Infrastructure can deliver superior returns

One of the worst hit sectors in the 2008-09 recession was infrastructure. Of course, that is a huge portion of the economy. Everything except fast moving consumer goods and pharmaceuticals sectors can be classified as infrastructure. The 25-stock CNX Infrastructure index declined 67 per cent from its peak (6,260 in January 2008) to bottom (2,076 in March 2009), while the Nifty lost 64 per cent from peak to trough.

Not much difference on the downside. But, the Nifty has gained 146 per cent since March 2009, while the CNX Infra has seen a relatively muted, albeit impressive, recovery of 87 per cent.

There are fundamental reasons behind the under-performance. Activity dropped in trade and transport-related sectors. Investments via private financing, including overseas funding, vapourised. Projects awards slowed to a crawl. Election worries made governments go slow on sensitive issues like road-building. Fuel subsidy issues with risk-sharing models in model concession agreements, land acquisition issues and environmental clearance-related problems came to the fore. There were also juicy scandals like Maytas-Satyam.

Activity across infrastructure has now rebounded significantly. There have been big-ticket IPOs. There have been spectrum auctions. The process of road-project awards has rebooted. Some action has taken place on fuel subsidy. Transport activity has increased. Financing is tight, but not near-impossible.

Significant problems remain. But indications are that activity will increase in the next couple of years. Every sector has ambitious plans. Over the next five years, investments will more than double.

The chances of super-normal growth are high. There is a good chance that the CNX Infra will outperform the Nifty through 2010-2014. The sector is notoriously difficult to analyse. Plans and projects are long-term and capital-intensive. There are many risks, including unquantifiable political ones. Return projections are based on many long-term assumptions and prone to huge errors.

Still, there are several ways to try and take part in growth. One is, buy the CNX Infra index. Or, buy sector funds with decent betas and Treynor ratios with respect to the CNX Infra. If the sector beats the Nifty, this is good enough and it’s low-risk because the sector is well-diversified. Second, isolate the five best stocks in terms of appreciation and buy hoping that they will maintain their momentum. This seeks immediate returns. The third idea is a contrarian inversion of the second plan. Buy the five worst performers. This assumes the recovery will soon impact those stocks positively and cause a turnaround. It is more long term and potentially just as risky as the second idea.

The author is a technical and equity analyst