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Back in the Reckoning

Tanvi Varma/Money Today        Print Edition: May 2011

It is quite likely that you struck off the infrastructure sector from your list of investment options some time ago. But the budget proposals for 2011-12 may change that mindset with the fortunes of the sector finally set to revive.

In 2007, before the global financial crisis altered sentiments considerably, infrastructure was the dominant theme among most investors. The average returns of infrastructure equity funds were about 81% compared to 47% delivered by the BSE Sensex between January and December 2007. Funds such as Canara Robeco Infrastructure Fund and ICICI Prudential Infrastructure Fund posted returns in excess of 90% in that period.

"Stock valuations were low and there was a lot of emphasis on growth which meant large order books. This led to stock prices shooting through the roof," says Shailesh Kanani, analyst-infrastructure, Angel Broking. The IVRCL Infrastructure share, for instance, went up by around 3.5 times between January 2006 and January 2008 and Jaiprakash Associates saw its share price increase five-fold during the same period. These stocks were not among the investor favourites and were languishing near their lows in March this year.

So, what went wrong? "Infrastructure stocks have been impacted by the high risk-aversion and the slowdown in project implementation, says KN Sivasubramanian, chief investment officer, Franklin Equity, India, Franklin Templeton Investments. Execution of projects also got delayed due to the extended monsoons and political unrest in certain states resulting in lower top-line growth. "Also, high balance-sheet leverage and higher working capital requirement, coupled with high interest rates affected bottomlines adversely," says Avinash Nahata, head, fundamental desk, Aditya Birla Money.

Infra Funds v/s Sensex
Environmental and land acquisition issues contributed to the delays. But all this might change if the measures announced in the budget for 2011-12 fructify. Most importantly, almost half of the government's plan outlay or Rs 2.14 lakh crore has been allocated for infrastructure development. "This is in line with the government's intent of pushing up expenditure on the sector to around 9% of gross domestic product (GDP)," says Sivasubramanian. The rural sector is a special beneficiary with the allocation for the government's Bharat Nirman scheme up from Rs 48,000 crore to Rs 58,000 crore and that of the Rural Infrastructure Development Fund increased from Rs 16,000 crore to Rs 18,000 crore. This will benefit small regional players such as Simplex Infrastructures and NCC.

The flow of funds into infrastructure projects is constrained by sectoral caps-up to 20% for infrastructure- under the exposure norms of banks and the absence of an active corporate bond market. It is not equity so much, as long-term loans at reasonable rates that developers need. The budget has sought to address this by allowing tax-free infrastructure bonds worth Rs 30,000 crore in 2011-12 and by raising the investment limit of foreign institutional investors (FIIs) in corporate bonds to $25 billion from $5 billion earlier. Says Mahesh Patil, head, equity, domestic assets, Birla Sun Life Asset Management Company, "We need to attract foreign capital to achieve the envisaged spending of $1 trillion on infrastructure in the twelfth five-year plan."

Rs 2.14 lakh cr: Plan outlay for infrastructure in 2011-12

$25 billion: New FII limit for investment in corporate bonds

Rs 30,000 cr: Worth tax-free infra bonds to be issued in 2011-12
According to Nahata, the additional Rs 30,000 crore to be garnered by issuing tax-free bonds will be able to sustain the current momentum provided by the public private partnership (PPP) model. But the success of these bonds will depend on the interest rates offered by the institutions issuing them. He cautions that the availability of better investment options may hamper the success of such issues.

The increase in the FII investment limit in corporate bonds is likely to bring in additional long-term funds from foreign players at comparatively cheaper rates. This will boost the prospects of companies with portfolios that include high gestation projects such as airports, power and ports. However, Patil believes that FIIs will look at the macro factors such as the government's fiscal deficit before investing. The fact that they have not yet exhausted the current limit of $5 billion on investment in corporate bonds could prove to be a dampener, he adds.

The budget has also proposed special infrastructure debt funds. Interest payments by such funds will attract a reduced withholding tax rate of 5% instead of 20% for other debt funds.

Top Stock Picks
WHO WILL GAIN?

According to Sneha Rungta, analyst at Sharekhan, 2011-12, being the last year of the eleventh five-year plan, will see a pick-up in infrastructure spending and this would improve the inflow of orders to the sector. Rungta says foreign direct investment (FDI) which was up 31% in December 2010 after months of negative growth will trickle down to some new projects that have been announced.

Companies such as Larsen and Toubro (L&T), IRB Infrastructure, IVRCL Infrastructure, IL&FS Transportation Network, among others, are likely to benefit the most considering their area of expertise in the construction and transportation segments (See Top Stock Picks). The construction sector accounts for nearly 45% of the total investment in infrastructure and is expected to gain the most from the surge.

Some allied industries will also receive an impetus. For instance, the extra demand for medium and heavy commercial vehicles will prove positive for companies such as Ashok Leyland and Tata Motors. Banks may also gain as advances are expected to grow by 20-22% led by demand from the infrastructure sector. Not to mention the cement industry which gets 25% of its demand from the sector. "If you are looking at some defensives in the space then the gas transmission and distribution sector looks attractive. Here, risks are not too high compared to rewards, says Avinash Gupta, assistant vice-president, equity research, Bonanza Portfolio.

THE FLIP SIDE

The budget, however, did not bring any good tidings for some companies. Getting the Special Economic Zones (SEZs) under the purview of the minimum alternate tax (MAT) may hit the bottomlines of companies such as Mahindra Lifespace and Mundra Port and SEZ (MPSEZ). And then there are corporates that are not expected to recover despite the budget bonanza. Rungta is negative on companies such as Punj Lloyd, whose order book execution has been behind schedule. It has also disappointed on earnings for the last few consecutive quarters.

Long-term investors can look at infrastructure funds or stocks
And now the big question. Should you be taking direct exposure in the infrastructure sector? According to analysts, investors with a long-term horizon, of about three years and above, could start allocating a portion of their funds to infrastructure funds or stocks. A large number of stocks in this space were down 70-80% in March 2011, from their peaks witnessed in January 2008. Also, after the correction, most were trading at a 30-40% discount to their long-term average valuations, says Rungta. "However, if your view is for the short to medium term, then invest in diversified funds since there is still some pain left in the sector especially on the raw material and leverage issues," says Nahata. He sees infrastructure companies to be back on track after the second quarter of 2011-12, when the interest rates are expected to peak.

ONLY ON PAPER?

Many are cautiously optimistic till the government decides to actually walk all the budget talk. "The government's infrastructure focus dwindles every once in a while. It got diverted last year due to various issues such as the high inflation, and the numerous scams," says Rungta. The execution risks for the sector have also increased given the land acquisition problems, lengthy approval processes and shortage of resources.

"Today, the concerns are related, more to implementation and the budget is not the best document to address that," says.

Patil agrees that execution capability of companies is going to drive performance in the future.

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