Do not see rise in capex expenditure before FY18-19: Sanjay Dongre of UTI Mutual Fund

As the capacity utilization in the Indian economy is about 74%, the capex recovery is expected to be slow and gradual and should gather steam post FY18

Thursday, June 16, 2016

Infrastructure has been one of the key areas of reforms since the time Narendra Modi took the top office. While unveiling the Setu Bharatam project, the Prime Minister noted that India is set to take a quantum leap in infrastructure and the government is committed to strengthening it. Will infrastructure be the next pocket of outperformance? Jinsy Mathew talks with Sanjay Dongre, EVP and Senior Fund Manager of UTI Mutual Fund (Fund Manager of UTI Infrastructure Fund and UTI Leadership Equity Fund) on the outlook of infrastructure sector.

What is your take on infra space which has been in spotlight over the last one year?

The spotlight is once again on infrastructure thanks to the various initiatives taken by the Government. However, there is no guarantee that infrastructure will be providing above average returns just because of the news around the sector. The important point to watch out here is how the earnings pan out. It would be a function of capex recovery in the economy.

Generally, it has been observed that infra as a theme tends to benefit the most when capex cycle revives. Therefore, given the gestation period, it would be reasonable to pencil in two to three years time to see meaningful returns being generated in this space.

Do you see the capital expenditure cycle reviving in medium term?

As on day we have enough capacity in several sectors (especially heavy industries) to meet any possible surge in global demand. Therefore, I do not see a case for any rise in capex expenditure before FY18-19.

As the capacity utilization in the Indian economy is about 74%, the capex recovery is expected to be slow and gradual and should gather steam post FY18 because of following reasons. 1.   There is a sharp increase in Government spend towards road, railways and urban infrastructure. 2.   RBI intends to bring liquidity deficit to a neutral position 3.   Infra cos. repairing balance sheet: Some of the infra companies are selling their assets and raising the equity from the market so as to deleverage their balance sheet.  This is making them creditworthy again - a critical precondition for capex recovery. 4.   Project economics changing for good. Low oil price and low commodity prices is flattening the cost curve from the projects. 5.   Conducive macro environment: Macro stability, characterized by low inflation, restrained fiscal spends and external stability would create the condition for a sustained pick-up in investment cycle.

What are pockets of opportunity in infrastructure?

Roads, railways, urban infra are the pockets of opportunity, as the spending in these areas have improved considerably.

The roads sector is witnessing a significant revival in terms of order awards as also in the pace of execution. NHAI is planning to award project totalling 15000 km in FY17 while Ministry of Road & Transport hopes to award 10000 km projects in FY17. Improvement in traffic growth on the back of recovery in economy coupled with lower interest rates may lead to higher profitability and hence higher valuations for road assets. Metro rail projects are currently under construction or are in advanced development stage in 12 cities, including Bangalore, Chennai, Jaipur, Chandigarh, Pune, Nagpur, Lucknow, Hyderabad, Mumbai, Ahmadabad, etc. The combined cost of these projects is expected to be in excess of Rs1lacs crores. Railways  has planned an ambitious investment outlay of Rs8.56 lacs crores over FY15-FY19 with major focus on network decongestion, network expansion and rolling stocks. What are the key factors that are worrisome in the near term for Indian markets?

Uncertainties in global market arising due to weakening of the global economy, downturn in commodity markets, asset quality issues in local banking space and muted capex cycle are some of the points which can play spoilsport in near term.

What reasoning would you attribute for the recent rally in Indian equity market?

Rally in the India equity market in the last three months is more attributed to improvement in the risk on global environment because of following factors.

A cyclical rebound appears to be underway in China though the GDP for the 1QCY16 is 6.7%. But evidence points to a policy-driven pick-up, supported in particular by property and infrastructure investment.  With both fiscal and monetary policy still being loosened, the Chinese economy is likely to accelerate in the months ahead.  The renminbi has appreciated against the US dollar in recent months. This has helped temper depreciation expectations and led to an easing of capital outflows from Chinese economy. This also led to stability of Asian currencies including Indian Rupee.

The Fed opted to leave its key policy rate unchanged while also lowering its projections for the pace of future rate hikes. The new "dot plot" illustrates that Fed officials expects the fed funds rate to be at 0.9% at the end of the year, down from December, when the median projection for the fed funds rate was 1.4%. That new projection now means that officials now expect two rate hikes this year, rather than four back in December 2015.

In a bold move by the ECB, the Governing Council decided to materially ease its monetary policy stance in March 2016.  First, the ECB announced a cut in all the policy rates. Second, the monthly purchases under the asset purchase programme were expanded from EUR60bn to EUR80bn. Third, non-bank euro denominated bonds will be included in the list of assets eligible for regular purchases. ECB seems to be using all the levers at its disposal to fight the deteriorating inflation outlook on account of weak oil prices and currency appreciation.

Do you think the worst is over in terms of earnings?

Central Government's spending thrust continues in roads, railways and rural development sectors. Pay Commission impact may play out in FY17 and FY18. State govt are allocating higher allocations towards urban spend, water, rural, agri, irrigation related sectors. Good improvement was observed in the high frequency indicators such as cement production, retail credit, Electricity consumption and petroleum product consumption. It shows that the improvement in the GDP in FY17 is likely to be led by the consumption sector. Govt policies and better than normal monsoon may lead to recovery in the rural economy.

Worst in terms of earnings seems to be over.  March quarter of FY16 results saw more beats to estimates than misses to estimates.  FY17 & FY18 earnings upgrade cycle seems to have started especially in domestic cyclical sectors.  Earnings growth is expected to 15% plus in FY17 as higher expenditure by the government coupled with lower interest rates may lead to higher GDP growth in the economy. Substantial growth in the earnings is likely to be witnessed in the cyclical sectors which are direct beneficiaries of the domestic recovery.  FY17 would also see some impact of softened raw material prices and full impact of lower interest rates, resulting on improvement in margin and aiding growth in the earnings.

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