as multiple central banks re-affirmed the status quo on interest rates and tapering with a nudge and a wink and given the significant spike in energy prices, continued supply chain disruption and under the pall of China’s regulatory crackdown exacerbated by its property sector on life-support.
Vaccination-led revival
Specific to India, we remain constructive on the broad economic revival as vaccination rates continue to improve and on structural reform measures anchoring a new capex cycle. We have continued to engage virtually with dozens of businesses and policy-makers on the ground and would like to highlight the following:
The stand-out feature is higher input labour, commodity and logistics costs. Earnings have surprised positively (above 28% y-o- y for the BSE500) thanks to very strong top-line growth (above 31% y-o-y) although operating margins have tracked 200bps lower than expectations.
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Crucially for the banks, the asset quality cycle has visibly inflected. Having pored through the recent September quarter results from both the private and the public sector banks, we have been positively surprised by the incremental data on non-performing loan slippages, write-backs and credit costs as well as by managements’ expectations on loans growth, margins and credit costs.
Meanwhile, after a painful seven-year downturn, India’s housing sector is seeing a strong cyclical upswing: the earnings releases and management commentary on recent launch announcements/pre-sales data have surprised positively, with low inventory levels allowing for an improved pricing environment.
Government spending on infrastructure and a strong recovery in housing stats are good lead indicators and our conviction is that private corporate capex is set to accelerate given liquid corporate balance sheets, a banking system flush with surplus liquidity, industry utilisation rates of about 80%, and the government’s targeted production incentives.
The focus industries that we are closely tracking are renewables, metals and mining, hydrocarbons, chemicals, cement, data centres, real estate, and textiles .
The high frequency data we track continues to “improve” too:
- Despite a sluggish automotive sector, manufacturing PMI rose to an eight-month high of 55.9 in October.
- Services PMI accelerated to 58.4 in October (vs 55.2 in September), the highest reading since April 2011.
- CMIE’s weekly unemployment rate stood at 7.2%, similar to pre-pandemic levels.
- GST collections in October registered INR1.3 trillion ($26.3 billion) — the second-highest monthly collection ever — with the two-year CAGR in GST collections improving to +16.8% from +12.8% in September).
- Power demand improved to a two-year 7.5% CAGR.
- Airline passenger load factors are at 70%, with 638,000 average daily airport footfalls in October relative to 78,000 average daily footfalls in June.
The key overhang remains higher energy costs, with rising inflationary expectations, the headwinds posed to monetary/fiscal policy and consumption, and potentially negative implications for the rupee.
What is meaningfully different this time, relative to past bouts of elevated energy prices, is that Prime Minister Narendra Modi has eliminated government fuel and cooking gas subsidies — avoiding legacy bloated fiscal deficits and the government’s borrowing programme crowding out the private sector.
We would be looking to take advantage of market volatility to increase our exposure to Indian equities. We expect markets to remain volatile in the short-to-medium term, given the risks embedded in higher energy prices, and the market’s very strong outperformance over the last year. That said, the real economy is on the cusp of a strong cyclical recovery anchored by government reforms and infrastructure investments, the revival in the private capex cycle, and pent-up consumer demand.
We are invested in a concentrated portfolio focused on the consumer and digital economies, industrialisation, financial services, infrastructure and logistics. We believe that the valuation of our portfolio holdings is compelling relative to the long runway opportunity set, and the visibility on earnings and cash flows compounding at 15%-plus over the next three years.
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Stock of the month The stock we would like to highlight this month is ABB India, a precision engineering company with core competence in power products, automation, mobility, and robotics. Thanks to its parent’s comprehensive product portfolio, localised, low-cost manufacturing, and stellar execution track record, ABB India sits in a sweet spot, a pure play on India’s private sector capex revival, and in particular, the focus on industrial automation.
We expect ABB India’s revenues to compound at a 25%+ CAGR over the next three years, while market consensus would seem to be pencilling in a much more sedate 15% run rate.
A significant tailwind would come from the government’s production-linked incentives to encourage industrialisation and job creation; investments being made in infrastructure broadly, and the railways in particular; and investments in renewables and electrification.
In addition, we see sustained demand from the growth in data centres across the country. The launch of E-mart, an online fulfilments platform, targeting Tier II and Tier III customers with about 6,000 products, has opened up a significant opportunity. We are yet to build in any estimates for the investments currently being made in robotics, motors, and testing capacity, to support domestic production of electric batteries and green hydrogen.
We expect ABB India to compound earnings at above 70% CAGR, almost double consensus expectations.
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Management has systematically invested in operational efficiencies, process optimisation and logistics to maintain a globally competitive cost structure, allowing for margins to be protected despite higher raw material input costs.
Order inflows have reached pre-Covid levels and we anticipate an improving ordering cycle to drive significant operating leverage and margin expansion. We expect RoEs to triple over the next three years and exceed the historical peak levels of about 18%.
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 with strong conviction on the structural opportunity, scalable business models and in management’s ability to execute. Tantallon Capital Advisors, the advisery company, is a Singapore-based entity and holds a Capital Markets Service Licence in Fund Management
Photo: Bloomberg
