As the March earnings season draws to a close, we saw impressive “breadth” in the earnings-driven recovery of companies in India.
For the third quarter in a row, the share of profits of the top 10 companies by market cap as a percentage of the aggregate profit pool of the BSE-500 declined and is at a four-year low.
In terms of sectors, materials and consumer discretionary stocks reported the strongest revenue growth and the most improvement in margins on the back of higher commodity prices, pent-up demand and operating leverage. Energy stocks posted the most significant recovery in profitability while financials reported the most significant “beat” versus consensus on lower provisioning.
The efforts to rationalise fixed costs over the last year are structural and will yield durable margin uplift even as utilisation rates recover and scale benefits mean the BSE-500 is likely to continue to deliver on strong earnings over the next two to three years.
We were most encouraged by the ninth consecutive quarter of improving margins for the BSE-500. Ebitda margins in aggregate improved by slightly higher than 250bps y-o-y, reflecting strong revenue growth as the economy “normalises”, industry consolidation, strong operating leverage, and durable cost-savings and working capital discipline that should survive the pandemic.
Earnings expectations for FY2022 ending March 2022 and FY2023 ending March 2023 have moved higher to +30% and +14% respectively.
India Inc shows agility, resilience
A year in, corporate India has demonstrated impressive agility and resilience, prioritising structural cost-control measures and working capital discipline, and a commitment to de-leveraging that augurs well for a sustainable uplift in margins, profitability, and free cash flow.
Demographics, a nascent industrial and capex cycle, the resilience of rural demand and services sector, sector consolidation and operating leverage, and the cyclical uptick in commodity prices have anchored positive earnings “surprises”.
China+1 remains a long-term investment theme as global supply chains commit to diversifying away from their dependence on China-centric manufacturing.
Regulatory forbearance and the delay in recognising Covid-19 compromised lending and provisioning remains an overhang for the banks and finance companies.
Given the social and healthcare infrastructure’s significant shortcomings in the face of the second wave, the concerns over the risks of an imminent third Covid wave are valid.
However, despite the intense criticism the government has faced, India is on track to vaccinate about 450 million people with at least one dose and to fully vaccinate about 150 million by the end of August.
Crucially, about 85% of those aged above 60 and about 75% of those aged between 45 and 60 have received at least the first dose of a vaccine.
Meanwhile, elevated crude oil prices remain a wild card. The impasse at Opec+ raises the spectre of higher crude prices in the short term, disconnecting from the fundamentals of supply/demand and the marginal cost of production.
Historically, higher oil prices — on the back of supply constraints, artificial or real — have harmed inflation and inflationary expectations in India, fiscal and current accounts, growth, the currency, domestic interest rates, and, ultimately, equity valuations.
Although we remain extremely watchful, we are relatively more sanguine than in the past given the short-to-medium-term visibility we have on the foreign direct investment pipeline into the country.
Despite the pandemic-related uncertainty, FY2021 ended March saw US$55 billion ($74.4 billion) of FDI inflows, matching the inflows in FY2020.
Given the shift of global supply chains away from China, India’s structural labour law reforms, manufacturing sector tax incentives, investments being made in export infrastructure, the domestic market opportunity for infrastructure and multinationals, our sense is the FDI pipeline is set to deliver US$60–70 billion in inflows annually.
Stock of the month
The stock we would like to highlight this month is JB Chemicals and Pharmaceuticals (JBCP), a domestic formulations and small-molecule contract manufacturing organisation (CMO) on the cusp of significantly expanding its domestic cardiac, gastro-intestinal, nephrology, paediatric and respiratory portfolio. Having tracked its management transitions over the last 18 months after KKR bought out the founding family and brought in seasoned industry professionals, and having carefully evaluated management’s articulated investment and growth expectations in the legacy brands, new therapeutic areas, and the sales and marketing channels, we are enthused by the opportunity to transform a sleepy domestic portfolio, while simultaneously ramping-up the CMO and active pharmaceutical ingredients (API) export opportunity.
We expect JBCP to compound revenues at 20%+ annually over the next three years, well ahead of market expectations of revenues compounding at sub-15% annually.
We expect the domestic portfolio, which currently accounts for around 45% of consolidated revenues, will compound revenues at 20%+ annually over the next three years on the back of the branded legacy cardiac portfolio increasing penetration in Tier 2 and Tier 3 cities, and calibrated new product launches in diabetes, nephrology, paediatric, and respiratory segments.
The branded generics portfolio in the US, Russia/CIS, and South Africa accounts for about 40% of consolidated revenues.
Management’s focus on accelerating new product registrations and the new product launch schedule should support the generics portfolio compounding revenues at 15%+ annually over the next three years.
We expect the API and CMO export business, which currently accounts for 15% of consolidated revenues, to double revenues over the next three years. With 60% capacity utilisation across the export manufacturing facilities, there is a significant opportunity to scale existing relationships with global pharmaceutical companies which are actively looking to reduce their dependence on Chinese domiciled CMO and API manufacturing.
We expect JBCP to compound earnings at about 25% annually over the next three years although consensus estimates seem to suggest earnings compounding at half that rate.
Management’s intentional investments in sub-scale therapeutical verticals, new product launches, the re-organisation of sales and distribution channels, and scale economics will underpin operating margins in the domestic portfolio expanding by about 500bps over the next three years.
The scaling of the export API and CMO opportunity will be further margin-accretive given improving mix and operating leverage.
India is on the cusp of a sustained growth cycle thanks to a strong, internal free cash flow-driven private capex cycle, the government’s concerted efforts to ramp up infrastructure spending, and the favourable tailwinds from demographics, foreign direct investments, and industrialisation.
We retain conviction in the structural reforms underpinning the growth runway over the next three to five years. We are invested in idiosyncratic growth opportunities in industrialisation, infrastructure development, urbanisation, financial services, and the consumer and digital economies.
We believe our portfolio holdings will deliver on earnings and cash flows compounding at 15%- plus annually over the next three to five years. As India’s vaccination programme ramps up and economic activity “normalises”, we anticipate pent-up demand, operating leverage, and structural cost savings to sustain strong earnings visibility.
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 fiveyear horizon, in a concentrated portfolio, market cap/sector/capital structure agnostic, but 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 table Singapore-based entity, set up in 2003, and holds a Capital Markets Service Licence in Fund Management from the Monetary Authority of Singapore