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Business News/ Markets / Stock Markets/  Infra stocks to continue their run beating capital goods shares, here's why

Infra stocks to continue their run beating capital goods shares, here's why

On valuation terms, infra stocks are in a better position compared to capital goods, as indicated above. While capital goods are currently trading at an all-time high, one-year forward 40x P/E. However, such premium valuations are bound to stay due to an optimistic outlook.

Indian stock market

Domestic Infrastructure and Capital Goods stocks are on a sturdy path. Over the past 3 years, capital goods stocks have, on average, tripled in value, while infra stocks have doubled. There were concerns about whether this trend would persist during the recent national election period due to high prices and valuations. However, these concerns have eased with the formation of a stable coalition government and expectations of continued growth policies. The RBI reinforced this optimism by raising the GDP growth forecast for FY25 from 7.0% to 7.2% in its June policy update.

Index

1 Year Return (%)

3 Year Return (%)

3 Year CAGR (%)

Nifty Infrastructure

60

100

26

BSE India Infrastructure

110

156

37

BSE Capital Goods

80

208

46

BSE Sensex

22

46

13

NSE Nifty

25

48

14

Dated 13th June 2024

NB: BSE Capital Goods index mostly consists of industrial equipment makers & service providers.

Nifty & BSE Infra index is wisely diverse, consisting of energy, construction, power and equipment, transportation to tourism. BSE has performed better due to high exposure in PSUs & Midcaps.

Capital Goods have outperformed infra stocks due to the lean capital requirement compared to the high long-term and working capital required by infra based companies. Their cash conversion cycle is longer due to the long period of inventory, manufacturing, EPC, and dependence on timely disbursement of government funds, which in total may take 2 to 4 months. Consequently, capital goods companies are experiencing stronger earnings and better balance sheets, leading to significant upgrades as their utilization rates increase.

The outlook for EPC companies in the infrastructure sector is currently strong, with the daily completion rate of road construction increasing by 20% in FY24. This trend is forecast to improve in the medium-term. Fund mobilization from NHAI is on the rise, and the high allocation of 2.78 trillion in FY25 is likely to expand companies order books. India’s gross fixed capital formation (GFCF) to GDP hit 11year high of 33.5% in FY24. The newly elected government's swift action, with a 100-day agenda to award 3,000 km of highway projects, underscores its focus on infra development.

Similarly, in the infra space, segments like railway, cement, and affordable housing will be major beneficiaries. As of February 2024, the government has spent 85% on FY24 capex. Additionally, the government has outlined a plan to purchase 1 trillion worth of coaches over the next few years. The modernization of 40,000 normal bogies into the standard Vande Bharat bogies and an increase in the production of rolling stock are expected to further elevate the sector's profile. The Cabinet's approval of 3 crore rural and urban homes under the PMAY scheme is anticipated to have a substantial multiplier effect due to its connections with over 250 ancillary industries. The government’s strong infra push by NIP, GATI Shakti, and budget outlay, robust order book, and healthy bid pipeline are expected to witness strong profitability with improved return ratios in the coming years.

On the valuation front, the BSE Infra Index, like NSE Infra Index, is currently trading at a one year forward P/E of 18x, historically at premium, but in-line with the country valuation. However, given the robust business and earnings growth outlook, such industries deserve to trade at a premium, which we can anticipate in the next 1-3 years.

The growth in the capital goods sector is driven by India's expanding capital expenditure. With the FY24 budget estimating an effective capex of 13.7 lakh crore, we observe a 27.7% CAGR in capex from FY22 to FY24. India’s GDP is expected to grow at a 6 to 7% CAGR in FY24–30, with private consumption expenditure estimated to grow at a faster pace than government expenditure. The Production Linked Incentive (PLI) scheme is anticipated to attract investments worth Rs.3-4 trillion over the next 4 years, facilitating the creation of 200,000 jobs.

The average orderbook-to-sales ratio of the capital goods index constituents is at a comfortable multiple of 2x. On average, the topline of industry constituents is expected to grow at 18% CAGR in the FY24–26E period, while the EPS is expected to grow at 24% CAGR. Margin contraction could arise from rising raw material costs as most of the metal prices continue to remain at elevated levels. However, a high-volume growth forecast will help to maintain a healthy operating margin. On valuation terms, infra stocks are in a better position compared to capital goods, as indicated above. While capital goods are currently trading at an all-time high, one-year forward 40x P/E. However, such premium valuations are bound to stay due to an optimistic outlook.

The author Vinod Nair is the Head of Research, Geojit Financial Services.

Disclaimer: The views and recommendations above are those of individual analysts, experts, and brokerage firms, not Mint. We advise investors to consult certified experts before making any investment decisions.

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