Mumbai/Bangalore: India’s construction and engineering companies are set to produce the best returns for investors for a third year running as India pours more cash into building roads, airports and power plants, but their popularity has left some stocks with lofty valuations.
The stockmarket stars of three to eight years back, technology and software companies like Infosys, will stay out in the cold as they are heavily exposed to a potential recession in the United States.
Analysts and fund managers said a recent stock market slide, which has left the benchmark BSE 30-share index down around 10% this month alone, has helped skim some of the froth from infrastructure stocks. They say India’s builders, power equipment makers and engineers are relatively protected from any U.S. downturn.
This is because the Indian economy is driven mainly by domestic demand, and rising incomes are boosting demand for everything from consumer goods to cars and houses, and companies are building new factories and expanding.
“If 1995-2005 belonged to information technology, then 2005-2015 belongs to infrastructure,” said Ved Prakash Chaturvedi, managing director of Tata Mutual Fund, which runs two infrastructure funds worth $1.3 billion.
Infrastructure funds were the best performers for two years in a row, with four of the top 10 funds notching gains of 90% in 2007 following a more than 55% jump by six of the top 10 in 2006, data from fund tracking firm Lipper showed, outperforming the main BSE index’s 47% rise.
“It will be a predominant theme in 2008 also and should outperform the broader market,” said R. Rajagopal, chief investment officer at DBS Cholamandalam Asset Management, who oversees $835 million in assets.
The benchmark index is forecast to reach 22,000 points by end-2008, a Reuters poll showed in early December, up about a quarter from current levels.
Investments in construction and engineering companies by diversified equity funds almost doubled to $19 billion in 2007 and made up more than half their total equity assets of $37.5 billion, said fund tracking firm ICRA Online Ltd.
The government has said India needs to invest $500 billion over the next five years to build infrastructure to help sustain an economy that is expanding at about 9 % annually.
Fund managers believe the spending offers opportunities for the next few years, though many stocks in the sector are pricey and trade at nearly a third more than the price multiples of their peers in Asia.
Companies such as India’s No.1 construction and engineering firm, Larsen & Toubro, and power equipment maker Bharat Heavy Electricals are expensive, but they do have an upbeat outlook.
“L&T remains one of the fundamentally best proxies to India’s infrastructure build,” Citigroup analyst Venkatesh
Balasubramaniam wrote in a report, adding its earnings should grow more than 40% in the coming two years.
At Friday’s close, L&T shares, which nearly tripled in 2007, had fallen about 6% this month to Rs3,890 and trade at 54 times forward earnings, according to Reuters data, while Bharat Heavy trades at 33 times after dropping 16% to Rs2,095.55.
In comparison, shares in China’s Taiyuan Heavy Industry trades at 58 times forward earnings, while South Korea’s Doosan Heavy Industries trades at 40 times.
“You have to take a long-term view in this sector though some of the companies are expensively priced over their peers,” said Mugunthan Siva, chief investment officer at Optimix.
Analysts said a US recession would hit export-focused firms such as software services, but investments would flow into projects like expressways, bridges and metro rail systems.
Tata Consultancy Services, Infosys Technologies Ltd and Wipro Ltd have fallen from grace in the fund portfolios on worries about the health of the economy in the United States, which provides more than half their sales.
Data from ICRA Online showed investments by diversified equity funds in software stocks dropped to $1.7 billion in 2007 from $2.8 billion in 2006, and the trend is expected to continue this year.
Infosys was the worst performer in the BSE index in 2007, falling 21%, while the sector index dropped 14%. A 12% rise in the rupee’s value against the dollar also weighed on software services exporters.
Shares in peers such as IBM, which gets more than half its revenue from software services, gained 11.3% in 2007, while Microsoft rose 19.2 %.
Indian software firms say demand for outsourcing is robust and companies are rapidly expanding to Europe, Asia-Pacific and Latin America to lower their dependence on the US market, but fund managers are worried about shrinking margins.
“If you look at it as a move, we are only halfway through. There is still a risk that as we get into 2008, things get uglier,” said London-based Sam Mahtani, who manages $156 million at F&C Asset Management’s Indian Investment Company.