What the Budget means for investors

Power, fertilisers and commercial vehicle manufacturing are sectors which could give high returns

This column has been modified. Please see the clarification at the end. 

Power, fertilisers and commercial vehicle (CV) manufacturing are three areas of potential investor opportunity in this Budget. In each case, there is an element of faith involved in expecting higher returns.

Taking sectors in alphabetical order, CVs have not done very well in terms of unit sales over the past two-three years. Tata Steel has struggled with falling profits, while Ashok Leyland seems to have registered a turnaround quite recently. However, if GDP growth is accelerating, CVs are likely to see a pickup in demand in the coming financial year. The stock market was already anticipating this pre-Budget and the shareprices of CV manufacturers have been bid up. In fact, there was a correction because optimists were expecting a lot for the auto sector in the Budget.

The Budget does add one layer of protection for CV manufacturers because it enhances the customs duty on imports.  The effective customs duty goes up to 20 per cent from 10 per cent for complete vehicles (the official duty rises to 40 per cent). The duty stays at 10 per cent for completely knocked down kits which are assembled in India.

In practice, industry experts say there are very few CV imports and those are extremely high-end (Mercedes trucks). However, although the tariff protection may not be necessary, it will ensure rising CV sales will benefit local CV manufacturers. If growth improves, the sector must gain.

Fertilisers have seen bumper profits this year. The reasons are fairly simple. The feedstock is crude and natural-gas based. The sector has seen large cost savings due to fall in crude prices (even after adjusting for inventory). There is a large government subsidy for urea. Prices are controlled and the entire process of subsidy is complex and cumbersome. A lot of expectations hinged on urea price decontrol that would have been beneficial for private players. But urea is one of those "politically sensitive" items and it was not decontrolled. But so long as crude prices remain low and subsidy and price are not trimmed accordingly, there are profits to be had. The subsidy has actually been raised marginally from Rs 70,000 crore to about Rs 73,000 crore.

If crude and gas prices don't climb, this financial year could see strong profit growth for Chambal Fertiliser, Tata Chemicals, Zuari Agro, etc. Tata Chemicals has seen a turnaround. Zuari could offer an interesting opportunity. There was a shutdown at the plant due to technical reasons and that would affect Q4 profitability and it may cause temporary weakness in price.    

The situation in the power sector is much more complex. Power is among the worst-affected infrastructure sectors. In general, the erstwhile state electricity boards have suffered huge accumulated losses and continue to bleed because tariffs are unrealistically low. Commercial tariffs are set high and farmers and households are heavily subsidised.

Thermal generators have struggled due to endemic coal shortages. Multiple projects are stuck due to tardy clearances, land acquisition issues, lack of coal linkage, etc. Banks and other lenders have enormous non-performing assets (NPAs) stuck in the power sector - the sector has the largest NPAs.

To the government's credit, it is trying to improve matters. Coal India has improved its efficiencies. The first round of the Supreme Court-mandated coal block auctions went well and the next round should see captive coal allocations to power producers. The government also committed in the Budget to five new plug-and-play ultra mega power plants (UMPPs). These will be delivered with all clearances and linkages to bidders. If the plug and play is indeed successful, it will be a great demonstration of political will and it will help in terms of attracting more investment to the sector.

Power has a long, capital-intensive value chain. The chain involves coal (or other fuels), generation and transmission equipment, sophisticated control systems and metering/monitoring tools, intelligent grids, etc. Plus there are the financiers, there are the power trading businesses. And down the line, there are all the power-intensive businesses (metals, cement), which desperately need reliable, reasonably-priced power. A turnaround or even hopes of a turnaround could drive a big boom across the value chain.

The fixes may be temporary. Until tariffs are realistic and reflect costs, and transmission and distribution "losses" (meaning unbilled thefts) drop, the sector cannot be rescued in a sustainable fashion. There is hope that the Centre can make some things happen and it can persuade some states to rationalise. There is excellent legislation but the provisions of The Electricity Act, 2003, have never been fully implemented.

CLARIFICATION: This article had mentioned that Volvo imports high-end buses, which is not true. This has been corrected and the error is regretted.