Taking Stock of Capex

The government's ₹7.5-lakh-crore capital expenditure push is already pumping up capital goods, construction, cement, metals and banking stocks — sectors at the core of infrastructure development.

On February 1, 2022, the BSE Sensex gained 848 points following finance minister Nirmala Sitharaman's announcement of a 35.4% year-on-year hike in capex for FY23 in the budget. The next day it gained 696 points. The broader Nifty rose 440 points in the two trading sessions, making a recovery of 943 points from the previous week's low of 16,836.

The recent thrust on capital spending has boosted the Nifty Infra index, a representation of 30 infra companies, where oil & gas, construction and cement make up for about two-third of the index. In fact, in the last one year, Nifty Infra has outperformed Nifty 50 by a big margin, rising 39.89% against a 28.68% increase in the broader index.

The return scenario was reverse when the government went slow on capex. In the last five years, Nifty Infra gave 13.42%, while Nifty 50 delivered 16.61%. Since its inception in 2004, Nifty Infra delivered a total return of 10.79% (CAGR).

Asset Creation And Earnings

What was there for the markets in the budget? It made a large provision for asset creation through capital expenditure.“The virtuous cycle of investment requires public investment to crowd-in private investment. Private investments seem to require that support to rise to their potential and to the needs of the economy," Sitharaman said in her budget speech.

The Centre aims to revive demand and pump prime private investment through seven engines of growth — roads, railways, airports, ports, mass transport, waterways and logistic infrastructure. These engines are supported by the energy transmission, IT and communication, bulk water and sewerage treatment sectors.

By raising capex spends significantly, especially in infrastructure segments such as roads, railways, solar modules and affordable housing, the government hopes to trigger multiplier effects and crowd-in private sector investments into construction, cement, steel and capital goods sectors and kick-start the private capex cycle, says Gurpreet Chhatwal, managing director, Crisil Ratings.

“Last time India saw such a huge allocation for capital expenditure was in 1999-2000, when in one go capex was raised by 20%, which had not happened formally in the Indian budget till then,” says Vibhas Jha, an independent economist.

After the 1999-2000 budget, infra and construction companies mushroomed and investors made a beeline to be part of the infra growth story. HCC, IVRCL, GMR, GVK, Lanco, Hind Dorr Oliver, Punj Lloyd, Reliance Infra gained, but also lost their sheen within a decade. The decline of these heavily indebted companies coincided with the stagnant capex by the Central government. In 2013-14, non-plan and plan capital expenditure (including railways) was ₹2.51 lakh crore, which reached ₹3 lakh crore in 2019-20, a mere hike of ₹50,000 crore in six years.

The Current Scenario

The story this time is different though. Corporate India is ready for a new capex cycle after a massive deleveraging exercise in the last one year. In the last cycle (between 2000 and 2010), the biggest overhang on corporate balance sheet was debt. But this time, for a change, instead of amassing debt, companies have been repaying loans.

In FY21, just two companies — Reliance Industries and Tata Steel — cumulatively reduced their gross debt by around ₹1 lakh crore. According to data from online database Capitaline, 750 companies have reduced gross debt by ₹3 lakh crore to ₹14.7 lakh crore in FY21, from ₹17.71 lakh crore in FY20. Net debt (gross debt minus cash) is down by ₹4 lakh crore to ₹9.5 lakh crore from ₹13.51 lakh crore.

The top five gross debt-reducing sectors in FY21 included refineries (₹75,823 crore), steel (₹44,635 crore), textiles (₹14,384 crore), fertilisers (₹10,870 crore) and power generation (₹10,230 crore).

The leaner balance sheet of corporate India has received a thumbs up from rating agencies as well. Chhatwal of Crisil Ratings says the firm has had a ‘positive’ outlook on credit quality of companies since the second wave of Covid-19. “Our credit ratio that captures rating upgrades to rating downgrades has increased 2.96 times in the first half of the current fiscal, compared with 0.54 times a year ago,” he adds.

Rating upgrades on the back of a leaner balance sheet has led to optimism on earnings revival. In the last decade, Nifty was primarily running on higher multiples (P/E) and not on earnings per shares (EPS), which showed muted growth for a long time.

Nifty Drivers

The provisioning cycle for banks has normalised and the bulk of Nifty's profit growth in future will come from financials, including the banking sector, says Harshad Borawake, head of research, Mirae Asset Investment Managers.

Besides banks, investors are pinning their hopes on insurance and asset management companies for an earnings revival. According to a Bloomberg consensus estimate, Nifty EPS is expected to grow by 19% and 16% in FY23 and FY24 to ₹882 and ₹1,020 per share, respectively. Nifty financial sector EPS is expected to grow by 27% and 21% during the same period.

The Street is expecting a cumulative profit of ₹1,96,230 crore and ₹2,37,616 crore from Nifty financial companies in FY23 and FY24, respectively. In FY21, their cumulative profit stood at ₹1.2 lakh crore.

The Indian economy and equities are in better shape than the rest of the world, says Srinivas Rao Ravuri, chief investment officer, PGIM India Mutual Fund. “The Indian economy is on a structural growth path after consolidating in the last few years and whenever there is a visibility of growth for the longer term, markets tend to ascribe better valuations."

The composition of Indian indices favour high-growth sectors that justifies the higher earnings multiples ascribed to Indian markets. “The Indian market has diverse representation in the main indices, including new-age companies, pharma and consumer firms constituting a high share and cyclical ones accounting for a smaller share, which justifies the higher valuation for Indian equities,” adds Ravuri.

Though the government has shown its growth intent, eventually, the capex revival of private companies will decide the shape and swiftness of earnings revival and the next moves of the market.