Many experts gave buy calls in the beginning of 2012 and 2013 on the infra sector, as a contrarian play, as a deep value play. The sector remained truly contrarian - nobody bought into it, and as a result, its become even deeper value as we begin 2014. Srinivas believes that valuation differentials between deep cyclicals and defensives - which are now at levels last seen in Dec 2003 and Dec 2008 - offer a compelling case for mean reversion. Adding weight to the mean reversion case is the view that as the economy gradually moves into a higher growth trajectory, things can only get better for this battered down sector, which is just too crucial to ignore forever. Read on to understand why Srinivas believes that the infrastructure sector and his Infrastructure Fund offer an attractive opportunity to play the Indian economic recovery story.

WF : Several experts had suggested investing into the infra theme in the beginning of 2012 and then again in the beginning of 2013, as a contrarian play on a beaten down sector. These calls on both occasions however did not work out as the infra pack continued to drift lower. What are some of the factors that give you the confidence that this sector has bottomed out now and that this is indeed a good time to invest in the infra theme?

Srinivas : You are right in saying Infra sector as a contrarian play did not work out in 2012 and 2013. Essentially, no one expected things turning out to be challenging for economy (below 5% GDP growth) in general and infrastructure sector in particular. Since Jan 08, CNX Infrastructure Index is down by ~60%, BSE S&P SENSEX is almost flat, CNX 500 is down ~10% and CNX Consumption Index is up by ~36% (refer chart below)

Even though, BSE S&P SENSEX is almost flat (~ 20,000), the market is highly polarized (refer table below)

Averages hide more than they reveal. These very reasons make us confident that it would be good time to invest in Infra Fund with a 2-3 year view.

As for Indian economy, broadly there are two issues - 1) Economy suffered as both current account and fiscal situation worsened 2) capital spending has taken a massive hit as projects under construction/completed are facing challenges to be viable. In the last twelve months, government took many actions and initiatives to address these challenges and we have already started seeing benefits of the same. This along with attractive valuations of the sector would lead to good returns from Infra.

WF : Skeptics argue that a leader of the previous bull market rarely leads the next one. In this context, is the investment argument for the infra sector more a call on a bounce back / mean reversion or a call on the sector becoming a market favourite again?

Srinivas : I am not saying that Infra would be the next favourite sector of the market and neither I am building that in as an assumption while recommending this fund. However, today it is a beaten down sector and trading at significant discount to defensive sector. Please refer the chart below

As can be observed from past data, it is only a matter of time before this changes. I am not betting that Infra would trade at premium to defensives. But current earnings of infra and infra related companies are low due to weak macro and high interest rates. These companies are also trading at low P/E. Tomorrow, when macro environment improves and interest rates fall we could see strong earnings growth and also P/E re-rating.

WF : You have made a valid point that the new land acquisition laws make it difficult to set up large new projects, which should benefit the current players. But, would this also limit growth and expansion of the existing players in the long term?

Srinivas : We are essentially highlighting a point that companies that created/commissioned new assets would derive better value for their projects as new projects would be expensive for variety of reasons including rupee depreciation, inflation and land acquisition issues.

WF : Some experts believe that as the world slowly moves to an era of lower liquidity and higher interest rates, capital intensive businesses may not be the best investment opportunities. Is this equally applicable for India or do you think our interest rate cycle does not warrant these concerns?

Srinivas : There is no need to debate on need for better Infrastructure in a country like ours. Demand is huge, unfortunately government does not have funds to do it on its own and they need pvt sector investment. Private sector would invest only when they can make reasonable returns and right policy frame work is in place.

WF : You have identified three segments within the infra pack : asset financiers, asset creators and asset owners. Which segment offer the best value and growth opportunities in your view now?

Srinivas : Being convinced that Infrastructure would do well in the country, we want to participate in this growth story through three broad categories - asset financiers, creators and owners. Though risk-reward and underlying business dynamics are different in each category, at this point of time we find value in all three categories. We follow bottom-up approach for stock picking in this fund also. There are too many variables in each company and each category, so final decision to add a stock is based on merit of individual stock and not based on category. At the end of December 2013, we have about 33% of AUM in asset financiers,34% in asset creators and about 26% in asset owners.

WF : How is business momentum among the companies you speak with in this space? Are you seeing evidence of order momentum picking up? Is pricing now at sensible levels? Are execution challenges now behind us or are they still a worry?

Srinivas : On ground, things remain challenging. Infra companies continue to face challenges on account of a) fewer orders 2) increased competition 3) execution challenges. However there is a definite improvement on pricing front in many areas as competition became weak due to funding challenges. Companies with better balance sheets would benefit from this.

WF : What is your view on earnings momentum for this segment? Are we likely to see earnings upticks in the coming quarters or is there still a few quarters to go before we see earnings momentum in the infra sector?

Srinivas : Overall earnings performance is going to be mixed in the near term. However companies that are better managed would show better performance. Essentially, current slowdown is going to separate men from boys in the sector.

DISCLAIMER: The views expressed by Mr. Srinivas Ravuri, Fund Manager - HDFC Infrastructure Fund, constitute his views as of January 29, 2014. The views are based on internal data, publicly available information and other sources believed to be reliable. Any calculations made are approximations, meant as guidelines only, which you must confirm before relying on them. The information contained in this document is for general purposes only. The document is given in summary form and does not purport to be complete. The document does not have regard to specific investment objectives, financial situation and the particular needs of any specific person who may receive this document. The information/ data herein alone are not sufficient and should not be used for the development or implementation of an investment strategy. The statements contained herein are based on the current views and involve known and unknown risks and uncertainties that could cause actual results, performance or events to differ materially from those expressed or implied in such statements. Past performance may or may not be sustained in future. Neither HDFC AMC and HDFC Mutual Fund (the Fund) nor any person connected with them, accepts any liability arising from the use of this document. The recipient(s) before acting on any information herein should make his/her/their own investigation and seek appropriate professional advice and shall alone be fully responsible / liable for any decision taken on the basis of information contained herein.

MUTUAL FUND INVESTMENTS ARE SUBJECT TO MARKET RISKS, READ ALL SCHEME RELATED DOCUMENTS CAREFULLY.

Share this article