Should you buy infra stocks?

The performance of the Infrastructure sector hasn’t kept up with market expectations.

However, some companies have given stellar returns.

The CNX Infra index, in anticipation of an infrastructure push by a new government, surged 77% between September 2013 and June 2014, even as the broader Nifty index rose by just 38% during this period. The thumping mandate to the Modi-led BJP government last year added to investor interest in infrastructure stocks. However, more than a year on, the story has not played out as anticipated. The CNX Infra index has fallen 10% since June last year, even as the broader market gained 4%. Should investors cherry-pick value stocks from this segment, or stay away from what could be value traps?

Legacy issues persist

While the delay in earnings recovery–across sectors–has served as a reality check, the moderation in sentiment has hit the infrastructure sector the most. “I firmly believe the initial euphoria around infra stocks was too high, and the market was wrong to paint all sub-sectors within infrastructure with the same brush,“ says Swapnil Pawar, CEO, Karvy Capital.

In all fairness, much of the problems in this sector are beyond the immediate control of the government. The heavy borrowings by infra companies in the past has added to the complications of jump-starting this sector.The total debt of Indian infra companies is at its highest in more than a decade. Also, banks are unwilling to lend, given their already high loan exposure to the infrastructure sector and their rising non-performing assets (NPA).A lower interest rate regime is critical to starting the investment cycle, but with the central bank adopting a wait-and-watch policy on inflation, before slashing interest rates in earnest, companies will have to wait longer to borrow at lower rates. “Across industries, capacity utilisation levels are low and investment in new capacity additions will be delayed till utilisation levels rise,“ says Vetri Subramaniam, Chief Investment Officer, Religare Invesco Mutual Fund. Given the problems, experts reckon there are very few opportunities for investors in the infrastructure sector. Vikas Gupta, Executive Vice-President, Arthveda Fund Management, believes any investment in this sector is a high risk-high return proposition: “There is no doubt that infra will be the biggest story for the next several years. But the listed companies in this space are loaded with unviable projects from the previous cycle and are saddled with debt. Unless they are able to clean up their balance sheets, they will not be able to participate in this growth.“ The clean-up of balance sheets, which involves asset sales and restructuring of existing loans, will take time.

Focus on sub-sectors

In light of the various legacy issues, rebooting the sector is proving to be a tough task for the new government. But it has moved swiftly on several fronts. Since presenting the 2015-16 Budget, it has given clearances for 42 stalled projects worth `1.15 lakh crore. Road infrastructure, in addition to railways, has emerged as a key focus area for the government. “Within the infrastructure space, we like project execution companies in roads, railways, water and urban infrastructure. We have seen increasing traction in these subsectors with reasonable order inflows and a gradual pick-up in execution,“ says Sanjay Kumar, Head of Investments, PNB MetLife Insurance. From just 2 km of road construction per day till May 2014, the pace has been ramped up to nearly 12 km per day. In a bid to more than double highway construction to 30 km per day, the government plans to award road projects worth `3 lakh crore this year. Most experts are convinced that the roads sector is likely to be a good play for investors over the next 2-3 years. “While outlook for the roads sector is certainly positive, only companies with lower debt in this segment will be able to take advantage of the government’s push,“ cautions Pawar. Companies such as IRB Infrastructure Developers, Ashoka Buildcon, Sadbhav Engineering and IL&FS Transportation Networks are top analyst picks from this segment.

Experts do not share the same optimism for the power sector, another vital cog in the infrastructure wheel. While the clearance of supply-side bottlenecks–coal-linkages to fuel-starved power generation units–has breathed some life into the sector, the average plant load factor, a measure of capacity utilisation, has dropped to a 15-year low of 65%, leading to weak earnings. This is because cash-strapped power distribution utilities, which are saddled with huge debt, are purchasing less power. “Challenges remain on the ability of gencos to sell expensive power to discoms resulting from gas transportation issues, transmission bottlenecks, willingness of power surplus discoms to buy power,“ reads an Axis Capital report. Power Grid Corporation of India and NTPC are analysts’ top picks in this space, given their earnings visibility and low operational risks.

Water treatment solutions provider VA Tech Wabag also has a strong buy call, being a direct beneficiary of various government initiatives such as the ambitious Clean Ganga and Swachh Bharat Abhiyaan programmes.