Abhinav H Sharma, Senior Analyst and Fund Manager, Tata Mutual Fund, gives his outlook on the engineering and infrastructure sector for 2022
With a revival in economic activity, how do you see the construction/cement/engineering sectors doing in 2022?
Going into 2022, we are very optimistic on the cement/engineering/construction sectors. Our optimism stems from our belief that the capital-investment cycle in India, which is the key earnings driver for these sectors, is at the cusp of a long-awaited upturn.
For most of last decade, investments in India have been driven primarily by the government as the corporate sector suffered from leveraged balance sheets, weak demand, and excess capacity. Residential real estate, which is the main driver of household capital investments, also went through its own challenges. However, conditions are now ripe in our view for a cyclical upturn in both corporate and residential real-estate capex, which in combination with steady government capex, sets the stage for a broad-based capex cycle upturn.
Last two years have seen the corporate sector benefiting from strong margins and demand (despite COVID-19), leading to increased capacity utilisations. Coupled with the resolution of large-stressed assets, low-interest rates and ease of equity funding, the corporate balance sheet has significantly deleveraged. The government has also announced several investment-friendly policies like production-linked incentives (PLI), increased focus on indigenisation and corporate tax rate cut, to name a few.
Thus, the corporate sector has reason, means and favourable policies to get into the investment mode again. Themes like China+1, digitalisation/automation and decarbonisation will provide further tailwinds to capex momentum. We have already seen large capex announcements in sectors like steel, cement, data centres and renewables. Corporate commentary suggests that the trend will only intensify going forward, with investments picking up across other sectors as well.
The residential real-estate segment has seen large-scale consolidation, catalysed by demonetisation and the NBFC crisis. This consolidation, along with a strong pick-up in demand driven by low-interest rates and strong job markets, has led to developers reporting record quarterly sales bookings in Q4FY21 and Q2FY22. Going forward, we expect these trends to consolidate and lead to a residential realty upcycle, which will inevitably drive higher investments.
Government capex, the third driver of investments, is also expected to grow steadily. With fiscal deficit under control, we expect the government to take up large transformative projects in sectors like roads (expressways), railways (dedicated freight corridors, high-speed rail) and water (river interlinking).
Along with positive demand momentum, what gives us further comfort is reasonable valuations across most parts of this space. Valuations are closer to historical averages and are far lower than seen in 2008 peak. Thus, there is ample scope for valuation rerating as more visibility emerges on the investment upcycle. In the near term, input-cost pressures may impact margins, but we expect companies to pass them on, given strong demand momentum.
Given this backdrop, we expect cement/construction/engineering sectors to deliver strong returns over the medium term and investing in a thematic infrastructure fund will be a good way to capture these returns.
This interview was conducted in December 2021.
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