Equitymaster.com
When we compare ourselves with our Chinese neighbours, one of the main differentiating factors is often the quality of infrastructure. Such is the poor state of India's infrastructure, that we lose an estimated 2% of GDP (Gross Domestic Product) growth because of it.
Currently, the condition of infrastructure companies is akin to the state of India's infrastructure. While the Indian stock markets have been severely battered in recent times, the infrastructure stocks has been the worst hit.
You would recall that the once sunrise sector of India, had everything going for it until 2007. After decades of wobbly growth, the Indian economy had reached an inflection point and was set to grow at a robust pace.
The government chalked out big plans like providing electricity for all, building 20 km of roads per day and so on. Infrastructure companies plunged in to grab this golden opportunity. They did very well for quite some time. But then, as fate would have it, both reality and adversity struck and everyone realised that the story was not going to be as hunky-dory as imagined.
The sector has been getting everything wrong for quite some time. The second quarter ended September, 2011 (2QFY12) saw the infrastructure players posting dismal numbers. Most companies reported significant year-on-year decline in profit after tax (PAT).
The poor show was attributable to a steep incline in interest costs, which escalated in the range of 200 to 500 basis points (2 to 5%). One reason for this was the slew of hikes in key lending rates by the Reserve Bank of India (RBI) to battle steep inflation rates. The other reason was the high debt burden coupled with a significant increase in working capital requirement. But this is just one part of the story. The other concerns plaguing the sector include regulatory hurdles, land acquisition problems, delays in project execution and such other structural bottlenecks.
So there is no denying that there are ample reasons for the negativity surrounding the infrastructure sector. But we believe that in times of panic, investors have a tendency to be shortsighted. The reactions at such times are often extreme and disproportionate to what the events call for. Such is situation of infrastructure stocks currently, with many of them trading below their book value.
| Company | Returns* | (P/BV)^ |
| NCC | -76% | 0.37 |
| IVRCL | -75% | 0.32 |
| GVK Power | -75% | 0.47 |
| GMR Infra | -57% | 1.02 |
| HCC | -56% | 1.08 |
| JP Associates | -44% | 1.20 |
| IRB Infra | -37% | 1.98 |
*Returns calculated from 1st January to 25th November, 2011; ^Price to Book Value
What should value investors do? With the overall pessimism over infrastructure stocks, it may be a good time to go bargain hunting. It is important to note that the fate of the infra stocks is not going to turnaround overnight. Infra companies are very sensitive to interest rates. While it may seem that interest rates in India have peaked, it is anybody's guess as to when the Reserve Bank of India (RBI) would cut down the rates.
On the other hand, the order pipeline has slowed down. Several companies have hit regulatory roadblocks. Project execution has slowed down. All this has weighed heavily on their balance sheets. There are chances that some of these players may face further distress and deterioration.
But when the cycle turns, the better-off players would be in a good position to capture the opportunity. Within the infrastructure space, infrastructure developers have not been hit as badly as the EPC (Engineering, Procurement & Construction) players. In recent months, the road sector has witnessed some improvement in order inflows.
In conclusion, the infrastructure sector is likely to report poor performance for at least a year or two. We suggest value investors keep a watch on this sector. Some patience coupled with some well-informed investment decisions are quite likely to pay off well in the long term. (Equitymaster is a Mumbai-based independent equity research house)
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