The Indian markets appear to be preparing for a boom in the Indian infrastructure space.
The Nifty Infrastructure Index, composed of infrastructure and construction material companies, has risen by 15.36 per cent over the last year, compared to 12.65 per cent for the Nifty 50 index.
While some of the performance can be attributed to the companies of the index mainly being small and mid-caps, even behemoths like Larsen and Toubro have outperformed the broader Nifty 50 index.
Strong Earnings, Growth Expectations Are Driving Returns
The growth in stock price appears to be driven by the market’s expectation of increasing earnings for infrastructure companies.
For Larsen and Toubro, consensus analyst estimates suggest that earnings per share will rise by 24 per cent in the financial year and a growth of 22 per cent in FY24.
Adani Ports, another component of the index, is expected to see a 50 per cent jump in earnings per share in FY24 and another 19 per cent growth in earnings in FY25.
In contrast, Nifty 50’s weighted earnings growth, excluding financials, is expected to be around 20 per cent.
Several other companies in the infrastructure and construction space are expected to witness similar earnings outperformance. However, growth is unlikely to be limited only to the next two years but is likely to continue long into the future. The sharp increase in earnings per share is driven by multiple factors.
Why is Investor Optimism Justified?
While some are sceptical about the market’s optimism around the infrastructure space, several data points back the market’s optimism.
To boost the economy, the government has stepped up spending on infrastructure. For FY24, Rs 10 lakh crores were allocated by the government to boost infrastructure spending.
Unlike other government spending, infrastructure spending is expected to have a multiplier effect. For every per cent of infra spend as a percentage of GDP, the growth in GDP is expected to double as per S&P Global.
There has been a major change in India’s infrastructure over the last several years.
One of the main focus areas of infrastructure spending has been transportation. The government’s focus on transportation infrastructure is clearly visible in numbers.
India’s road network has grown rapidly, with national highways adding 50,000 kilometres over the nine years. However, progress is not limited to major road networks. The rural road network nearly doubled under the current government’s infra push. The rural road network, which stood at 381,000 kilometres in 2014, has nearly doubled over the same period.
The infrastructure push has also been supported with initiatives to make more capital available for the infrastructure sector.
For instance, the launch of Invits and REITs has helped infrastructure and construction companies offload cash-generating assets from their balance sheet and pay down debt.
Even the Indian government is looking to monetise its assets in a similar manner, where it retains ownership of the assets but shares cash flows with private investors.
Railway has been a large beneficiary of capex by the government. State-owned railway companies like RVNL, IRCON, and others have developed significant expertise over the years. As a result, a larger share of contracts that would’ve gone to international players would now go to these Indian players.
Modernisation of the railway infrastructure and the introduction of high-end trains is also expected to help railway coach manufacturers and ancillary companies earn higher revenues since the value of each coach sold would increase sharply.
India’s focus on launching 500 new Vande Bharat trains could mean that it could develop scale economics and expertise in building such trains. Hence, the government believes it can be an exporter of these trains to the world.
The expansion of railway infrastructure is helpful on the freight side as well. The volume of cars transported through the railway freight route hit an all-time high in 2022. India’s largest carmaker Maruti has seen the share of cars transported by railway jump from 5 per cent 2019 to 17 per cent in 2022.
India has seen marked improvement over the last several years on the energy infrastructure side.
India’s power shortages have been on a downtrend since 2016, only witnessing a surge in 2022 due to the coal shortage and unexpectedly high power demand.
The government has been working on revamping the power sector, especially to ensure timely payments for power producers. Ensuring timely payments would encourage power producers to set up power plants.
In the last year alone, power generation volumes grew by 8.8 per cent. Over the last eight years, power generation volumes have gone up by 56 per cent.
As a result of the changes, the power sector has been one of the best-performing sectors over the last three years.
NTPC, earlier viewed by investors as a slow-growing utility behemoth, has nearly doubled since 2021 – delivering higher returns than the broader indices. Similarly, Tata Power has nearly tripled over the same period. The returns are not driven by spectacular earnings growth but by multiple expansions.
The sharp expansion in multiples points towards investors’ decreasing pessimism about the power sector and a fairer value being assigned to these assets. The stability of regulations and the government’s explicit focus on not scaring investors by making arbitrary policy decisions has also helped.
The government has also conducted auctions for different geographical areas for the development of the gas pipeline infrastructure. This move would increase access to cleaner fuels while propelling heavy capital expenditure from the private sector to build these pipelines.
While the government does not spend directly on the project, when a contract is awarded, the private gas distribution company is mandated to lay a certain number of kilometres of pipelines yearly.
Gas pipeline companies are expected to make investments worth thousands of crores annually cumulatively each year.
Stable policies and freedom in gas pricing have ensured that the private sector investments in the energy infrastructure space continue. For instance, the PNGRB has not been given the power to regulate gas prices for gas distribution companies so far.
Investor optimism around infrastructure stocks might not be misplaced, given the government’s focus on the space and its history of strong execution. However, the benefits of an infrastructure boom are not limited to a few companies and their investors but are beneficial for society in general.
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