Why are infra and capital-goods stocks in demand despite premium valuations?

The common theme among industrial firms such as Larsen & Toubro, Cummins India, Siemens India and ABB India has been strong growth in the topline and order inflows, said Priyankar Biswas, an analyst at BNP Paribas India, Photo: Bloomberg
The common theme among industrial firms such as Larsen & Toubro, Cummins India, Siemens India and ABB India has been strong growth in the topline and order inflows, said Priyankar Biswas, an analyst at BNP Paribas India, Photo: Bloomberg

Summary

Several infrastructure and capital-goods stocks are trading above their 10-year average PE multiple. Yet, most fund managers are comfortable investing in them because of the underlying growth visibility in these sectors.

A rally fuelled by robust fundamentals has led to a re-rating in the infrastructure and capital-goods sectors, pushing several stocks into what seems like overvalued territory.

Several infrastructure and capital-goods stocks are trading above their 10-year average price-to-earnings (P-E) ratio. The P-E ratio compares a company's stock price to its earnings per share, so a high number means the company's stock could be overvalued or that investors are anticipating significant growth.

Despite the premium valuations, most fund managers are comfortable investing in these stocks because of the underlying growth prospects in these sectors.

“Agreed valuations are at a premium, but I do believe in looking at the right businesses and investing rather than waiting for the markets to consolidate," said Shreyash Devalkar, head of equity at Axis Mutual Fund.

Priyankar Biswas, an analyst at BNP Paribas India, said the common theme among industrial firms such as Larsen & Toubro, Cummins India, Siemens India and ABB India has been strong growth in the topline and order inflows.

“The delivered numbers largely exceeded street estimates and earnings have been revised upwards. Thus, multiples and its re-rating is driven by delivery on earnings and outlook," he said.

Also read: Supreme Court’s Delhi Metro verdict opens a Pandora’s box for PPP infra projects

Currently, there is a widespread revival in capital expenditure (capex) across sectors, not just roads and railways, Biswas said. The enhanced outlook, coupled with the expectation of policy continuity, augurs well for a robust growth trajectory, he added.

However, Ajay Argal, SVP & portfolio manager, emerging markets equity - India, at Franklin Templeton said the fund house assesses whether the growth implied by the current price of a stock is reasonable and leaves room for positive surprises.

Long-term trend?

India is among the world's fastest-growing economies and requires sustained investment and capacity expansion to support its growth. This isn’t just a short-term trend but a prolonged capex cycle which will affect several ancillary sectors, said market experts.

Many sectors, including infrastructure and capital goods, have thus undergone a re-rating owing to increased growth visibility, they added.

Also read: JSW Infrastructure plans 2,500 crore capex for FY25

Amit Anwani, analyst at Prabhudas Lilladher, said he sees growth in these sectors after the elections despite most stocks trading at irrationally high valuations. He added that the consistent delivery of earnings growth by these companies is reassuring.

Fund managers are now factoring in the growth potential of these companies rather than relying solely on historical trends to determine if they qualify for an investment.

According to Amit Nigam, fund manager at Invesco Mutual Fund, “Historical valuation serves as an anchor point, but the focus is on growth prospects and visibility to determine if a particular company makes a good investment bet, especially when the stocks look pricey."

Other than simply looking at the PE ratio, Nigam suggests monitoring parameters such as order books, working-capital management, return on capital employed, free cash flows, and operating margins.

Investors have been increasingly enthusiastic about infrastructure and capital-goods stocks, going by the 35% increase in the Nifty Infrastructure Index in just six months, compared to the Nifty 50's 16% gain. The Nifty Infrastructure Index has surged 164% since 2019 general elections, while the S&P BSE Capital Goods Index has shot up 229% over this period.

Also read: Road construction to clock 16-21% rise in FY24 ahead of general elections: Icra

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