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Stocks That Could Ride the Railway Capex Cycle podcast

May 2, 2023

India recently became the most populous country, displacing China. Of the many factors that influence whether this population becomes a demographic dividend or disaster, infrastructure in the country will be a key determinant.

Today, I'm going to share a specific sector under infra, Railways that seems set for a massive growth, thus opening up the opportunities for the companies in the railway sector.

India recently became the most populous country, displacing China. Of the many factors that influence whether this population becomes a demographic dividend or disaster, infrastructure in the country will be a key determinant.

While a lot needs to be done in that regard, we seem to be going in the right direction.

A few months ago, I had shared a video on why infrastructure is my favorite theme for the decade. You could watch that video using the link in the description section.

Today, I'm going to share a specific sector under infra, - Railways that seems set for a massive growth, thus opening up the opportunities in the companies in this sector. I'll be coming to these companies in a while.

First, let's take a look at the the big policy push in favour of the railways.

Railway is the cornerstone of two key plans laid out under Gatishakti and National Logistics policy. The Indian government is investing heavily in the sector.

To be specific, in the latest Budget, the roads and railways' allocation together accounted for a capex outlay of nearly Rs 5 trillion, i.e, for almost 50% of the Budgeted capex outlay of Rs 10 trillion.

Railway capex alone has gone up 9 x in the last decade to Rs 2.4 trillion and was almost doubled in the recent Budget.

The National Rail Plan aims to increase the share of freight traffic by rail from 27% to 45%.

While many rail stocks have gained on account of growing allocation towards railways, I believe it is better to avoid companies with asset heavy business models and long gestation periods. While these companies may win the bidding round as L1 bidders and undertake projects, extended project cycles make the execution and stock valuation sensitive to shifts in the macro environments, commodity prices and competition, and the return profile may not turn out to be good.

I would rather focus on companies where the balance sheets and return ratio profile offers comfort.

I'm particularly interested in companies that that don't have to incur a disproportionate share of capex to participate in this theme.

So, moving on to these stocks...

The first is RITES.

RITES is a PSU engineering firm that earns a major share of its revenue from the business of consultancy services for transport and infrastructure sector for railways, but not limited to it. The other sectors it caters to include highways, airports, seaports, city planning, waterways, etc.

Together, the allocation for road and rail both is at 50%, giving RITES both a better runway than just railway focused companies, along with diversification opportunities.

Rites seem to be the most well-placed company with respect to balance sheet, return ratios, dividend yields, and even valuations in the perspective of fundamentals. The company has a low capex business model, with capex trend in the range of 100 to 140 crore rupees.

The scope of its projects is diverse, such as railway electrification work, direct freight corridors, station redevelopment, consultancy for metro projects, DFCs, high speed railways, airports, ports, ropeways, renewable technologies, Swachh Bharat, city mobility, and waterways both in India and abroad. The company has clients like SAIL, NTPC, Indian railways, metro rail corporations. It has a JV with Railway Ministry - REMC, in which it has a 51% stake. REMC is focused on use of green energy for traction power of Indian Railways. In my view, REMC is likely to benefit from increased electrification in Indian Railways, along with the focus on renewable energy. REMC enjoys a margin of over 50% and is on a healthy growth trajectory.

RITES orderbook at the end of December 2022 stands at Rs 55 bn, compared to revenue of Rs 26 bn in FY22 offering decent revenue visibility of over 2 times.

Within the business, there are two key segments - consultancy that is high margin and turnkey which is low margin. While the current orderbook has higher share of low margin turnkey projects, Consultancy is expected to contribute to over 50% of the revenues. The reason for the difference in mix in the revenue and orderbook is longer period for the execution of turnkey projects.

The cash and liquid investments on balance sheet is Rs 32bn, one third of the marketcap. The stock is trading at a PE of 17 times. RITES has a limited trading history as the company was listed in 2018. Over this almost 4-year period, the median PE has been 13 times.

The company has operated on a low capex model, with capex trend in the range of Rs 1 bn to 1.5 bn. It offers an attractive dividend yield of over 4.4%. The debt on the balance sheet is zero, and cash conversion cycle is negative which is a good thing.

With parentage of Indian Railways and strong track record at execution, the company is well placed to make the most of the capex revival in this segment in my view and its stock deserves to be on your watchlist.

Moving on to the second candidate for your watchlist....

RailTel is associated with telecom infra and the execution of connectivity related projects for Indian Railways.

It owns a pan-India optic fibre network providing broadband and multimedia services, along with modernisation and maintenance of the communications network of the Indian Railways. Being a PSU, it enjoys the parentage of Government and Ministry of Railways.

RailTel is a beneficiary of growth in railway capex and network. There is opportunity of growth from content on demand, Railway display network, Signalling Systems, Video Surveillance, and defense system to avoid train accidents.

It's going to be a facilitator for rolling out 5G along railway track. It is also focusing on sectors like coal, banking and defense and exploring education, health, and urban development projects. Last year, in some projects, the company faced execution issues due to chip shortage, but the issue is easing.

As against a trailing 12-month revenue of Rs 17 bn, the order book is Rs 50 bn, offering around 3 year of revenue visibility. Orderbook is divided between project business that is expected to have 7 to 8% margins, and telecom business that has 20%-25% margins.

The key aspects to monitor would be revenue and orderbook mix between projects and telecom business. In FY22, project business formed 33% of FY22 revenue. Key risks are competition from other telcos, and potential chances of delay in receivables or subsidies due to significant govt dealing.

The company is debt free, with a dividend yield of 2%. Cash is 13% of the market cap. The stock is trading at a PE of 22 times, versus a median of 21 times since listing.

Now as railways infra projects get executed, I expect a multiplier effect in play where other sectors too will benefit.

Logistics is one such sector, which brings me to the third candidate - Container Corporation. The company provides inland transportation of containers by land, and associated services like warehousing, container freight station operations and so on. The National Rail Plan aims to increase the share of freight traffic by rail from 27% to 45%. Since most of the company's terminals are rail linked, Container Corp is likely to be a big beneficiary of this shift.

The company's market share in rail freight segment stands around 64%.

Its key triggers for growth would be double stacking and opening up of DFCs or direct freight corridors that will encourage growth of containerised traffic in India that is currently below the global. Such investments would reduce the traffic time and will allow better predictability of transit times that will encourage the shift of freight movement from road to rail. The revenue growth guidance for the company is 10%-12%.

The government of India has 54.8% stake in the company, and it wants to offload 30.8% stake. The privatisation of the company is a key catalyst to watch out for.

Now the unfolding in the railway infra can have some multiplier effects on logistics, and commodity prices like that of steel. So, stay alert for other potential opportunities.

Please note that today's discussion does not imply any view on the stock. With this disclaimer, I have come to the end of the video. Do share your feedback and press the like button if you found it useful. For more such video alerts in future, subscribe to Equitymaster Youtube channel.

Thank you for watching. Goodbye.

Richa Agarwal

Richa Agarwal (Research Analyst), Managing Editor, Hidden Treasure has over 7 years of experience as an equity research analyst. She routinely scours the small cap universe for fundamentally strong companies trading at attractive prices. Having degrees in both finance as well as engineering has served her well in analysing business models across the small cap space.

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2 Responses to "Stocks That Could Ride the Railway Capex Cycle"

prabhakar harkal

Jan 29, 2024

Nice railway stocks

Like 

Murali

Nov 5, 2023

I think developing country like there is huge opportunity in infra sector focused of railways

Like 
  
Equitymaster requests your view! Post a comment on "Stocks That Could Ride the Railway Capex Cycle". Click here!