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Indian markets focused on May election

Tantallon Capital Advisors
Tantallon Capital Advisors • 7 min read
Indian markets focused on May election
SINGAPORE (Mar 18): The Tantallon India Fund closed up 1.05% in February, the markets impressively shrugging off the highstakes drama over Kashmir, with India conducting a bombing sortie on terrorist camps across the line of control in response to the sui
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SINGAPORE (Mar 18): The Tantallon India Fund closed up 1.05% in February, the markets impressively shrugging off the highstakes drama over Kashmir, with India conducting a bombing sortie on terrorist camps across the line of control in response to the suicide bombing that killed 40 soldiers, and Pakistan, in turn, retaliating by downing a couple of Indian MiG- 21’s. The focus now seems squarely upon the prospects of Prime Minister Narendra Modi’s re-election in the next general election (slated for April 11 to May 19), and on the increasingly visible recovery in rural India, fixed asset investments and private sector capital expenditure.

• High-frequency data points and robust volume earnings growth for the December quarter would affirm that we are on the cusp of a new investment/consumption upcycle;

• We see credit growth and profit margins inflecting higher; and

• We find valuations increasingly attractive — especially in the small- and midcap space — given the prospects of sustained revenue and earnings growth, and the likelihood of further easing by the Reserve Bank of India (RBI).

Overtakes China as high-growth big economy

Having just returned from several days in India visiting companies, we wanted to pass on some of our takeaways:

• Tight liquidity and risk aversion in October and November last year pushed India into a growth air pocket of sorts — with the real economy expanding only 6.6% in the December quarter, boosted by strong exports, recovering fixed asset investments and robust manufacturing output. With system liquidity having meaningfully improved, and given our growing confidence in the capex cycle ahead of us, we remain comfortable with our expectations of real GDP growth compounding at more than 7%over the next three years;

• That growth soft spot and inflation trending below RBI’s inflation-targeting framework reinforces its accommodative policy bias, in accord with central banks’ globally signalling a collective “pause”. We now expect another 75bps to 100bps of policy easing in the next 12 months — and this is definitely not consensus; and

• Rural India continues to surprise positively, thanks to stabilising farm-gate prices and the government’s specific rural policy initiatives, targeted incentives, building out rural connectivity, infrastructure and rural housing. Sustained rural demand is the clear bright spot for corporate India.

Expecting a Modi win

• Politics — and yes, everyone has an opinion! — dominates the airwaves. However, mind-numbing permutations on pre-andpost- poll alliances by a host of psephologists and media pundits would suggest that no one really has a clue as 900 million Indians prepare to vote!

• Our expectations remain that Modi will be re-elected, albeit with a smaller majority;

• We are equally clear in our view that if Modi is not re-elected, as in previous election cycles, the market’s initially into an assessment of: (i) stability and the strength of the institutions, (ii) underlying reform momentum, and (iii) the outlook/sustainability for growth;

• The bottom line is that irrespective of the election outcome, we believe Modi’s structural reforms have been institutionalised and will sustain a new investment cycle and our growth outlook; and

• The key risks to assess are: (i) the external pressure points (energy prices, geopolitics, trade conflicts and so on) affecting global risk appetite/flows, creating a potential drag for Indian risk assets and, in particular, for the rupee, (ii) fiscal constraints in an election year limiting government spending, and (iii) delayed/impaired transmission of RBI’s easing bias, given a moribund public banking sector, and the risk of government borrowing crowding out the private sector.

Exposure to Indian consumer to increase

Our portfolio remains significantly exposed to the idiosyncratic growth opportunity in domestic consumption through our investments in financials, as well as in consumer discretionary and staples. We expect our exposure to the Indian consumer to continue to increase over time.

• Aspirational discretionary spending constitutes a sustainable investment thematic, thanks to demographics, urbanisation, increasing education levels, job creation and rising disposable incomes;

• We see our portfolio companies investing disproportionately in branding, distribution (both direct access and through organised retail) and product innovation to drive category awareness/ penetration, product differentiation and market share gains;

• Despite the liquidity crunch in the December quarter, household and personal care companies posted a 130bps q-o-q growth in volumes, suggesting that we are potentially on the cusp of a sustained consumption recovery;

• Given the focus of this government on driving rural incomes, rural spending is likely to continue to outpace urban consumption;

• Importantly, discretionary spending continues to exceed staples growth, suggesting that urbanisation and aspirational consumption are likely to sustain both volume growth and mix improvements;

• Operating leverage and mix improvement have sustained margins despite the spike in raw material input costs;

• Big data analytics and increasingly sophisticated predictive algorithms feeding off online consumer behaviour are recasting the e-commerce landscape and potential winners/losers; and

• The key risk to assess is whether or not the wave of multinational and private equity investments into both listed and unlisted consumer-facing vehicles will ultimately increase competitive intensity at the expense of margins.

HDFC Bank remains a favourite

The stock we would like to highlight this month is HDFC Bank, India’s leading full-service bank with a pan-India footprint of 5,000 branches and more than 13,000 ATMs across 2,800 cities. As it leverages its investments in brand, distribution reach, customer service and digital platform, HDFC Bank’s liability franchise is poised to be the significant beneficiary of the capital constraints at the public sector banks and the weaker finance companies.

Over the next three years, we expect HDFC Bank to compound its loan book at a compound annual growth rate of more than 20%; consensus is looking for 15% to 18% growth.

• We expect continued market share gains in both the corporate and the retail loan book at the expense of the impaired public sector banks and finance companies;

• There is a significant opportunity to grow working capital loans for small and medium- sized enterprises, credit cards and consumer lending to the salaried class on the back of its brand’s brick-and-mortar expansion into second and third-tier cities; and

• The careful investments into semi-rural and rural India will represent the next generation of growth opportunities and we are just scratching the surface at this point. Over the next three years, we expect HDFC Bank to deliver on consolidated profits compounding at 25% annually, with return on assets trending in excess of 2% and a return on equity of more than 18%.

• Operating leverage as the deliberate investments into brick-and mortar in the smaller cities and semi-rural India start to deliver on strong customer acquisition and new loans growth;

• The stellar liability franchise (with a current- and-savings-account ratio currently at 41%) and the ability to price for risk in an environment where competitive intensity has eased will allow the bank to deliver on sustainable net interest margins in the 4.3%-to-4.5% range;

• The investments in technology and its digital outreach has seen the cost-to-income ratio decline by 100bps in the last 12 months; we expect 70bps of further margin improvement annually over the next three years; and

• We expect credit costs to remain below 100bps, thanks to management’s discipline and prioritising an enviable credit culture.


We do expect the markets to remain choppy in the build-up to the general election in May; on the ground, however, strong rural consumption dynamics and a new capex cycle would suggest that India’s idiosyncratic growth opportunity is intact. We would urge investors to look through the temporary uncertainty and continue to increase their allocation to Indian equities.

• Irrespective of the election outcome, India’s structural reforms and domestic economy stand poised to deliver on sustained real GDP growth compounding at more than 7% annually over the next three to five years;

• We retain strong conviction in our portfolio companies’ delivering on earnings and cash flows compounding at more than 15% annually over the next three years; and

• Given the correction in markets/multiples over the last six months, the risk/reward is compelling.

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 to 30 unlevered positions), 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, an advisory company, is a Singapore-based entity, set up in 2003, holding a Capital Markets Service Licence in Fund Management from the Monetary Authority of Singapore.

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