Discover more from Finding Outperformers, by Aditya Grover
Tracking India's Infra Boom!
More on L&T and Nifty Infra Index as you read
The Indian Central budget for FY 2021-22 was a historical one. It marked the transition of the primary focus of government from increasing the income directly to indirectly via the Capex route.
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Let me explain that first quickly:
Every government has 2 primary ways of increasing the income levels of its citizen. First is by income transfer or subsidies wherein you directly impact the income of the individuals. It can be implemented in various ways, in form of tax cuts as well. Herein, the government lets more money stay in the hands of citizens rather than having it in its buffers/tax kitty. This allows citizens to consume & spend more, which indeed signals companies to invest more, which further generates employment & the cycle goes on.
The second way of increasing income is via indirect route wherein the government focuses more on the investment & Capex side, by spending & redirecting more money towards infrastructure & Capex rather than giving subsidies/tax refunds as is in the 1st case. Herein, the focus remains on investments first & consumption later. (practically the reverse of the 1st case)
In terms of impact, the 2nd way is more impactful as it generates more employment & income in the long run due to having a higher income multiplier effect on the economy. But in terms of successful implementation, it faces 2 roadblocks. Firstly, is how the general public views it (generally less favorable as there isn’t any instant good news for them in the budget) & second roadblock is the government’s involvement in decision-making over how the money would be spent, leaving room for corruption if not implemented with honesty.
In short, economists always prefer the Capex expenditure route over the consumption route, despite its challenges, because of the sustainability it provides to future growth in the long term. This is where the current central government is now focusing on.
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How is it related to L&T?
L&T is India’s biggest infrastructure company with annual revenues of over Rs 1.5 lakh crore with ~50%+ coming infrastructure & power projects alone, and the rest being contributed by development projects, IT services, Financial services, etc.
The bull run of 2003-2007 was also marked by Capex-led growth where in the Nifty Infrastructure Index went up by over ~7 times. Okay wait-wait, lemme explain the Nifty Infrastructure Index before moving forward.
Nifty Infrastructure Index is a less talked about index but of immense importance. You can trade this index via options & futures as well on NSE. It includes companies belonging to Telecom, Power, Port, Air, Roads, Railways, etc., & the key components of this index are Reliance, L&T, Airtel, Ultratech & NTPC which together have a weight of 50%+ in the index. Here’s the list of its top constituents:
Back to 7 times return from this index, happened because the country witnessed its strongest investment cycle ever back in 2003-2007. In fact, Larson & Tubro, which has ~15% weight today, went up by over 40 times in just 4 years!
The economy was growing, exports were rising & the Capex cycle in India was in a boom phase. All this happened when the inflation was creeping up (CPI went from 5.1% in April to 6.3% in May and further to 7.6% in June 2006, which was the highest in several years) & interest rates too were rising (on 10-year yield rose 5% to 8% in those 4 years), but both of them were not good enough to stall the rally in infra stocks.
Back today, economists have pointed out many similarities (& dissimilarities too) between then & now. With the government's continued focus on Capex-led recovery, in form of the budget of 2021 (which was tilted towards infra spending), reforms that took place like RERA, Corporate tax cuts of 2019 & more, one may expect the Infra index to do well. In fact, the Infra index has been amongst the best-performing index over the last 2 years post covid.
IF THAT’S THE CASE, SHALL NOT WE INVEST IN L&T?
Larson & Tubro today is 100 times the size it was back in 2002-03 in terms of market cap, which today stands at over Rs ~3 lakh crores. Seeing the size of the company & the extent of coverage it has got today from all brokerages in India, it would be wrong to expect a similar kind of return (or even near to that) it gave in those 4 years. In fact, there was euphoria around it in that phase of the growth cycle & the share prices went much beyond where they should’ve been. It took over 7 years after 2007 for Larson & Tubro to make a new peak in terms of share price, in 2014.
In fact, that’s the story of the whole Nifty Infra Index, which is yet to cross the price levels it saw in 2007 as shown in the graph below:
This is where my point comes in. We believe that the current rally in the Nifty Infra index is one of the key leading indicators of the Nifty 50's rally to sustain. If the Capex-led recovery continues, despite the recent interest rate increase, the economy shall boom & so will the markets.
In that case, Nifty Infra Index will lead from the front. If the story of Infrastructure-led growth led by Capex spending holds true, it shall have the highest multiplier effects on the whole economy & hence all domestic-facing stocks. If it starts to lose its leadership & starts underperforming the Nifty 50 index in the medium term (measured for at least a period of 4-6 months), it can be taken as an indication that the government’s efforts for a CAPEX are not bearing the desired fruits.
In summary, if your risk-taking abilities are high, you may place your bet on the whole Infra index with stocks like Larson & Tubro, and other small infra stocks. But in our view, the return on the Infra index is an indication of how well the economy & broader markets could do in following months to come. It would be better to track them to decide how much to invest in equity markets for the medium term.
Personal & client investment/interest in the shares may exist; this isn’t investment advice; DYOR (do your own research) is recommended; Investing & trading are subject to market risk; the Decision maker is responsible for any outcome