Are green shoots visible in the capital goods & infrastructure space was the question asked to Shirish Rane, head of research, IDFC Securities in an interview to CNBC-TV18 from the sidelines of IDFC Annual Investors Conference.According to him green shoots are already visible in the roads and ports sector. The volumes in both the container segment and bulk have grown substantially, which in turn is driving the volume growth for ports.He feels with the government restructuring around 11 premium old projects and giving environment clearances to the projects that were stuck has given a boost to the road sector. And now with NHAI in a much better position to award projects, they expect round 4200 km of roads to be awarded in the next six months. Out of that about 1,700 kilometres will be on Build–operate–transfer (BOT) and another about 2,500 kilometres will be on EPC, says Rane.
The house is upbeat on Adani Ports and Gujarat Pipavav Port from ports sector and from roads they are very bullish on IRB Infrastructure and Ashoka Buildcon. These two companies don’t have a balance sheet issues they can capitalise on growth going forward and they have biding capacity to win new projects, says Rane. They are also bullish on Jaiprakash Associates with the outlook that the company is likely to pare significant debt in a 12 months time frame.GMR Infra and Larsen and Toubro are also good bets on back of strong airport business and defence sector revival respectively, he said.
However, the house is a little bearish on BHEL primarily because the current order flow is only sufficient for them to maintain their current profitability. The growth in the earnings will not be there for the next couple of years and which is why we are bearish on the stock right now. Below is the transcript of Shirish Rane’s interview with CNBC-TV18's Menaka Doshi and Senthil ChengalvarayanMenaka: Exactly in which specific areas of infrastructure and capital goods are you seeing maybe the first signs of a return to growth if at all?A: We have been very bullish on ports and road sector for a while. We think there are very clear green shoots visible in roads and ports already. Ports, the volume growth has already started picking up. In the last month of October we have seen 13 percent year-on-year (Y-o-Y) in containers which is after nearly about an year or more than a year we have not see this kind of a container growth. In bulk also because of the coal imports we are seeing pretty strong growth in bulk imports. So both these things are driving volume growth in the port segment.In the road side government seems to have resolved all its pending issues like premium restructuring old projects which developers were not willing to go ahead because of delays in clearances, land acquisitions so on and so forth. So both these things have been completed, premium restructuring has been completed for 11 projects, the environment clearance related projects have been surrendered by the developers to the NHAI. So that pipeline has been by and large cleared. So all these things have now led to fresh activity in roads. We are expecting about 4,200 kilometres of roads to be awarded over the next 6 months. Out of that about 1,700 kilometres will be on Build–operate–transfer (BOT) and another about 2,500 kilometres will be on EPC.So we are very clear that these two segments will do well from here because of the strong activity in these two segments.Senthil: How about payment delays, because we were speaking to Mr Gulabchand yesterday and he said the biggest bane for them is payment delays from government. Is that likely to affect new orders or is that only something that older payments have to be worried about?A: The problem is mainly in the older orders where there have been claims submitted against NHAI by the road developers and mainly it is the EPC players who had claims on NHAI for various clearances not being given on time and they have claimed compensation and this has been going on now for nearly 4-5 years and the amounts have become very large for some of these guys. That is mainly a problem for older projects. For newer projects NHAI is in much better shape to award them because they have land in hand and most of the clearances are already in place.Menaka: Which stocks do you think stand to benefit the most from this uptick that you speak of in for the both port and freight traffic as well as road sector coming back?A: We are very bullish on Adani Ports and Special Economic Zone (SEZ) and Gujarat Pipavav Port. In roads we are very bullish on IRB Infrastructure and Ashoka Buildcon. These two companies don’t have a balance sheet issues they can capitalise when the growth going forward and they have biding capacity to win new projects. Their old projects too are pretty much on stream they are generating cash flows and they are doing a good job of sort of paying back debt as well. So, overall their balance sheet is much stronger and they have biding capability for getting newer projects.Menaka: Amongst sectors that everybody is hopeful will return to strength is Power. Now some of the stocks I understand or recommendations that IDFC has made have to do with Jaiprakash Associates, GMR Infrastructure and KSK Energy these are all outperforming stocks according to IDFC at least according to the data I have. Can you talk us through why you continue to be so bullish for instances on JP assets sales are becoming so sticky?A: We are very bullish on JP Associates because we believe they will be able to reduce their debt substantially over the next 12 months. Already a beginning has been made by selling the power assets. Further they are also looking to sell one of their thermal assets to another private company so once all of this is done the debt should come down by about 30 odd percent and if required they are willing to sell their one or two cements plants as well if required to bring down the debt to sustainable level of about Rs 450 billion or so. We think this is achievable over the next 12 months and which is why we are bullish on JP Associates.Menaka: You are bullish on GMR Infrastructure and KSK Energy all in the power sector can you talk us through your investment case for power before we move on to some other sectors?A: Our investment case in power has been mainly that there are been two major issues in power - one is tariff issues and other is fuel issue. In case of tariff issues the whole issue is in some sort of legal circles it is going around currently it is in the Appellate Tribunal for Electricity (Aptel) one of the tariff revisions is pending in APTEL. Whereas for fuel issues the coal mine allocation and the linkage given to people who don’t win the coal mines this two things should help a lot in assuaging the coal shortage problems. As far as gas is concerned the proposed gas pooling arrangement should also help reduce the gas shortage with the gas power producers and that should be positive over the next six months for gas plants. So, combination of these two makes us bullish on the power sector where we think there is not as many issues in Power Trading Agreement (PTAs) or there are not as many issues in fuel so case to case where we think there is very little issue in fuel according to us and that is why we are bullish on KSK. GMR is not only a power company, GMR has also airports routes and we are very bullish on airports because we think they are unique assets, there is a good annuity model and as traffic continues to grow with the economic growth they will be able to get very good cash flows and there is also a real estate in both the airports Delhi and Hyderabad which will act has big kicker for the valuations once the monetisation of the land starts.Menaka: I want to talk now about defence and railways. These are two new sectors that will benefit from the hiking of the FDI limit. How should investors approach these sectors or approach investment ideas in these sectors because again in defence many of the private sector companies run their defence arms quite literally in subsidiaries right. So you either invest in the mother company or you don’t or you have a PSU option. So what should you do in defence and equally in railways?A: It is a difficult case to make out which companies you should play in defence and railways because still it is not very clear in what form the companies will benefit because in defence especially where the orders will be give out to companies where defence will be one of the portions of their entire business. So you cannot play a company just because of defence for example L&T will benefit materially from the defence orders but you cannot play L&T only for defence orders. There is a huge portion of non defence business in L&T. Same is the case with bulk of the defence companies. In railways case things are slightly different. There are manufacturing companies who makes bogies, who lay down the rail lines and stuff like that. So there are specific companies depending on How the outlook in railways pans out, one can decide to play whether a wagon manufacturer, a coach manufacturer or some kind of EPC company which lays down rail tracks or some kind of electrical HVDC or electrical installation signalling systems, things like that. So in my view railways is probably too early in the cycle right now, defence we have seen a lot of progress. So it is probably better to focus in defence in the next six-nine months. Railways will probably take next 6-12 months to make the background work, preparatory work before we start moving full stream ahead. Menaka: In defence are you saying may be L&T is the best bet, not just because of its defence business because hopefully of a recovery in almost across the infrastructure spectrum or would you say an M&M or a Bharat Forge for that matter are better investment ideas at this point?A: Our view is that we are more bullish on L&T because overall recovery will help order flow as well as margins for L&T and the working capital cycle should reduce as the growth picks up over the next 12-24 months. Defence will be an added benefit or added booster to the overall economic upturn cycle in case of L&T. So both these factors make us more bullish on L&T then any other play in terms of defence.
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Senthil: I can understand your scepticism about getting into railway companies right now because it is still only a promise, nothing yet really on the ground but the fact is that the markets tend to discount very far ahead. So are you worried that these shares could go up too much by the time you really get a chance to have policy clear get into them or do you think that it doesn’t matter, it is too much of risk to take at this time?A: I think stocks will always ride on the optimism. The point I was trying to make is we don’t see a concrete upturn in order flow over the next 6-12 months. Till then only optimism or a bout of pessimism is what is going to drive these stocks. So if you are comfortable doing that kind of a bet it is fine otherwise for fundamentals to match the price movement it will probably take 12 months. Menaka: Some stocks have already moved up for instance some of the ceramic players, the sanitary ware players have moved up, this is the Swachh Bharat Abhiyan and the hope that may be it will mean better sanitation across the country and therefore some companies stand to benefit from that. I am not sure whether the investment case is as linear as I have just mentioned right now but your thoughts on this?A: I don’t think the case is so linear because if you see some of these ceramics and sanitary ware companies, bulk of their business is driven by new house installations and part of it is replacement demand. So unless we see the real estate segment picking up materially over the next 12-18 months, only a Swachata Abhiyan cannot drive these stocks for a longer period of time according to me. Again in this Abhiyan the bigger issue is how will the funding come through? Even if somebody starts actually spending money and putting up toilets and what not, who will fund it, how will the cash flow go to these companies. Those are the issues which we need to be focused on. Having said that I think the real estate side looks promising with the rates likely to come down over the next 12 month, I think there will be some amount of recovery in real estate which can drive the sales of these companies. So they are interesting bets but for different reasons, not for Swachh Bharat Abhiyan. Senthil: If the real estate pickup comes through would you prefer paint companies like Asian Paints to these because companies like Asian Paints have been relative underperformers in the last 8-10 months?A: Finally when the upturn actually happens, when the rates fall we will have to look at valuations across in terms of whether it is a paint company or a ceramic company or any other derived play on real estate demand. And depending on the valuations we will take a call. Too early to say whether Asian Paints is better or ceramics companies are better.Menaka: Let’s talk about the core than of infrastructure. Both in terms of large infrastructure companies you already taken us through your views on L&T but other stocks for instance public sector undertaking (PSU) Bharat Heavy Electricals Limited (BHEL) and also on capital goods and where you see or when you see the recovery coming in. Yesterday we were talking to Ajit Gulabchand and he says he doesn’t expect to see new orders kicking in at least for another year. So, we start seeing all of that reflecting on the balance sheets of these companies on the financials of these companies may be only two years down the line. A: In BHEL case the problem is the order flow has been sluggish for the last two years primarily because of the fuel issues. At this point time we are not that bullish on BHEL simply because the fuel issues need to be resolved first. There now a concrete progress has been made, however actually for people to start ordering power plants will take another 12 to 24 months because it is not only fuels which you have to tie in you have to get in land, you have to get in environmental clearances and then only you can look at ordering equipments. So, it will probably take 12 to 24 months before we will start seeing a big amount of jump in fresh order inflows in BHEL. Having said that it is not that BHEL today doesn’t get orders it is getting reasonable amount of good orders from PSUs which have fuel which has land which have all the clearances so it is a question of acceleration in those orders and not in absolute sense of orders.However we continue to be little bearish on BHEL primarily because we think the current order flow is only sufficient for them to maintain their current profitability. The growth in the earnings will not be there for the next couple of years and which is why we are bearish on the stock right now. As far as recovery in capex cycle, we look at the whole recovery element in two parts one is what I call infrastructure recovery and other one is a capital goods part. Infrastructure already the orders are happening as you can see L&T and some of the other infrastructure companies order flow is pretty good at this point in time in India. We expect that to accelerate over the next four quarters like as I said in roads, in waters, in buildings all this things are looking to accelerate. Having said that in capital goods which is more of equipments, there will be some lack of anywhere between nine months to eighteen months depending on how quickly we can see the balance sheets of the user industries improving, interest rates falling and the user industry is actually being in a position to raise equity or able to fund their expansion plans. So, in my opinion this will take at least 12 months or more and hence the timeline of may be 12-24 months before we see a major upturns orders in the capital good segment.Menaka: What is your take on how the coal auction announced by the government is going to work because here onwards we should expect that it will be auctions that will determine all coal allocations and coal purchases to that extent? So, can you talk us through what you make of the draft modalities that were announced yesterday and this entire space of coal?A: Basically we think it is very clear after the Supreme Court judgement that the entire coal which is being given to private sector will come through auction method.Menaka: Yes, and that change actually took place in the United Progressive Alliance (UPA) government’s phase itself, the fact that mines were only being auctioned, except that the auctions at that time didn’t do very well. So, I am just curious to know whether you think this effort to auction coming out of the Supreme Court decision will succeed based on the modalities you heard as well?A: Basically the main difference between last time and this time of the auction is last time you were doing incremental auction and that too for non power drating power plants whose mines have got de-allocated. So, if you don’t get coal on 1st April your plants will shut down.So there will be enough and more interest in bidding this time around for these coal mines. What price discovery happens depends on the modality of how the auctions works, whether it is a single bid auction or is it a continuously improving bid auction. We will have to wait and see what modalities government chooses to follow, but it is going to be very clear that coal will come at market price. The private sector will have to align their business model to coal coming at some sort of in and around Coal India’s notified price. That is a very big change in the mindset which the industry will have to accept.Menaka: It is interesting you say that because yesterday the coal secretary went to great pains to keep saying that this is not a revenue maximisation effort and we will cap. He suggested some sort of cap when he was talking about the auction specifically for coal for power plants and I am just curious. I couldn’t quite understand how he could cap prices in that auction but not cap prices in the auctions, let’s say, for steel and cement and used plants. So did you get enough clarity on how this is going to function hereon?A: The draft guidelines don’t mention about the cap at all. In the final modalities they may mention certain caps on the tariff. What I think they would be looking to do is that if they would be looking to do is that if they don’t put a cap in fuel pass through in the tariff then I can bid a very high amount for getting the coal and if that gets passed on in the tariff then it defeats the purpose of having an economical power price for the customers, which is why they will put some kind of fuel pass through possible, if you have a coal mine there would be some kind of cap on that. That is my understanding of it but the draft guidelines don’t have any clarity on this issue, but I assume that by the time of month end when they issue the final guideline this should be clarified by the government.
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