Keeping the Faith in the Infrastructure Story

The first quarter earnings for Indian Corporates that have come in so far have been disappointing. The sectors which did well are Banking and Automobiles. The list of laggards is much longer with Infrastructure, Capital goods, cement, metals and information Technology surprising on the negative. Leap of faith would now peg the FY11 earnings growth expectations at 20% down from the 25% at the beginning of the result season.

The biggest disappointment has been in the Infrastructure & Capital goods space. Larsen & Toubro, the biggest company in the construction space, came up with the revenue growth of 6% on yoy basis against a guidance of 20% by the company in the beginning of the year. While core Engineering and Construction order book increased by 65%, Larsen is still grappling with issues on the execution side. Several projects on the infrastrucre and metal side were either shelved or failed to achieve financial closure during the recession. It seems the progress is still slow on those projects. However, one should not rush to judge the basis of just the first quarter numbers A lot of construction sector companies have lumpy orders and sales booking. Leap of Faith believes that the bulging order books would start getting reflected in the topline and bottomline in an accelerated manner in the coming quarters.

The infrastructure segment that looks most promising is the roads segment. With the change in leadership of the ministry last year, several policy changes have been carried out to improve the financial viability of highway projects, streamline procedural bottlenecks and increase access to financing. This is evident in the increase in bidding and awarding activity of road projects by NHAI in the last six months. Leap of faith’s interaction with infrastructure lenders confirms the huge growth in financial closures and disbursals for the road space. Around 30,000 new highway projects are slated to be awarded in the next four years, opening up a US$60bn investment opportunity. IRB Infrastrucre and ILFS transportation Networks are best geared to ride this investment boom and remain a core holding in the model portfolio.

The RBI in its credit policy on last Tuesday has unequivocally shifted the focus on inflation management. Leap of faith would expect another 100 basis points hike repo and reverse repo in the next 2-3 quarters. The fact that food inflation has dropped down to below 10% provides some relief. However, inflation expectations especially in the core sector are now firmly on the uptrend and therefore a continued tightening stance is warranted.

While Indian markets have been flat in July due to muted earnings numbers, the Shanghai composite market has rallied very sharply. It is up almost 15% from its recent lows. The Chinese government’s attempt at trying to slow down the Chinese economy seems to be working. A purchasing managers’ index released today by HSBC Holdings Plc and Markit Economics slid to 49.4 from 50.4 in June. The Government has taken measures to reduce overheating risk in the economy especially in the real estate pace. Leap of faith believes that concerns on further tightening are overdone. The Chinese government, considering the fragile economic scenario in Europe and its dependence on exports, is expected to desist from further tightening.

While the corporate earnings in US surprised on the positive, concerns on economic recovery continue. The remark of Fed chief Ben Bernanke that “economic conditions are likely to warrant exceptionally low levels of the federal funds rate for an extended period” indicate the fragile nature of the recovery. With the congressional elections in November and unemployment running at over 9%, Leap of Faith would believe new stimulus package would be announced soon. As the result season is out of the way, the next trigger for equity markets would be the announcements of that stimulus package which could contain both monetary and fiscal measures.