Despite historical factors, this is not the time to write off the Indian infrastructure sector
The infrastructure sector is considered a very vibrant space and there are compelling reasons for the same. The industry works across 250 subsectors with linkages across sectors. Thus, it is considered to be a sector with a high amount of capital gearing. In simple words, with such a deeper linkage between subsectors, even one rupee invested in the infrastructure sector results in opportunities generated worth 10 times.
Broadly, the infrastructure sector can be divided into real estate and infrastructure construction. However, despite such high vibrancy, higher gearing and consistent focus of the Government (in terms of reforms and financial assistance), many investors shy away from investing in listed infrastructure companies. Naturally, there are historical factors why investors feel ‘once bitten, twice shy’. With the kind of wealth erosion that has happened in the Indian construction contracting and realty space (and almost all top companies hardly provide returns), investors have provided a cold shoulder to the infrastructure space for over a decade.
Indeed, since the 2008 global meltdown, not many realty and infrastructure companies have been able to create wealth for investors. Just to put things in perspective, the Nifty Realty Index, introduced on August 30, 2007, with a base of 1,000, is trading at 521 today. After the introduction of the index, there was a brief period when it moved northwards to touch the levels of ~1,780 in February 2008. However, after that, it has remained under constant pressure. In all, hardly any broader wealth creation has happened in the Indian real-estate sector. There were smaller up-moves witnessed in the sector. However, despite the fact that benchmark indices witnessed significant gains, the infra construction and realty space remained subdued. The story has been no different for the larger players.
That said, such examples of underperformance notwithstanding, there are certain recent examples like GR Infraprojects, which got listed a few months ago. And if the response to the IPO is anything to go by, the infrastructure segment looks like a great investment opportunity.
The IPO, which was issued at `837, is currently trading at `1,885, showing gains of 125 per cent in just three months. In a nutshell, there are great opportunities available in the construction contracting space as well and investors need to take a deeper look at the same. There would be a counter argument that it is a secular bull phase for Indian equity markets, and hence the improved performance in the infra construction space as well.
While one can continue to debate over available opportunities and past wealth erosion, we believe the Indian infrastructure space will remain vibrant. And this vibrancy will extend to subsectors and allied sectors. Policy reforms by the Government focus on both urban and rural development and helping the sector in terms of financial viability are some longer-term drivers for the sector. The way construction companies are building nations, it is important to understand they can build value for investors as well.
Now, let's take a closer look at the macroeconomic scenario.
Let’s take a look at how the different parameters stood for the past year.
The first and the foremost factor that was affected at the start of the pandemic was GDP growth. In Q1FY21, GDP declined by 23.90 per cent. However, after that there has been a steady recovery.
For Q2FY21 it declined by 7.40 per cent and gradually increased from 0.50 per cent in Q3FY21 to 1.60 per cent in Q4FY21. The recovery further improved and in Q1FY22, the 20.10 per cent growth, though on the low base of Q1FY21, indicates betterment (see GDP growth graph).
The Index of Industrial Production (IIP) has also witnessed improvement over the past four quarters. In Q1FY21, the IIP declined by 35.50 per cent but eventually improved to stand at 7.7 percent in Q1FY22. While the IIP witnessed improvement, inflation numbers also remained under the tolerance levels of the Reserve Bank of India (RBI) (see chart and CPI figure charts).
With inflation levels remaining under the tolerance levels of RBI, even the repo (at 4 per cent) and reverse repo rates are at historically low levels. This has resulted in abundant liquidity in the system that eventually benefitted the economic scenario.
The above parameters also indicate some positivity coming to the Indian markets. Loan growth has been consistent and, most important, cement volumes have also increased to double-digit growth.
As the economic parameters improved, so did earnings for India Inc, as the following chart shows.
After remaining under pressure for almost five quarters, the performance of India Inc has started to improve from Q4FY21. Significantly, there is consistent growth visible in EBITDA margins as well. With operating leverage coming into play, PAT growth has been much better. And if macro factors remain supportive, this growth will be sustained.
The following table gives an idea about sectors related to construction and the contracting segment.
To put the numbers in perspective, the MSCI Emerging Market Index has moved to 1,270 to date from the level of 758 in March 2020, providing returns of over 67 per cent. It is now trading at 1,927 from the level of 876 in March 2020, resulting in more than 119 per cent returns. Outperformance has been much more significant since February 2021, when the MSCI EM Index witnessed marginal decline, but the MSCI India index has remained strong. When indices move upwards, this is mostly backed by earnings. As earnings growth picks up, the indices move accordingly. But there is another factor – along with earnings growth, P/E expansion is also occurring. And in a bull phase (which Indian markets are now witnessing), 75 per cent of the move is backed by P/E expansion.
The following table shows the month-on-month changes in GST collection.
While the macroeconomic data is sending a positive signal, even the sectoral data points are indicating positivity. Let’s take a look at the factors emerging from various sectors.
All considered, the realty segment is on the verge of revival. Reforms like RERA, GST and demonetisation have resulted in consolidation in the sector. We believe larger players with a clean balance sheet (lower debt levels) and a focus on affordable housing are likely to be major beneficiaries going ahead.
While we all know steel is a cyclical industry, leading manufacturers are of the opinion that it will be a super cycle this time. There are various factors behind such claims. In the past century, the world has witnessed such super cycles after key events such as rapid industrialisation in the USA, rearmament before World War 2, rebuilding economies after the war and the sharpest upcycle powered by China’s industrialisation. Lasting anywhere between five and 15 years, super cycles coincide with large-scale urbanisation, industrialisation and massive infrastructure spend.
Currently, the global environment is characterised by supply inelasticity, demand surge, improved market sentiment and large-scale public expenditure on commodity-intensive infrastructure. And we believe steel as a commodity is a natural beneficiary. According to a leading manufacturer in India, the global energy transition towards renewables provides a huge opportunity for the steel sector, with demand expected to rise 7x to around 100 million tonne just from the renewable sector. With the Indian Government focusing on infrastructure, rapid urbanisation and the renewable sector, the steel sector is also set for strong growth. While metal stocks (including large cap) have provided returns in multiples over the past one-and-a-half year, the commodity cycle seems to be much stronger this time. We wouldn’t be surprised if the equity rally and commodity cycle move in tandem, the way India had witnessed during the 2003-2008 period.
With one of the best central ministers at the helm of the Ministry of Road Transport and Highways (MoRTH), execution has been at its best. Awards in the roads sector had peaked in FY18 with the National Highways Authority of India (NHAI) granting 7,397 km in orders and have again started to pick up pace. Orders have been better than expected in the roads sector, with a strong bid pipeline in place. (They have been weak for the past two years.) The strong ordering momentum is expected to continue into FY22, given the land acquisition work done by NHAI.
The following chart shows that road construction per day has improved significantly in FY21.
With regard to HAM projects, unlike the general perception, declining interest rates have turned out to be a negative for road players. This is because they carry a negative spread on the debt of HAM projects. However, on a positive note, in future, project returns would now be linked to the marginal cost of funds-based lending rate (MCLR) rate rather than the bank rate, thereby addressing the negative spread concern. Order book positions remain robust and should lead to strong execution over the next two to three years.
While everything seems to be falling in place for the infrastructure sector, financial viability and private participation are two important challenges. And here, the new National Monetisation Pipeline (NMP) will play a vital role.
The strategic objective of the asset monetisation programme is to unlock the value of investments in public-sector assets by tapping private-sector capital and efficiencies. The capital can thereafter be leveraged for augmentation and greenfield infrastructure creation. Asset monetisation, also commonly referred to as asset or capital recycling, is a widely used business practice globally. There is already an established track record of investment by institutional investors and funds in mature economic infrastructure projects such as toll roads, ports and airports in North America, Europe and Australia. This consists of a limited period transfer of performing assets (or disposal of non-strategic, underperforming assets) to unlock ‘idle’ capital and reinvest the same in other assets or projects that deliver improved or additional benefits.
How large would the NMP be?
The NMP estimates aggregate monetisation potential of
`6 lakh crore through core assets of the Central Government over FY22-FY25. The top five sectors (by estimated value) capture around
83 per cent of the aggregate pipeline value. These include roads
(27 per cent), followed by railways (25 per cent), power (15 per cent), oil and gas pipelines (8 per cent) and telecom (6 per cent).
Further, this wagon wheel shows how the different sectors are expected to contribute going ahead. A positive factor is that all segments are being considered for monetisation. Other assets in the pipeline include airports, ports, warehouses, hospitality assets and urban infrastructure. About `88,000 crore of asset monetisation is expected to be completed in FY22 itself. This is likely to provide much-needed impetus to the infrastructure sector. Thus, a lot of value building is expected to happen in the Indian infrastructure space.
list in 2019 over the past three years, as follows:
Year 1: October 1, 2018, to September 30, 2019
Year 2: October 1, 2019, to September 30, 2020
Year 3: October 1, 2020, to September 30, 2021
We checked the performance of these companies (from the construction and building material sectors) on the bourses. And the data that emerges is very interesting. Evidently, it wouldn’t be correct to say that infrastructure and its subsectors are not helping investors create wealth. If we take a look at the performance of ceramic tiles and paints companies, for instance, value creation has been really good.
Here, we should focus on the CAGR returns generated by the companies over the three years. Almost all the companies have performed on this parameter. One may argue that last year’s performance has resulted in such returns. However, in the case of paints companies, one can see that it has been a consistent performance over all the three years. In the case of tiles companies, the 2020 returns were negative. However, it was an overall industry scenario. Remember, anything that provides at least double than risk-free returns is considered a good investment. And paints and tiles companies seem to have created value for investors.
Realty companies For realty companies, it has been one of the most difficult decades in terms of financials. But again, on the three-year basis, the price performance seems to be good. It is true that the majority of gains were added in the past year. However, the CAGR of companies like Godrej Properties, with 58.20 per cent, is obviously good. The list clearly indicates that cleaner and leaner balance sheets have posted better returns. Again, it proves that investment with a longer-term horizon provides decent returns. There are a few failures (HDIL) but such investments could be avoided with some basic research.
Apart from the few sectors mentioned above, other subsectors like pipes, wood and laminates as well as a few retail stories related to building material are expected to be the next places to watch for. Astral Poly, Prince Pipes, Finolex Industries and APL Apollo are some examples.
As they say, you may find a multi-bagger from slow growing sectors in a sort of cyclical business and mundane segment. Therefore, it is surely not the time to write off the infrastructure sector at its current level – it’s time to find real value in the segment.