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INFRA ON GROWTH DRIVE

India’s infrastructure spend at 3.5% of GDP is not only much lower


than China’s spend at ~11% of GDP but needs to go up to at least 4%
of GDP by FY12 if current growth rates are to be sustained. This would
require an investment of over Rs12,265 bn across sectors over the
next six years, even at a conservative estimate. But unlike in the past
when most of the investment in infrastructure was made by the
government, this time around the government has decided to act as a
facilitator preferring to fund projects through public-private
partnerships (BOT route). This has opened up several opportunities for
private players and FDI investors with IRR as high as 25% even for
low-margin infrastructure projects like roads. As for investors, with
market capitalization of infrastructure companies set to increase by
over US$100 bn over the next 3-5 years, returns would clearly
outweigh risks in the medium to long term.

Estimates on sector spends based on outlays (Rs bn)

Sector Spend over FY07-12(11-five year plan)


Roads 1,520
Power 4,812
Railways 1,100
Telecom 1,227
Aviation 370
Ports 800
O&G 2,201
Urban infrastructure 1,974

Total spend 13,973($350 bn)


Source: RBI, Edelweiss research

1. Government is planning to invest in urban infrastructure through the


Jawaharlal Nehru Urban Renewal Mission. It is a Rs 1,00,000-crore (Rs
1,000 billion) programme covering 63 cities across India.

2. However as per the latest planning commission estimates, investments


in infrastructure is set to go up by a whopping 130 per cent to $520
billion for the eleventh Five Year Plan (FY 2008-12) as against the $226
billion made during the tenth plan (FY 2003-2007).

3. The government is planning to invest around Rs246 bn in its Bharat


Nirman scheme.This will see massive infrastructure boost primarily in
the rural sector.Since government spending on infrastructure is the
most important growth driver for construction companies, the proposed
increase in allocation will translate into awarding of more projects.
Further, leveraging of foreign exchange reserves for infrastructure
development will result in increased availability of funds with the
government and thereby result in faster infrastructure growth for the
country.The salient features of the scheme are:

• Allocation towards Bharat Nirman increased by 32% to Rs 246 bn.


• Increase in provision for National Highway Development Programme
(NHDP) by 7.2% to Rs 107 bn.
• Corpus of Rural Infrastructure Development Fund-XIII (RIDF) for FY08
raised to Rs 120bn
• Separate window for rural roads under RIDF-XIII to be continued in
FY08 with a corpus of Rs 40 bn. Utilisation of foreign reserves towards
infrastructure development

(Source:Planning commision)

Likely Beneficiaries: This investment will be positive for construction


companies like IVRCL, HCC and Gammon who are engaged in the
development of roads, irrigation and water supply projects.Also will
benefit companies in manufacturing of pipes like Punj Lloyd Welspun
Gujarat,PSL & Jindal Saw.

All the companies who are into infrastructure development,turnkey


project developement ,cement production and heavy
engineering(capital) goods manufacturers.Until recently the capital
goods companies were commanding a premium but the recent
correction has made them attractive yet again. Most of these
companies have an order book to sales ratio in the range of 2.5-4
times FY07 revenue. This implies that for the next two-to-three years,
even if the companies do not get fresh orders, they can still maintain
revenue growth of 30-40 per cent.

Major Capital Goods Players:


Earnings EPS (Rs) PE (x) PEG (x)
CAGR* ROE CMP
07-09 FY07 FY08E FY09E FY08E FY09E FY09E
(%)
L&T 29.4 63.9 84 107 50.5 39.7 1.35 26.1 4244
The company is a diversified engineering and construction company
BHEL 39.91 42.4 63 83 43.1 32.7 0.82 28.8 2715
The company supplies electric equipment to core sectors of the Indian economy such as power generation
& transmission, industry and transportation
Crompton 40.35 6.6 9 13 45.6 31.5 0.78 32.6 410
The company offers products and services related to power generation, distribution, transmission and
industrial electric products
ABB 47.44 16.1 25 35 64 45.7 0.96 36.7 1600
The company provides automation products, switchgears and industrial lighting solutions to manufacturing
companies
Thermax 40.98 16.1 23 32 38.7 27.8 0.68 39.7 891
The company is into cooling and heating solutions and supplies plant equipments
Siemens 34.4 31 42 56 45.3 34 0.99 36 1904
The company produces electric products and services used by different industries
Voltas 41.42 4 5.5 8 37.1 25.5 0.62 38 204
The company is present in mining, machine tools, and construction equipment
(as of Nov’07-source BS)

Most of these investments in infrastructure are of a long-term nature and


projects will be executed over the next four to five years. The ongoing capex will
open up a plethora of opportunities for companies in the capital goods.
One can also emphasise on capital goods companies which have exposure to the
growing power sector. The government has set aggressive targets to take
current power generation capacity of 1,32,329 MW to 2,20,000 MW by 2011-12
and further to 3,05,623 MW by 2016-17. This will also require a huge investment
in power generation and other related equipment

Players like L&T, Siemens and Crompton Greaves will benefit from the booming
industrial capex in the country. Even smaller players like Voltas and Thermax will
stand to gain, Within power generation equipment, Bhel will be the key
beneficiary. Bhel is the largest power equipment manufacturer. Besides,
companies like L&T, ABB, Siemens and Crompton Greaves will benefit as
suppliers of transformers, switchgears and EPC contracts.

One needs to have a look at the capital goods counters in BSE Capital Goods
Index

Co_Name PAT] ROG-PAT (%) Price Earning (P/E] Price to Book Value ( P/BV)
ABB 340.31 55.62 47.04 13.32
AIA Engg 66.92 79.51 34.3 5.3
Alstom Projects 109.39 136.16 27.05 7.99
Areva T&D 137.02 277.88 31.59 11.17
BHEL 2414.7 43.8 23.83 6.3
BEML Ltd 204.93 9.63 19.5 3.87
Bharat Electron 718.16 23.18 17.29 4.63
Crompton Greaves 192.38 17.99 39.34 11.09
Elecon Engg.Co 54.9 96.92 22.27 6.41
Havells India 102.15 61.6 23.49 8.94
Jyoti Structures 55.02 98.84 25.22 4.96
Kalpataru Power 159.5 139.71 18.47 4.49
Kirl. Brothers 336.49 95.19 11.6 6.36
Kirl. Oil Engine 178.41 -11.06 13.25 2.68
Lak. Mach. Works 206.2 42.37 18.68 6.41
Larsen & Toubro 1403 38.62 33.98 7.99
Praj Inds. 86.53 254.49 38.1 21.43
Punj Lloyd 61.59 75.22 70.37 3.87
Siemens 596.54 65.65 39.11 14.34
SKF India 101.96 59.14 14.55 3.4
Suzlon Energy 1061.1 29.22 27.74 7.79
Thermax 187.8 52.37 25.84 7.89
Voltas 186.08 163.98 15.53 7.37
Construction companies will also be among the primary beneficiaries of
these investments and will deliver good and sustainable long-term growth. Since
the investment plans for each of the sub-segments in infrastructure space varies,
based on priorities, there is reason to believe that not all the segments or
companies will grow at all times. For instance, regional players or less diversified
ones may experience volatility in revenues. For companies, faster project
execution capabilities and access to key construction equipment are equally
critical, which in turn will determine the growth rates and profitability margins,
respectively for any company. For example some companies are looking at
purchasing their own equipment to tackle rising hiring costs and protect margins.
Recent correction in stock markets provides an opportunity to buy good
companies in the space at reasonable valuations. Among many stocks, we have
picked some stocks which are likely to emerge as key beneficiaries of the
ongoing investments in the infrastructure sector. Bigger companies are well-
established, diversified and less risky. Investors with low risk appetite can
consider them. The smaller ones are efficiently managed and are on the growth
path with good earnings visibility. Notably, they may also grow faster, given the
size of the opportunity and their individual strengths. But, small size also means
that there is an element of risk and hence, investors need to review them on a
quarterly basis and look at the flow of new business and financial performance.

SAL ES PAT P/E ORDER/SALES CMP


FY'08e FY'09e FY'08e FY'09e FY'08e FY'09e FY'08e 15 Feb
IVRCL Infra 3400 4300 197 270 26.33 19.75 3.24 436
Punj Lloyd 8900 12150 355 580 27.58 17.42 2.08 377
Nagarjuna Cons 3600 4900 190 282 27.18 18.48 2.71 288
HCC 3145 4150 112 170 34.89 24.15 2.88 171
Era Infra Eng 1322 1985 132.8 165 11.77 13.16 3.03 750
Sadbhav Eng. 866.3 1332 52 83 27.98 16.7 3.35 1162
Partibha Indu. 528.5 842 37.2 56 13.57 8.94 4.5 329
Ahluwalia Cont. 970 1427 53 85.5 26.24 15.93 3.24 247
Tantia Cons. 353 535 17.2 27 10.18 6.22 3.4 131
Gayatri Projects 690 1104 35.8 58 12.63 10.04 4.52 522

Our picks are:

1) Punj lloyd: In the domestic market, it has forayed into onshore drilling, real
estate and ship building business with 25.1 per cent stake in Pipavav Shipyard.
Its consolidated order book of Rs 18,500 crore, provides reasonable comfort.
Going forward, net profit is expected to grow faster on the back of turnaround of
Sembawang; consolidated operating margins are expected to improve to 10 per
cent by FY09 (8 per cent in FY07). After acquiring Singapore-based Sembawang
in FY07, Punj Lloyd tapped the growing global energy market with extended
services portfolio.
2) Tantia Construction: Company generates about 96 per cent of its
revenue from the eastern and north eastern region by undertaking
roads and railway projects.It will be the key beneficiary of slew of
investments which have been proposed for the Eastern sector in
coming days. North East and eastern India are considered to be
underdeveloped. Investments are required towards construction of
roads, ports, power and other infrastructure facilities. The Centre has
already indicated that it intends to spend Rs 50,000 crore towards
construction of roads and another Rs 2,000 crore for rail connectivity in
the North-East over the next five years. To further capitalise on this,
the company is foraying into other segments of infrastructure and BOT
projects. Its relatively smaller size and limited presence is reflecting in
the lower valuation it enjoys vis-à-vis its peers, which should hopefully
correct as the market gains confidence in the company. What is
currently playing in its favour are opportunities and relatively less
competition in the North East. Considering the industry outlook and
healthy order book to be executed over the next 30 months, the
company may maintain revenue growth of over 50 per cent in the next
two years.

---Vishwesh Chandra Shrivastav

---Gagan Sharma