When investing in equity assets for the long term, two rules stand investors in good stead. First, the earnings outlook for the sector must be good and favourable overall, and second, valuation of the sector should be really attractive, given the plausible improvement in earnings opportunities.
Considering these guidelines, the sector which currently fulfils both of these conditions is infrastructure. The point to note here is that this is one sector that has been undershooting the market on a relative basis for nearly a decade now. This makes the opportunity in the infrastructure sector quite attractive based on current valuations.
Also, earnings are expected to be improving here on, thanks to the initiatives taken by the government to remove the various bottlenecks and impediments in this space.
For a massive country such as India, improvement in infrastructure is a necessity. Over the next decade, an estimated $1.5 trillion is needed to create infrastructure, and overhaul and refurbish existing infrastructure. Consequently, there are multiple segments within infrastructure that show better value.
Over the past 2 years, the government has been working on providing the much-needed groundwork that can see the sector take off in coming years.
Following several initiatives such as ‘Housing for All’ and ‘Smart Cities,’ the government has been working on reducing the bottlenecks that impede growth in the infrastructure sector. The latest budgetary outlay for infrastructure spending has been increased to Rs3.96 lakh crore for various projects including housing, railways, ports and irrigation.
A case in point is roads. In the past few years, road construction has come to a standstill—only about 1,000km of road construction had been awarded in 2013. However, the removal of infrastructure bottlenecks is seeing an increase in road construction now, with contracts being awarded rising to over 4,000km in financial year 2016 and beyond.
Also, with just 24% of the National Highway network being four-lane or more, the scope for improvement is immense. Other initiatives such as metro railways are expected to add nearly 500km of railway lines in metro cities and beyond.
But the Indian infrastructure story is not just about road construction. In almost all sectors such as power, railways, metro rail, ports, irrigation, pipelines and so on, the growth potential is immense.
Thanks to initiatives such as the Uday scheme, the power sector has been clocking fast growth. Through this scheme, the government has taken steps to improve operational and financial parameters and increase tariff to help distribution companies (discoms) reduce mounting losses and debt. It has thus far laid out a visionary target for India—providing 24x7 power.
For this target, the government plans to spend $50 billion on transmission infrastructure. It also aims for 1 billion tonne of domestic coal production.
In the past few years, grid construction has improved considerably, thus enabling power to be carried seamlessly even to the remote corners of the country. In fact, India has one of the lowest electricity prices in the world as discoms subsidize tariffs for residential and agriculture use by charging industrial and commercial consumers heavily.
‘Housing for All’ is another initiative that is expected to make significant contribution to boost GDP growth. In terms of budgetary allocation, there has been a 45% rise in allocation with the government targeting 3.3 million houses in FY18-19.
Besides, affordable housing has been given infrastructure status, which could reduce borrowing costs for this sector. Additionally, the definition of affordable housing has been changed from built-up to carpet area, which allows an increase in area of approximately 13-17% of such homes.
The other positive for this space has been the increase in interest subsidy, as announced in Budget 2017, which is likely to encourage home loans to the middle class.
Further, interest rates have cumulatively seen a 175-basis-point cut over the past 2 years. One basis point is one-hundredth of a percentage point. Lower rates have helped these infrastructure companies to reduce their funding costs notably, and lower break-even levels of some projects.
Furthermore, infrastructure companies have been deleveraging, which means much of their balance sheets have been cleaned up and now look healthier and in a much better shape, empowering them to take on new projects.
Infra-support sectors such as cement and capital goods, too, stand a chance to gain as the demand increases. Even though market participants have started to realize the potential held by the infra segment, due to its chequered past of excessive leverage, stalled execution and over-expansion, infrastructure companies fail to command high valuations. Hence, they have a better risk-adjusted-return profile.
Even if a retail investor was convinced about this opportunity, understanding which companies are better placed in terms of their balance sheets, order books, ability to raise resources, and ramp up execution is not that easy. Therefore, the best way for such an investor to play the infra theme is via infrastructure funds. Through an infra fund, an investor can regularly take exposure to the theme through the systematic investment plan (SIP) or the lump sum route. Given the likely improvement expected in this space, an investor who is ready to stay invested over the next 1-2 years, is likely to have a rewarding experience.
Nimesh Shah is managing director and chief executive officer, ICICI Prudential Asset Management Co. Ltd.