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​​RBI and SEBI concerned about unfettered exuberance

Tantallon Capital
Tantallon Capital • 8 min read
​​RBI and SEBI concerned about unfettered exuberance
Information about election candidates is displayed at a polling station during the first phase of voting for national elections in Chennai, Tamil Nadu, India / Photo: Bloomberg
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The Tantallon India Fund closed flat in March, up just 0.02% from February, a month roiled by significant volatility with the sell-off of small- and mid-cap stocks spilling over into the broad market and local investors continuing to rotate into more “defensive” consumer discretionary, pharmaceutical, energy and public sector company stocks.

However, the markets seemed to have stabilised at the end of the month on the back of bargain hunting by local institutional investors positioning for a Modi victory, policy continuity and accelerating reforms after the conclusion of the General Elections on June 4. The sustained bid for domestic equities seems intact.

Volatility notwithstanding, the broad rally in risk assets globally is a standout feature for 1Q2024, climbing a wall of worry that extended through the tragedies in Crimea and Gaza, shock election outcomes (most recently in Turkey), recession headlines in Germany, Japan and the UK, rising energy prices, the weaponisation of trade flows and access to critical technologies, continued Chinese economic malaise and the ominous posturing ahead of the US Presidential elections in November.

The headlines celebrated the resilience of the US economy, the USD and US stock markets underpinned by a resolute labour market and a Fed “committed” to a path of “gradual” easing. The hype over AI is also not just about Nvidia: Equity risk assets globally seemed to have fully embraced the “promise” of generative AI.

We would also highlight the recovery in risk appetite in India following a sharp correction in March, the rally in Japanese and Korean equities, gold, crude, China and industrial commodities, Southern European financials and bitcoin.

Shifting gears to focus specifically on broad concerns about Indian equities, the Reserve Bank of India (RBI) and SEBI (Local Securities Commission) are perturbed by the unfettered exuberance in relatively illiquid small- and mid-cap stocks (SMID) and their “suspicion” that the dramatic increase in small-ticket, unsecured consumer lending was funding leveraged equity and derivative positions.

See also: Indian election unlikely to undermine GDP growth

The brakes have been applied, both through explicit restrictions being imposed on consumer lending by non-bank finance companies and through the blunt tool of “instructing” brokers to close out “excessively” leveraged positions and “encouraging” SMID equity mutual funds to temporarily be “closed” to new investors.

This was exactly what we have been highlighting over the last few months as we sold down our SMID exposure, carrying higher cash levels than normal.

That said, we are impressed that the “rotation” into more defensive, larger cap stocks has been “orderly”. More importantly, the strong domestic bid for equity assets is unabated.

See also: Standard Chartered sets up first global fund management entity in Singapore

Largest election in the world 

Is another decisive Modi majority in the upcoming General Elections factored “into the price”?

Anything short of a Parliamentary majority will be negative for domestic sentiment and markets. We must acknowledge the latent uncertainty with potentially up to a third of the electorate and, in particular, in rural swathes hit by two consecutive “bad” monsoons and sustained inflation, never having voted before.

However, we want to be clear: We expect a renewed Parliamentary majority for Modi, policy continuity, fiscal consolidation and accelerating land, labour, tax and FDI (foreign direct investment) reforms, which we believe, are not factored into the “price”.

Given the risk of higher crude prices and high inflation, will the RBI follow the US Fed, embracing “higher for longer”?
Our view is that given the unpredictability of global energy prices, the RBI will stick with its framework on growth, inflation and rupee stability. While in a position to be “accommodative”, it will likely only start a shallow rate-cutting cycle in the 3Q2024 once they have established some level of comfort on the monsoon season and the “direction” for food prices and inflationary expectations.

An additional “complication” for the RBI, which has a track record of “managing” the rupee’s depreciation to align with inflation differentials, is we do expect to see foreign institutional inflows pick up in 2H2024 assuming a “favourable” Modi victory. This reflects the “underweight” position in both Indian equities and fixed income (once India is included in the JP Morgan Bond Index this June). That might actually “encourage” the RBI to ease “sooner”. Watch this space.

For more stories about where money flows, click here for Capital Section

Has the corporate profit cycle, and as a result, equity valuations, “peaked”?
Unequivocally, no. Contrary to market concerns, we expect increasing top-line growth mapping well against real GDP compounding at plus-7.5%, higher utilisation rates and deleveraging balance sheets (despite higher capex) to drive sustained margin uplift and a cycle of earnings upgrades, with the domestic bid for Indian equities sustaining current valuation multiples.

We are increasingly confident that private sector capex is on the cusp of decisively taking the baton from government spending and driving sustained growth, a view validated over visits with scores of companies across multiple sectors over the last three months. Our careful analysis of their disclosed financials includes assessing trending order books, asset turnover ratios and capex plans.

Capacity utilisation is fast approaching “max” levels. With India’s manufacturing sector PMI hitting a 16-year high of 59.1 in March on the back of the strongest increase in output and new orders since October 2020, capacity utilisation for cyclical and capital-intensive sectors (autos, metals, capital goods, cement, building materials, petroleum products, pharmaceuticals and beverages) is now tracking more than 75%.

The discordant note, no question, is the divergence in consumption trends, and it does bear close watching.
“Affluent India” is humming. The strength in the data on purchases of premium/luxury housing and luxury automobiles, hospitality, travel, jewellery, and the financialisation of “excess savings”, is a revelation.

In contrast, “Aspiring India” is struggling with inflation-eroding purchasing power at the bottom of the pyramid. This is particularly true in rural India where agrarian incomes have lagged meaningfully over the last two years.

In conclusion, we have confidence in a renewed Modi Parliamentary majority anchoring accelerating reforms, infrastructure development, industrialisation, energy security, indigenisation, sustained job creation and affordable housing.

We are looking to take advantage of volatility to build on our exposure to long-runway and idiosyncratic opportunities in Indian capital goods, financials, pharmaceuticals, infrastructure, affordable housing and consumer discretionary stocks with attractive valuations and visibility on 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 Mankind Pharma, one of India’s largest domestic formulation companies. Mankind is also on the cusp of meaningfully expanding its domestic portfolio of cardiovascular, gastro, diabetes, dermatology, respiratory, anti-infectives, neurological, gynaecology and pain management brands.

We have conviction in management’s credible growth path, organically (through consumer-focused marketing and greater outreach to the network of physicians) and in-organically (through acquisitions and licensing deals), to drive sustained market share gains in chronic therapies, and as a result, improved mix and higher margins.

We expect Mankind to compound revenues at plus-20% annually over the next three years, well ahead of current market expectations of revenues trending in the low teens.
We believe that the calibrated new launches in respiratory, cardiac, neurological and diabetes segments will significantly exceed market expectations. The launch of DMF API (US FDA approved) formulations in India at affordable Indian price points has been a game changer, resetting expectations of product/efficacy/affordability for Mankind’s portfolio within the medical community and with specialist physicians in key therapeutic areas in particular.

We believe that Mankind’s strong balance sheet and sustained cash flows will support management’s intentional focus on addressing the white spaces in their portfolio through opportunistic acquisitions and licensing deals. The opportunity for institutional sales in the hospital and pharmacy channels is largely untapped as yet.

We expect Mankind to compound earnings by plus-30% annually over the next three years; consensus estimates would seem to suggest earnings compounding in the 18%–20% range.

We expect the investments in sub-scale therapeutical verticals, new product launches, growing chronic share and improving sales productivity to drive sustained top-line growth and scale efficiencies and underpin the expansion of operating margins in the domestic portfolio by about 500bps over the next three years.
Mankind has one of the lowest NLEM exposure (price-controlled drugs in India). This reduces the risk of capped margins.

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 concentrated portfolio (25–30 positions without leverage), 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, is a Singapore-based entity, set up in 2003, holding a Capital Markets Service License in Fund Management from the Monetary Authority of Singapore

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