Infrastructure Stocks To Cement Your Portfolio!
Infrastructure as a sector will always be in the limelight in India. That's because there is huge scope for development and almost always infrastructure development is a priority for any government. Yogesh Supekar and Karan Bhojwani discuss why stocks in the infrastructure space should be part of your diversified portfolio even as the DSIJ Research Team recommends top picks in this sector for investments
Equity investment is all about portfolio management, which is nothing but investing in a diversified manner across various sectors. Choosing the right sectors to invest in is one of the core elements of overall portfolio management. While being stock-specific can yield good results in terms of portfolio returns, choosing the right sector to invest can help achieve portfolio goals. Says Partho Gosh, an investor who believes in maintaining a diversified portfolio: “Sector selection is extremely crucial. I invested a large chunk of my portfolio monies in the pharmaceutical sector, which underperformed over the last 3-5 years. It started catching up only in 2020. If I would have given higher weightage to private banks, my portfolio would have been performing much better.”
Indeed, sectoral allocation is crucial and can determine whether your portfolio goals are fulfilled or not. When it comes to sectoral allocation and maintaining a diversified portfolio, the infrastructure sector is always considered an evergreen option for investing. Infrastructure stocks have to be part of any model portfolio if it needs to tap the India growth story. It is a huge sector for a growing economy like India and opens up a lot of investing opportunities for investors in the stock market. This space includes oil and gas, automobile, telecom, construction, tyres, ports, cement and cement products and power. The table below highlights the weightages of sub-sectors within the infrastructure space in Nifty 50.
The irony of course is that even if the infrastructure space is huge and incremental investing opportunities surface every year from this sector, its stocks have not seen a secular bull run as in 2008. That said, infrastructure stocks have outperformed the Sensex in 2020 so far if we go by the Nifty Infrastructure Index performance on YTD basis. As on August 3, 2020, Nifty Infrastructure Index was down by 2.82 per cent while the Sensex was down by nearly 7 per cent.
Infrastructure Focus
As of now, private investments in the infrastructure sector continue to be muted in the area of industrial capex and building infrastructure. However, public sector spending has remained firm and was robust in the areas of core infrastructure development. This was because of the government’s commitment to boost investment across multiple infrastructure sectors. The government has already announced a national infrastructure pipeline (NIP) of projects worth Rs100+ lakh crore up to 2025. Under NIP the focus areas will be energy, roads, railways, urban infrastructure and irrigation.
Nifty Infrastructure Index Performance
The sectoral index that tracks the performance of the infrastructure sector in India has 30 constituents from different sub-sectors.
Initiatives such as NIP along with other ‘pro-business’ policy initiatives can be expected to lead to a rebound in domestic demand in the medium to long term. The infrastructure sector, being a key driver for the Indian economy, receives focused attention from both the central and state governments. But FY20 was a challenging year both on the economy front as well as for the infrastructure sector in India. The construction sector recorded a six-year low growth if 1.3 per cent while cement production saw a marginal decrease of 0.8 per cent in FY19-20 as compared to 13.3 per cent increase in FY18-19. Finished steel production was flat in FY20 even as crude steel production was down by 1.5 per cent in FY20.
The government’s focused approach in this challenging environment continues to support the sector – affordable housing being just one example. Meanwhile, road construction activity (highways) slowed to 28 km a day during FY20 from 29.7 km a day in FY19. It is however expected that the activity will increase to 32 km a day in FY21 if we go by what the Ministry of Road Transport and Highways is aiming at. Under the aegis of NIP, roads, urban and housing, railways, power (renewable and conventional) and irrigation comprise up to 80 per cent of the total plan. Further, there is a discernable thrust on renewable energy under the ‘Saubhagya’ initiatives. As of March 31, 2020, over 26 million households have been provided with electricity connections under the scheme.
Overall, public sector spending on the infrastructure sector, including central and state governments and PSU capex, amounts to nearly Rs16 lakh crore for FY 2020-21. This translates into 7 per cent of the expected nominal GDP. The pandemic, as seen in the recent GDP numbers, will have a negative impact on economic growth and government tax collections which in turn will negatively affect government spending. It is expected that the government will borrow money from the markets to compensate for the loss of tax revenues. This figure could be as high as Rs 9 lakh crore.
In the latest report submitted by the NIP task force on April 30, 2020, it is envisaged that the expenditure on infrastructure will double from about 5 per cent of nominal GDP to approximately 10 per cent over FY 2021 to FY 2023. The report, while highlighting the targets, also outlines the challenges faced in order to achieve the targets, such as:
✓Installing long-term financing vehicles.
✓Opening up of insurance and pension funding further.
✓Setting a mechanism for dispute resolution.
✓Attracting long-term foreign capital.
The NIP allocation overall has increased by 9.1 per cent over the figures mentioned in the NIP December 2019 draft. The allocation to energy has increased by 9.8 per cent even as the allocation to roads has increased by 3.8 per cent. Urban infrastructure, irrigation and agriculture also saw substantial increase in outlay at 17.7 per cent, 16.2 per cent and 181 per cent.
"Whilst near term COVID-19 headwinds limit large ticket uptick in Central/State Govt Infra spend, mid to long term drivers remain intact. India has been always capital starved for Infrastructure capacity creation and NIP lays out roadmap for reforms and on securing loan term financing. We remain positive on large well diversified Infra services and product companies. In road sector, the companies stand to benefit from outlays on National Highway (NH) are KNR, PNC, Ashoka, DBL and HG Infra while LT, NCC, Sadbhav, KNR, JMC etc stands to benefit from outlays in irrigation EPC works."
-HDFC Securities
Infrastructure Financing and Reforms
As of FY19, power and road sectors have the largest exposure at about 72 per cent of the outstanding infrastructure credit. The outstanding credit to infrastructure as a percentage of gross non-food credit was 12 per cent in FY19. Infrastructure financing is dominated by banks and there is a need for change in regulation that can allow higher funds allocation from pension and insurance funds to the infrastructure. This may take care of the long-term capital needs of the sector.
Some of the key financing reforms envisaged in the NIP report are encouraging green finance, revitalising the bond and credit market, sale of land and nonoperational PSU assets, toll-operate-transfer (ToT) monetisation, Infrastructure Investment Trust, Real Estate Investment Trust, securitization of infrastructure loan assets via credit enhancement and strengthening of municipal bond markets. About 18-20 per cent of the pipeline is expected to be financed through the central government’s budget and about 24-26 per cent is expected to be financed through the state’s budget.
Up to 31 per cent would be raised though debt from the bond market, NBFCs and banks while equity from private developers, external aid from multilateral and bilateral agencies and internal accruals of PSUs would comprise 4-10 per cent. This suggests that the existing sources would be able to finance 83-85 per cent of the capital expenditure to be incurred between fiscals 2020 and 2025. Some financing gap can be filled through establishing new DFIs and using asset monetisation as a tool to monetise operational assets at both central and state levels.
Road Sector: Vision 2025
About 1,820 projects have been identified to be implemented in 2020-25 with a total capex for the projects by the central government estimated at Rs 13.8 trillion. This ambitious list includes construction of new expressways such as Delhi- Mumbai Expressway, Bengaluru-Chennai Expressway, etc.
Capex Plan FY 2020-2025
Energy Sector: Vision 2025
An estimated total capex of Rs 14 trillion by both states and the central government is expected to be incurred in the power sector over FY 2025. Electricity generation projects will cost Rs 3.3 trillion while Rs 3.2 trillion will be spent on electricity distribution projects. Electricity transmission projects will cost Rs 3.0 trillion. In the renewable energy space, the category of projects included are solar, wind, small hydro and bio power. The capex for these projects is estimated to be Rs 9.3 trillion.
Urban Infrastructure: Vision 2025
Urban infrastructure being a priority for the government is expected to incur overall capital expenditure of Rs 1,919,267 crore. This will be incurred by both the central government and states from fiscals 2020-2025. The central government is expected to execute about 1,362 identified projects that will be implemented in the period 2020-2025. These projects are estimated to cost Rs 1.5 trillion.
Rural Infrastructure: Vision 2025
Capital expenditure of Rs 773,915 crore is estimated to be spent by both the central government and states between fiscals 2020 and 2025.
The government’s focused approach in this challenging environment continues to support the sector – affordable housing being just one example.
Conclusion
Globally, the equity markets have recovered sharply, assuming a V-shaped recovery in the economy aided by fiscal and monetary stimulus. However, the recovery speed seems to be fading and the global equity markets look a little out of steam. Hence, investors may see some consolidation in equity markets going ahead. Some believe it is a healthy sign as the stocks rallied too much too fast. Indian markets also, taking cues from its global counterparts, may attempt to consolidate before resuming their northward journey.
After a long nation-wide debate on whether the Indian economy dipped the most amongst the large countries, IMF finally released a statement that this indeed was the case in the recent quarter. In absolute terms, according to a study by Credit Suisse, India suffered a loss of Rs20-22 lakh crore. According to the study, of this total loss, the government will bear 50 per cent, wage earners 25 per cent, informal firms 15 per cent and corporations the remaining 10 per cent. With the government bearing the maximum loss due to the dip in the GDP, there definitely will be pressure on government spending. And an important point to note is that government spending is extremely crucial for the infrastructure sector in India.
Most of the infrastructure-related businesses are highly leveraged and faced with delayed order execution. This can lead to losses. Infrastructure companies unlike IT or banking companies also face challenges related to environmental clearances. There are issues related to land acquisition that have been impacting the sector negatively. Higher interest rates impact the infrastructure companies most because these businesses are capital-intensive and most companies use debt financing to run their operations. These are the common issues plaguing the infrastructure companies. That said, the Government of India has to walk a tightrope and create employment opportunities for the masses. Building roads and transport (infrastructure) is the only way the government can immediately influence the employment rate so that there is an opportunity for the infrastructure projects to get back on track.
While choosing infrastructure companies for investing, looking at the balance-sheet is a paramount factor. It is worth the effort to study the project completion track record of the company under consideration. Leverage needs to be observed carefully and also the cash flows along with the order pipeline. Also, one of the reasons why infrastructure-related stocks can be part of any portfolio is their attractive dividends, especially the utility stocks. Even the dividend yield for the Nifty Infrastructure Index is attractive at 2.13 per cent. There is no visible broad- based rally seen in infrastructure-related stocks but stock-specific action is possible in quality stocks with earnings’ visibility. After carefully considering all the fundamental aspects we have come up with two top recommendations in the sector. These stocks can be a part of your diversified portfolio.
PNC Infratech CMP (Rs) : 162.00
BSE Code : 539150 I Face Value (Rs) : 2 I Mcap FF (Cr.) :1,413.02 I 52 Week High / Low : Rs214.75 /80.85
PNC Infratech Limited is an infrastructure construction, development and management company. It is primarily engaged in the areas of infrastructure projects, including highways, bridges, flyovers, power transmission lines, airport runways and other infrastructure activities. The company’s main business segments include EPC contract and BOT (toll and annuity). It offers end-to-end infrastructure implementation solutions that include engineering, procurement and construction (EPC) services. It implements projects in various public-private-partnership (PPP) formats, including designbuild- finance-operate-transfer (DBFOT), operate-maintaintransfer (OMT) and hybrid models.
PNC Infratech is also involved in the construction and development of highways, bridges and flyovers as well as industrial area development. Looking at the consolidated quarterly trends, net sales contracted by 28.32 per cent to Rs1,092.81 crore in Q1FY21 from Rs1,524.52 crore in the same period for the previous fiscal year. Revenues in Q1FY21 declined as execution of orders was impacted due to lockdown and lower labour availability. The operating profit reported by the company for Q1FY21 came in at Rs317.15 crore, down by 25.52 per cent from Rs425.84 crore in Q1FY20.
Net profit came in at Rs94.79 crore in Q1FY21, declining by 46.31 per cent from Rs176.57 crore in the corresponding quarter for the previous fiscal year. Looking at the annual trends, the company reported net sales of Rs5,602.57 crore in FY20, increasing by 48.44 per cent from Rs3,774.36 crore in the previous fiscal year. The operating profit of the company increased by 42.66 per cent to Rs1,502.81 crore in FY20 from Rs1,053.42 crore in FY19. The net profit of the company expanded by 54.96 per cent to Rs543.40 crore from Rs350.67 crore in the previous fiscal year.
Currently the key risks for PNC Infratech include slowdown in NHAI ordering and delay in the monetisation of HAM projects. But as projects commence operations and with improving labour availability, execution is expected to improve, thus giving a rise to revenue margins in the coming quarters. As of Q1FY21, PNC Infratech’s executable order book stood at Rs15,525 crore which includes two EPC projects and 5 HAM projects of Rs9,300 crore, the execution of which is yet to start. This is 3.2x of FY20 revenue and also aids in providing a strong and confident revenue visibility for the next few fiscal years.
The company is also expecting to receive appointed date for five HAM projects by January 2021 and also a few EPC projects to start from Q3FY21. Since PNC Infratech has a strong and healthy order book, it is a positive point in the current gloomy environment. Additionally, it is also planning to diversify its business to water, metro and railway development which will further contribute towards increase in revenue. As it steps towards diversifying, the company has submitted bids for three water supply projects which are of around Rs6 billion in combined value under the Jal Jeevan Mission. Hence we recommend a BUY.
Larsen & Toubro Limited CMP (Rs) : 932.20
BSE Code : 500510 I Face Value (Rs) : 2 I Mcap FF (Cr.) : 1,13,869.19 I 52 Week High / Low : Rs1,554.05 / 661.05
Larsen & Toubro Limited (L & T) is a technology, engineering, construction, manufacturing and financial services’ company. It manufactures engineering equipment, undertakes large-scale engineering projects and acts as the Indian representative for a number of overseas’ manufacturers of heavy machinery. The company’s products include bulldozers, road rollers, dairy machinery, chemical and pharmaceutical plants, switchgear, food processing machinery and feed milling plants. On a consolidated quarter front, total income was reported at Rs22,037.37 crore in Q1FY21, down by 27.2 per cent from Rs30,270.94 crore in the same quarter for the previous fiscal year.
Operating profit came in at Rs4,501.76 crore in Q1FY21, down by Rs5,781.96 crore in Q1FY20. Net profit saw a significant decline of 67.3 per cent in Q1FY21 to Rs645.07 crore in Q1FY21 from Rs1,972.52 crore in the corresponding quarter for the previous fiscal year. On an annual basis, total income saw growth of 7.85 per cent in FY20 to Rs147,813.26 crore from Rs137,056.82 crore in the previous fiscal year. The operating profit of the company was reported at Rs26,731.76 crore in FY20, up by 8.88 per cent from Rs24,551.80 crore in FY19. Net profit came in at Rs10,822.32 crore in FY20, expanding by 5.71 per cent from Rs10,237.57 crore in the previous fiscal year.
The company saw declines in revenue from almost all verticals with the exception of information technology and transformation services (IT and TS) which registered a 57.2 per cent YoY growth to Rs6,043 crore. Among the other key segments, infrastructure revenues stood at Rs6,456 crore, falling 53 per cent on a YoY basis. Hydrocarbon revenues came in at Rs3,070 crore, declining by 18.5 per cent YoY. Finally, financial services came in at Rs3,284 crore, registering a 5.1 per cent decline on a YoY basis.
L & T announced the completion of the much-awaited E & A division sale to Schneider which was initially announced two years ago. Adjusting for taxes and debt, the company is likely to garner net cash inflow of USD 1.4 billion as proceeds. These proceeds which were earlier planned to be used for buybacks and dividends are now expected to be used by the company to give it liquidity firepower and strengthen the balance-sheet to mitigate any unforeseen risks arising due to the ongoing pandemic. The company is also expected to benefit from the ‘Aatma Nirbhar Bharat’ defence push, wherein the Ministry of Defence has placed an import embargo for 101 defence items.
L & T is already manufacturing more than 50 per cent of the items stated in the first negative list of 101 items and intends to add more items so as to enhance the business opportunity. Despite the cash conservation sentiment by companies globally, L & T managed to secure orders across most of its business segments. The company has a strong order book amounting to Rs305,083 crore as of Q1FY21, and order inflow momentum is expected to improve post-lockdown. Moreover, around 82 per cent of the company’s domestic order book is dominated by governments and PSUs, thus providing a level of stability and lower cyclical risks. Owing to these favourable factors, we recommend a BUY.
(Closing price as of September 07, 2020)