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Is it Time to Buy Infra and Capital Goods Stocks?

Feb 2, 2022

Is it Time to Buy Infra and Capital Goods Stocks?

Recently, I spoke to a friend whose uncle is a bureaucrat at North Block i.e. the finance ministry.

The analyst in me was hoping my friend would give me a flavour of the mood in the finance ministry. I asked him the question which every investor worries about ahead of the budget... 'Is there going to be an increase in long term capital gain tax'?

He looked at me and cracked a joke. In the stock market at the start of every year, two things never change.

  1. Rakesh Jhunjhunwala telling you we are in the Mother of all Bull Markets
  2. Jim Rogers telling you the bubble is about to burst

Why not add this question every year.

  1. Is there going to be an increase in capital gains tax this year?

Well, now I guess we have 3 things which never change every year. At times we stock market people really consider ourselves to be very important.

'What are your budget expectations'? - is one of the most irrelevant questions typically asked a week before the Union Budget.

I find it funny when analysts and so called 'market experts' come on television to suggest what the finance minister India should be doing!

It's like Sachin Tendulkar taking batting advice from all the spectators in a cricket stadium.

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What to expect from the budget is not important. But the implications and opportunities which emerge post budget is very important.

So just like most of you, at 11am sharp, I was glued to the television yesterday with a pen and paper.

These days the love for tech, platforms, new age IPOs is the talk of the town.

The finance minister used 'digital/online' 28 times in her speech.

However, it was used primarily to address the crypto currency taxation issue.

On the other hand, the old economy represented by the word Infrastructure was used 27 times in the budget speech. Almost at par with the new found digital love.

My regular readers would know I have a cautious stance on the newly listed IPOs and I'm averse to investing in loss making companies.

So let me make calculated guesstimates on certain sectors and subsectors which are likely to benefit from the budget.

The budget is just a one day sentimental event for the stock market. In the end, stocks are slaves to earnings. The endeavour is to read between the lines about the government's intent on boosting certain sectors.

For starters, the key takeaway is that the government is ready for the next level of growth even if it means if it comes at the price of inflation.

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When you talk of a 9.2% GDP growth for FY22 and an 8.5% growth for FY23, corporate earnings are likely to grow at 12-13%.

This is strong growth by any measure. This level of growth can come only from capital and infrastructure spending.

Every budget has given us a theme. Be it a new announcement or allocating additional funds to an ongoing central government schemes.

This budget was no different.

To name a few..

The 'Nal se Jal' scheme in 2019 which gave a boost to the entire pipes sector and the supply chain required to manufacture pipes kept getting sizeable allocation every year. Yesterday's budget had an allocation of Rs 600 bn for it.

The Pradhan Mantri Ujwala Yojna launched in 2016 has been a beneficiary of increased allocation every year. This has immensely benefited gas distribution companies and the supply chains which involve companies making cylinders, steel pipes, and fittings.

I believe it is very clear the thrust is on reviving private sector capex.

Outlay for capital expenditure was raised by 35% from Rs 5.5 trillion to Rs 7.5 trillion. Out of the Rs 7.5 trillion capex, 25% is for roads and highways while defence will get 21%.

What does this mean for the markets?

To put it simply, the 2003-2008 period for capital goods and infrastructure is ahead of us.

If the last couple of years was about public capex done by the government, the next couple of years are likely to be led by private capex.

Now I acknowledge, all of us have a problem with the quality of infrastructure companies.

However, if we go deep and filter out companies which have reduced debt and promoter pledging, and have decent corporate governance, the reward can be worth the risk.

Also, you can play the private capex cycle indirectly by investing in steel and cement companies.

Think of the additional cement and steel required to build roads, highways, hospitals, and buildings.

These companies are much cleaner than infrastructure companies and have no issues on corporate governance.

Also, the margin of safety in terms of valuations is much higher compared to the loss making tech platforms which has become a fad these days.

When growth picks up, these companies will re-rate in terms of valuations.

The BSE Capital goods index made an all-time high of 20,000 in 2008 and currently is still at 29,900.

That's a CAGR of 3.5% over 13 years.

While the tide will be towards tech stocks and new age IPOs, I believe companies in the infrastructure, capital goods should be looked at.

Also don't forget, if capex has to pick up, funding is required. The shift has already started to happen from retail focussed banks to corporate banks.

A proxy play to capex are corporate facing banks. These are banks who have a higher share in corporate lending and are not focused on retail customers.

All in all, I believe the time to invest in infra and capital goods stocks has come.

Happy investing!

Warm regards,

Aditya Vora
Research Analyst, Hidden Treasure

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