Thread by @persistencecap

(1/n) As our previous tweetstorms have shown, we just can’t resist a hot take. We tried to make the case for why Trent was overvalued at 7,500 when it looked like the business could do no wrong. We tried to present a bull case for select small caps on Feb 14 when fund managers were advocating a rotation into large caps. We also shared four small / midcap ideas over the past four months (JM Financial, Indiamart, Samhi Hotels, Narayana Hrudayalaya) to better illustrate our thought process and rationale for sticking to small caps. We learn a lot from putting ourselves out there and soliciting debate on difficult questions. The latest debate raging in the stock market: given the Trump tariffs, how should we think about our portfolio allocation to export-driven businesses? Listed Indian exporters can be broadly divided into 3 categories: 1) IT services, 2) pharmaceuticals and 3) manufactured goods.

(2/n) IT services: Leaving aside the potential deflationary impact of GenAI, it is hard to argue that business uncertainty has fallen due to Trump’s recent antics. We listened to Jamie Dimon’s interview, heard Walmart’s earnings call and saw announcements of MSFT cancelling a few data centres. We get it. If investors in India are hesitant to buy US-focused businesses despite running a diversified portfolio where they can exit positions, how difficult would it be for an American CEO to convince themselves to continue spending at the same pace as they have before? Some caution, a pause in spending and belt tightening is natural as CEOs wait for policy predictability and resolution to the US-China trade war. Is it likely that there will be a discretionary demand recovery near term? No. It is in fact, more likely that we see some sort of pause in spending. While valuations have corrected (TCS trades in-line with its pre-covid multiples), so has growth and if you want growth visibility, you have to pay up (Persistent, Coforge). We do not see idiosyncratic upside here despite the correction.

(3/n) Pharma: We have been watching videos of politicians across the spectrum (democrat, republicans) who think that the US should be making more drugs onshore as a matter of national security. While we understand the sentiment, onshoring by using tariffs will lead to a material increase in cost of drugs and healthcare, entitlement spending is a big component of US’s deficit. Indian generic drug manufacturers do not generate attractive RoEs by selling to the US despite our cost structure, so we struggle to see how American cos will generate high enough RoEs given cost of labor, materials etc. If tariffs are imposed and they lead to drug shortages, the US president is likely to face political backlash. Besides, India exports $10B of generics to the US – it is not a large enough line item to move the needle on their deficit. At 25% tariffs, they are looking at $2.5B in additional annual revenue with increased risk of drug shortages given lowered appetite from Indian generic cos to expand capacity. There will be limited line of sight on production moving onshore given that the offshore cos anyway barely generate 15-20% RoE. The argument for onshoring CMOs is even weaker as Indian drug cos behaved responsibly during covid by respecting Pfizer and Merck’s IP. Again, total CMO revenues from India to the US are <$10B and so, the revenue benefit of these tariffs far outweighs the supply shortages that will occur until US capacity ramps up. This is by the way – IF US capacity ramps up. We heard a recent interview by Larry Fink (CEO, Blackrock) who said that the US does not have enough electricians to build data centers and this is despite an electrician being paid USD 150K per annum (>1.5x US GDP per capita). Unlike IT, pharma’s end demand drivers are recession resilient. However, Trump seems intent on levying pharma tariffs and so, we are waiting for further clarity on his thinking here before looking through the rubble. If last week is anything to go by, Trump should be taken seriously AND literally. He will try his best to follow through on what he said he would do but will back off if the consequences of his actions are severe. Also, a lot of pharma cos have one-off Revlimid profits in their base which makes the incremental growth outlook hazy. We are watching his comments with interest as we think negative news flow may present buying opportunities.

(4/n) Manufactured goods: Trump has hired an “AI czar” to ensure that the US can maintain its lead in artificial intelligence. “Defense tech” has received an influx in VC funding off late as the US recognizes that it needs to decouple from China to ensure that it does not lose a kinetic war. All of this is not good news for manufacturers who make goods that the US thinks are critical to their national interests. This is why we are explicitly avoiding manufacturing stories that we think are vital to maintaining American hegemony. We are instead focusing on manufactured goods in harmless categories such as building materials, jewellery, textiles and decoratives which are not vital to national security. Why? Well the recent Trump announcements have shown that 1) he can capitulate if he receives enough direct pressure (10 yr yields) or indirect pressure (Jamie Dimon interview) and 2) Bessent has signalled that they want to sign favorable deals with India, Japan, Korea and Vietnam as these 4 countries surround China. This is good news for manufacturers as it removes the spectre of unreasonable tariffs. Moreover, competition for Indian manufacturers of most of these goods came from China who is still facing steep tariffs and is likely to receive a worse deal than India (if any) given that they retaliated. This actually helps Indian manufacturers from a cost-competitiveness standpoint. Supply side discipline has also likely improved for these manufacturers as who in their right mind will double or triple capacity when their economics can be undone by a single tweet? There remains the question of demand destruction as the US-China trade war could trigger a recession. Some of that demand vacuum is likely to be filled by gaining share at China’s expense given the high differential tariffs and some of that demand vacuum is already reflecting in numbers. Most of these stocks are down 20-40% this month. Even Chinese stocks aren’t down that much. We have (in some cases) 10 year trough multiples, improved supply discipline and improved cost-competitiveness vs Chinese peers. Yes, there is the issue of demand hit due to recessionary impact of the US-China trade war but that threatens the midterms and Trump has shown that he will change his mind if he receives enough feedback to do so. In any case, the recession risk is likely already in the price as these businesses have corrected 20-40% in 4 trading sessions.

(5/n) Disclosure: This isn’t a buy or sell recommendation. We will change our minds if the facts change or if we see a new tweet tomorrow morning. We look forward to returning to a world where we don't have to follow American politics as closely as we have off late 😅.DYOD and consult a financial advisor before investing in any financial instruments.