Having built cash in the portfolio over the last six weeks, our sense is that we need to be prepared for more volatility, be patient, and to continue to build our “shopping list”.
Our expectation is that as rolling lockdowns take effect globally, and especially given the clear and present danger of a second round of infections spiking, job-losses will be significant, and the market’s current concerns over supply-side shocks will likely be magnified by pressing “new” concerns over demand destruction, and the need for even more aggressive fiscal/monetary stimulus in the face of stubborn US dollar strength and slumping global capex.
Our experience in the markets through multiple crises over the last 30 years would suggest the markets are likely to “bottom” only when the high-yield market “settles”. Our sense is that investors are still trying to calibrate the extent to which politics and central bankers might be distorting demand and pricing for government and investment grade corporate paper, and by extension, a rational pricing of risk/reward in high yield debt.
Our significant conviction — in terms of a multi-year runway for growth, accelerating industry consolidation trends, high quality management teams, and adequate internal growth capital — remains in Indian private sector financials and consumer discretionary stocks. Despite valuations already testing trough levels of 2008/2009, it feels a trifle premature given that Covid-19 infections in India are not likely to peak until the end of May.
Short sharp recession
There is, no question, the temptation to bottom-fish. While market troughs are defined in the rear-view mirror, Indian equity valuations are compelling relative to asset values, cash flows, and replacement costs.
Modi’s bold decision to try and get in front of infections spiralling out of control by imposing an initial 21-day national lockdown commencing on March 24, will likely see a short, sharp recession, followed by a strong recovery. As in crises past, the strongest, best-capitalised businesses will emerge with deeper moats, taking structural market share away from weaker competitors, and systematically re-investing for growth.
Simple screens would suggest that 70% of the Indian equity market is already selling at a discount to the 10-year average P/B, P/NAV, and P/ CF multiples, despite structurally lower inflation and interest rates, greater stability in the financial system, modest fiscal and current account deficits, and modest aggregate corporate leverage.
Particularly striking is the sharp sell-off in the highest quality companies — this past month has seen significant foreign institutional selling, and ironically, the most liquid, best-capitalised, and arguably, the fundamentally strongest companies have borne the brunt of the selling. Urgent sellers have simply had to sell whatever they actually can find a bid in.
Highlighted stock
The stock we would like to highlight this month is Hindustan Unilever (HUL), India’s largest consumer goods company with a pan-regional presence in beauty and personal care products, home care products, and food and beverages. HUL stands out for its management bench strength, enviable portfolio of well established brands, deep penetration into rural India with over 4m distribution outlets, significant economies of scale, and sustained cash flows to self-fund both organic and inorganic growth opportunities.
We expect HUL to compound revenues at a 15%+ CAGR over the next three years, well ahead of consensus estimates compounding in the 10%+ range.
The acquisition of Glaxo SmithKline Beecham Consumer’s Indian business is a significant revenue opportunity over the next five years given the strength of HUL’s brand management capabilities, robust distribution channels, and the opportunity to drive both category penetration and mix improvement in rural India.
We have a strong conviction in HUL’s new product innovation and launch strategies, and in particular, leveraging organised retail distribution, and in the naturopathy/Ayurvedic personal and home care categories, to grow national market share.
We expect HUL to compound earnings at 20%+ annually, versus the market looking for earnings to compound in the +/–15% or so range.
There is a significant opportunity to drive mix improvement as the taste of Indian consumers becomes more premium, and as the brands take disproportionate market share relative to the un-organised sector’s offerings in beauty, home and personal care, and F&B.
Economies of scale and the synergies across distribution channels, media buying, and corporate overheads will support sustained margin expansion over the next three to five years.
While it is impossible to project either crude prices or the extent to which HUL chooses to reinvest cost savings into category expansion, brand extensions, and volume growth, we expect that HUL will see margins structurally expand over the next three to five years given that 35% of HUL’s current input costs are crude linked.
Strong businesses to gain market share
There remains the risk of further volatility in global and Indian risk assets as markets assess the intensity and duration of the Covid-19 outbreak and the drag on growth and profitability.
The dislocation in the global economy and Prime Minister Narendra Modi’s prioritising “saving lives” by enforcing a national lockdown will weigh on growth over the next two to three quarters.
Assuming the median case in terms of the intensity and duration of the spread of Covid-19 in India; the government remaining in “lockdown” mode through the end of May, depressing manufacturing, exports, consumption, and the services sector; and significant policy, monetary and fiscal stimulus in the second half, we expect a short, sharp recession, followed by a strong recovery: we have scaled back our growth expectations for the fiscal year ended March 2021 to +2.5%, before reverting to a +6.5%-7% runrate in FY22–25.
We expect the strongest, best-capitalised businesses to emerge with deeper moats, taking market share from weaker competitors, and systematically re-investing for growth. We expect a two- to three-quarter hiccup to reported earnings. Over the longer term, we retain conviction in the fundamental demand drivers for our portfolio companies, industry consolidation, and their ability to structurally grow market share and sustain earnings and cash flows compounding at 15%+ annually over the next three to five years.
We are sharpening our pencils. Valuations are compelling relative to asset values, replacement costs, and the strength of the underlying cash flows. We expect a combination of coordinated global monetary easing, surplus domestic liquidity, the collapse in energy prices, and further domestic structural reforms to revive growth and the earnings cycle.
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 (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, the advisory company, is a Singapore-based entity, set up in 2003, and holds a Capital Markets Service Licence in Fund Management from the Monetary Authority of Singapore
