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Overcoming the Deficit

With the government intent on not allowing infrastructure bottlenecks to impede economic growth, the sector looks promising

The consensus among experts today is that one element that has the potential to stall India's growth momentum is its woefully inadequate infrastructure. This realisation has also dawned on the government which has decided to scale up infrastructure investment drastically. During the 11th Five-Year Plan (2007-2012) the government plans to spend US $514 billion on infrastructure, which is 2.3 times higher than its spending on this sector during the 10th Five-Year Plan. What is interesting is that for the 12th Five-Year Plan it once again plans to double the outlay on infrastructure to US $1,025 billion. Thus from 7.55 per cent of GDP in the 11th Five-Year Plan infrastructure spending is expected to rise to 9.95 per cent of GDP in the 12th.

Further, the government expects a lot of this spending to come from the private sector. If the private sector is expected to spend around US $186 billion (36.2 per cent of total spend) in the 11th Five-Year Plan, it is expected to spend US $512 billion (50 per cent of total spend) during the 12th Five-Year Plan. Thus the government wants increased private participation in infrastructure development via Public Private Partnerships (PPP) and through models such as Build Operate Transfer (BOT), Build Own Operate Transfer (BOOT) and Build Own Lease Transfer (BOLT).

The boom in infrastructure development means that this sector is likely to throw up a lot of attractive investment opportunities for equity investors in future and should be closely monitored. According to Krishnan Thampi K, head-research and strategies at Hedge Equities, “One is now likely to see a shift from the consumption-driven theme to an investment-driven theme. The infrastructure segment is well set to boom over the next few years. It has been a laggard in the current rally and therefore has a lot of catching up to do in the near future.”

Although the infrastructure sector comprises many segments, due to limitations of space we shall examine the prospects of three key segments: roads, power, and airports.

The crisis of 2008 showed that the rural hinterland can be a major economic driver with its consumption led demand. Says Thampi: “In order to facilitate greater economic development, bridging the rural-urban divide, and ensuring greater foreign investment into key sectors, the quality of roads in the country needs to improve.”

In FY09, the National Highways Authority of India (NHAI) awarded projects covering 643 kms. In comparison, it awarded projects for 3,361 kms in FY10. But between April-July 8, 2010 NHAI has already awarded projects for 2,873 kms. With the pace of projects being awarded gathering momentum, road construction companies will get a chance to bid for many more projects.

Opportunities. Investment in the road sector during the Eleventh Plan is projected at $78.50 billion. Analysts expect an order inflow of US$26 billion over the next two years due to acceleration in awarding of national highway projects.

Threats. Delay in project clearances is a major risk. A single road project requires clearances from many government departments. In places where the road has to be widened, the developers have to get clearances from several central and state government departments. Such processes have the potential to delay projects and cause cost escalation.

Over-zealousness and apathy at the bidding stage is another issue. For some corridors there is cutthroat bidding which has the potential to reduce the project's margin. On the other hand, for some corridors there is no enthusiasm at all. The danger herein is that the project may not take off at all.

Power shortage in the country is conservatively estimated at 11 per cent and as high as 18 per cent during peak demand. This demand-supply gap needs to be closed and this presents several opportunities to companies within this sector.

Opportunities. The consensus among analysts is that of the US $31 billion investments planned in transmission during the 11th Five-Year Plan, approximately US $13 billion had already been invested by FY10. This leaves the balance US $18 billion, which has to be invested between FY10-13.

Threats. Regulations in the power sector are evolving. Another uncertainty here relates to merchant power rates which tend to fluctuate depending on the demand-supply situation, and hence affect producers' profitability.

Allocation of fuel supply for coal and gas projects is the other major regulatory hurdle in power projects. Approvals are required from the Standing Linkage Committee and Coal India for coal linkage and from the Ministry of Coal for captive coal mines. Allocation of gas is done by the Power Ministry and the Empowered Group of Ministers (EGoM).

To fulfil the need for infrastructure in the aviation segment, the government has allowed the private sector to participate. But after the privatisation of a few major airports, there has been a significant slowdown in awarding new airports.

Opportunities. The Airport Authority of India (AAI) plans to develop 35 non-metro airports at an expected outlay of Rs 62 billion (estimate based on 2005-06 prices). While the air-side work such as terminals, taxiway, runway and other related infrastructure at these airports will be undertaken by AAI, the city-side development consisting of hotels, shopping complexes, entertainment facilities and convention centres will be executed under the PPP model.

Threats. Bidding for city-side airport projects has been delayed due to opposition from AAI employee unions and the lack of interest among private developers due to the slowdown in the real estate market.

Delays in land acquisition and environmental clearance have added to the decline in interest. Debate on the model to follow for determining the tariffs to be charged from airport users has also contributed to loss of momentum.

Purchasing an infrastructure stock
When evaluating an infrastructure company, look up its order book which is a good proxy for growth in revenue. A strong order book indicates robust prospects. However, one also needs to evaluate the quality of orders as operating margins vary from one project to another.

To execute large-sized orders, infrastructure companies need a lot of working capital. Adequate working capital suggests that the company has the financial muscle to execute projects.

Says Thampi: “One should also track the market capitalisation to sales ratio. Internationally, a metric averaging between 0.4 times to 0.5 times is a good benchmark.”