What does infrastructure means: Infrastructure is the general term for basic physical systems of a business, region, or nation; for instance, transportation systems, communication networks, sewage, water, and electric systems are examples of infrastructure. These systems tend to be capital intensive (capex) and high-cost investments and are vital to a country’s functioning, economic development, and prosperity. Projects related to infrastructure improvements may be funded publicly, privately, or through public-private partnerships. In economic terms infrastructure often involves the production of public goods. It is very typical to see public financing, control, supervision, or regulation of infrastructure either wholly or to a certain extent
Soft Infrastructure: This type of infrastructure usually ensures smooth functioning and is less capital intensive and driven more by servicing through human capital. Example: the healthcare system, financial institutions, governmental systems, law enforcement, and education systems.
Hard Infrastructure: These form the physical systems that enable entities to run a modern, industrialized nation. Examples include roads, highways, bridges, as well as the capital and assets needed to make them operational and functional.
Critical Infrastructure: As the name suggests, this infrastructure is crucial for the economy to function which includes facilities such as energy, electricity, telecommunication, public health, and agriculture among others
Infrastructure projects are usually signed as BOT; EPC or HAM projects
BOT (Build-Operate-Transfer): Under BOT annuity, a developer builds a highway, operates it for a specified duration and transfers it back to the government. The government starts payment to the developer after the launch of commercial operation of the project. Payments are usually made on a six-month basis.
EPC (Engineering, Procurement and Construction): Under this model, the cost is completely borne by the government. Government invites bids for engineering knowledge from the private players. Procurement of raw material and construction costs are met by the government. The private sector’s participation is minimum and is limited to the provision of engineering expertise. A difficulty of the model is the high financial burden for the government.
HAM (Hybrid Annuity Model): In India, the HAM is a mix of BOT Annuity and EPC models. As per the design, the government will contribute a certain load of the expenses of the project for a specific period through annual payouts (annuity) while the remaining payment will be made on the basis of the assets created and the performance of the developer. There is no toll right for the developer. Under HAM, Revenue collection would be the responsibility of the government or government assigned entity
Future of Infrastructure Sector
In the Union Budget of 2021, the Government has clearly prioritised infrastructure development and has accordingly given a massive push to the infrastructure sector by allocating in excess of INR 5,54,000 crore towards the capital expenditure of various infrastructure across the country. Of this, the govt has committed about INR 1,97,000 crore under various Product-Linked Incentive (PLI) schemes over the next 5 years starting in FY 2021-22. The National Infrastructure Pipeline (NIP) which was announced in December 2019 is the first-of-its-kind, whole-of-government exercise ever undertaken by the Govt. The NIP was launched with 6,835 projects; the project pipeline has now expanded to 7,400 projects. Around 217 projects worth ₹1,10,000 crore under some key infrastructure Ministries have been completed
To assist with the financing of the infrastructure projects, the FM also proposed the setting up of a Development Financial Institution (DFI) and a sum of INR 20,000 crore has been earmarked for the same with the aim of increasing the capital to about INR 5,00,000 crore in three-years’ time
Private sector is emerging as a key player across various infrastructure segments, ranging from roads and communications to power and airports. Private investment into physical and social infrastructure is key to putting India in a high growth trajectory, driving towards achieving the US$5 trillion goal by 2025. The core infrastructure industries include coal, crude oil, natural gas, refinery products, fertilizers, steel, cement and electricity
Infrastructure opportunities
Highway: Highway construction in India increased at a CAGR of 21.44% between FY16-FY19. In FY19, 10,855 km of highways were constructed. The Government of India aims to construct 65,000 km of national highways by 2022. In the union budget of 2021, the govt proposed a 3,500 km of National Highway works in the state of Tamil Nadu at an investment of INR 1,03,000 crore; 1,100 km of National Highway works in the State of Kerala at an investment of INR 65,000 crore; 675 km of highway works in the state of West Bengal at a cost of INR 25,000 crore and National Highway works of around INR 19,000 crore are currently in progress in the State of Assam. Further works of more than INR 34,000 crore covering more than 1300 kms of National Highways will be undertaken in the State in the coming three years. The FM is also providing an enhanced outlay of ₹1,18,101 crore for Ministry of Road Transport and Highways, of which ₹1,08,230 crore is for capital, the highest ever
Rail: Indian Railways will require investment of ₹3 trillion (US$545.26 billion) by 2032 for capacity addition and modernization. The capital expenditure in the sector is expected to increase by 92 per cent annually thereby requiring the capital goods to carry out the same. About 10 Indian cities are currently working on metro railway projects and the Government initiated a plan in 2012 to study the feasibility of such networks in all cities with a population of over 2 million. The project size is over ₹500 billion across the 22 different cities the project is being carried out in.
Power: India currently has power capacities of over 370 GW (Gigawatts) installed coming from Thermal, Renewables, Hydro and Nuclear sources producing over 1,250 BU (Billion Units) as of FY20. The Indian energy sector is expected to offer investment opportunities worth US$300 billion over the next 10 years.
Logistics and Warehousing: The segment plays a fundamental part in business infrastructure and is one of the key enablers in the global supply chain and trade. By 2022, the market size of the logistics sector is expected to reach US$215 billion vs US$160 billion for 2017. Investment in the sector is expected to reach US$500 billion annually by 2025 while warehousing in India is expected to get investment of over ₹50,000 crore in India, providing significant development opportunities and revenue streams in the future
Airports: The Airport Authority of India has worked on over 23 airports over the past 5 years, engaged in the development or upgradation of the same. With airports, other air-based logistics and other facilities also get developed which provide for additional revenue streams.
Factors to consider when assessing investments in the sector
Assess the debt levels if any held with these companies as infrastructure development is highly capital intensive and requires constant capital infusion from time to time. Investors can assess the same using ratios such as debt-equity and debt to EBITDA to determine the debt level and the company’s ability to service the same.
Infrastructure companies are mostly engaged in the construction or development of some project and therefore it is critical to assess their order book or deal pipeline to gauge revenue visibility as well as cash flows for the company.
Assess the regulation around the projects as many projects are either partially controlled by the government or are under strict regulations from the government. A flexible regulatory structure is better as it gives companies more breathing room around managing the project and its finances.
Assess the rate of execution the company has for projects which can give an idea on the operational efficiency the company has. The better the execution ability, the greater number of projects the company can take up for timely completion to grow further.
Assess the return ratios of the company such as the operating profit margins, and return on capital employed (ROCE). Also assess the order book/revenue ratio to determine the size of order book and the revenue visibility it provides. The higher this ratio is, the better but only if the company is capable enough to fulfil obligations.
Real Estate
Real estate is a tangible asset and a type of real property. Real property examples include land, buildings, farmland, and mineral deposits among others plus the rights of use of that land and all its improvements. The owners of real estate earn either through capital appreciation of the real estate and/or the rental income collected from the real estate.
The types of Real Estate are as follows:
Residential: Residential real estate includes undeveloped land, houses, apartments, bungalows and townhouses. The structures may be single-family or multi-family dwellings and may be owner-occupied or rental properties.
Commercial: Commercial real estate includes non residential structures such as office buildings, business parks, warehouses, and retail buildings of multiple formats and sizes. These buildings may be free-standing or, in the case of shops, in shopping malls.
Industrial: Industrial real estate includes factories, manufacturing facilities, power plants, mines, and farms among others. These properties are usually larger in size and locations may have access to transportation hubs such as rail lines, ports, aerodromes and harbors for effective logistics management.
There are differences between the residential and commercial & industrial real estate properties. The residential real estate is usually less expensive and smaller than commercial/industrial real estate, and so it is more affordable for the small investor. On the other hand, commercial real estate is often more valuable per square foot, and its leases are longer, which ensures a more predictable income stream over the longer term. But, commercial rental real estate is more heavily regulated than residential real estate, and these regulations can differ from country to country. Even within cities, zoning regulations add a layer of unwanted complexity to commercial real estate properties.
Along with listed companies in real estate, there are also REITs in which investors can invest. A real estate investment trust (REIT) is a company that owns, operates, or finances income-generating real estate. Modeled after mutual funds, REITs pool the capital of numerous investors. This makes it possible for individual investors to earn dividends and income from real estate investments, without the need to buy, manage, or finance any properties themselves. Properties in a REIT portfolio may include apartments, commercial office spaces, data centers, healthcare facilities, hotels, infrastructure (in the form of fiber cables, cell towers, and energy pipelines), retail centers, self-storage, timberland, and warehouses. In general, REITs specialize in a specific real estate sector. However, diversified and specialty REITs may hold different types of properties in their portfolios, such as REITs which consist of both office and retail properties.
The primary difference between real estate company and REIT is that when an investor buys shares of the real estate company, the investor buys a part of that company while in a REIT an investor buys a unit of professionally managed real estate property.
The Indian real estate sector is expected to reach US$1 trillion by 2030 and is expected to contribute to about 13% of the GDP by 2025. The urbanization of the country helps India in growth with the number of Indians living in urban areas is expected to reach 525 million by 2025. More than 70% of India’s GDP is expected to be generated from urban areas by 2020. The construction sector is also the 4th largest in terms of FDI inflows in the country. The Housing for All initiative by the government is expected to bring about US$1.3 trillion investment in the housing sector by 2025 giving large growth opportunities. Currently, the real estate space has been witnessing a lot of traction as prices are on a rise with an increase in inflation.
Factors to consider when investing in the real estate sector:
Investors need to assess the type of real estate the company is developing. Commercial real estate depends on large contracts from companies to set up offices but provide consistent cash flow in the form of rentals. The residential projects on the other hand mostly entails selling property to owners and realize large size gains and move onto the development of the next project. A mix of these two is usually good as it provides some level or recurring income and property sale realizations along with diversification of revenue streams.
Assess the location of the development. For commercial and industrial real estate, a preferred location is in a commercial district with good transport connectivity for logistics purposes, especially for industrial real estate. Residential real estate should be located in areas with amenities being available along with other recreational and critical facilities such as schools, shopping areas, hospitals and others around the location.
Assess the debt levels of the real estate developer along with the real estate being developed. This is critical since projects are capital intensive and need to generate enough cash flows to service debt and generate returns for equity holders. Since real estate projects are long term the debt terms are important to understand.
Assess the regulations around the real estate for the given location where the development is taking place. Based on the regulations, the profitability and efficiency of the project can be determined. Also, assess the real estate market overall, which moves in long term cycles, so as to determine the kind of value the developer can realize from the property given the market conditions
Assess the return ratios such as ROCE and ROE to determine the return the company generates from the projects it develops. Also assess metrics such as realization per square foot to determine the revenue generated from sale of every unit of area.
Portfolio Companies
Larsen & Toubro
Larsen & Toubro is engaged in the business of providing technology, engineering, construction, manufacturing and financial services solutions across the world. The company primarily undertakes EPC projects for construction of large infrastructure, power plants, hydrocarbon, defense engineering and heavy machinery. The company has maintained a strong order book and a healthy order book/revenue ratio gives it a revenue visibility of over 2-3 years. The company has been well managed to generate consistent cash flows and maintain a strong balance sheet.
Along with this, the company has branched out into IT, IT ER&D and financial services through its multiple companies and have managed to maintain a strong balance sheet while growing at strong pace in their respective segments. This further adds value to the parent company while diversifying across high growth sectors.
On financials, the company maintains a strong order book (India & Overseas) of ₹327,354 crore which grew by 4% despite the difficult environment due to COVID-19. Out of this, about 55% comes from the infrastructure projects. The OB/Revenue ratio stands at 2.4x on a consolidated level while over 3x on a standalone basis, which is higher than peers (average range of 1.3-1.5x) providing a strong revenue visibility for the company. The company generated a ROE of 18.5% in FY21 which is better than most peers in the industry. The company generated a strong operating cash flow of ₹22,844 crore in FY21 as compared to ₹6,694 crore in FY20.
Dilip Buildcon
Dilip Buildcon is engaged in the business of developing infrastructure facilities on engineering procurement and construction (EPC) basis. The company is primarily engaged in building roads pan-India and is among the industry leaders in the segment, the company is also engaged in other projects entailing irrigation, water, railways and ports. The company has seen stellar growth of 31.6% in revenues over the last 5 years on the back of strong deal wins and operational excellence.
The company has delivered strong operational performance while maintaining a strong order book of ₹27,411 crore (51.75% orders for road projects) as of FY21 and an OB/revenue ratio of 2.97x, giving strong revenue visibility going ahead. The company serves across the country and has no concentrated contracts to a specific state, thereby having a well-diversified order book. The company delivered an average ROE of 17% over the past 5 years while Net Profit CAGR of about 2% for the same period as the profitability took a hit due to COVID-19.
Adani Ports & SEZ
Adani Ports & SEZ is engaged in the business of development, operations and maintenance of port infrastructure (port services and related infrastructure development) and has linked multi product Special Economic Zone (SEZ) and related infrastructure to their flagship Mundra Port. The company operates 9 ports across the country among which their flagship is the Mundra Port, which is the largest in India. The total capacity of all the ports stands at 498 million tonnes; The company handled more than 5.6 million TEUs in FY21. The company aims to build its warehousing capacity to 30 million sq. ft. over the next 5 years. The Mundra Port also has an SEZ close to it which is operated by the company.
On financials, the company maintains strong operating margins at 64% for FY21. The company has a net debt position of ₹28,635 crore, which gives a Net debt to EBITDA ratio of 3.3x. The company has also delivered ROCE of 14.3% for FY21. On valuations, the stock trades at a P/E ratio of 30.4x. Despite the recent run up in Adani group stocks, Adani Ports continues to remain fairly valued. The company has also delivered strong cash flows with OCF growing on a YoY basis and currently ₹7,556 crore, resulting in an OCF/NI ratio of 1.51x hence, the company is considered as cash cow of the Adani Group.
Oberoi Realty
Oberoi Realty is engaged in real estate development and has developed residential, commercial and hospitality real estate, being predominantly located in Mumbai. The company operates multiple commercial real estate buildings which operate on lease basis while also having a hotel and mall in the portfolio. The company currently has over 27 million sq ft of area under construction which includes a mix of residential and commercial real estate. The company serves the premium housing segment of the market and has accordingly been able to generate strong results with low debt levels.
On financials, the company has a debt to equity ratio of just 0.16x, which is very low as compared to peers and was successfully achieved as per the company’s plans to reduce their debt exposure. The company has generated a ROE of 8.2% and ROCE of 9.5% for FY21. The company is characterized for its operational efficiency and is witnessed by its operating margins which are at 49% for FY21. On valuations, the stock currently trades at 30.1x P/E ratio which indicates the stock is fairly valued.
G. Infra Engineering
G. Infra Engineering is engaged in the construction of infrastructure projects like highways, roads and bridges. Over the years, the Company has evolved into one of the leading road infrastructure development companies in India. The company has mostly been engaged in projects across North and West India, with some contracts in the East as well. The company derives about 25% of its revenues from sub-contracting. The project mix is 76% EPC projects and 24% HAM projects as of FY20, with focus on growing HAM projects to tap into growth opportunities.
On the financials, the company has a strong order book at INR 7,040 crore with an OB/revenue ratio of 2.7x, which is much higher than peers and provides a strong revenue visibility for the company. The company has also been focusing on reducing debt and currently has a debt to equity ratio of 0.65x which can be easily serviced by the company’s operating profits with operating profit margins at 18% for FY21. The company generated a ROE of 25.1% for FY21. The stock trades at a P/E ratio of 9.97x only, which indicates that the company is priced attractively and can offer great upside for long term investors
