“India has always been a story of two step forward, one step backward. For whatever reasons, something or other holds us back in terms of acceleration of growth. So that is the biggest challenge that we see when it comes to infrastructure businesses,” says Sachin Shah, Portfolio Manager, Emkay Investment Manager.

In terms of your top holdings, you own a lot of capex companies; ABB and various other MNCs. Is that the best way to play the capex? How are you looking at capex coming up after 15-20 years?

Capex is overdue for at least seven, eight years if not longer. But what we are seeing is that the overall manufacturing sector seems to be coming into full throttle. Today, the kind of cash flow generation that we are seeing is giving a lot of confidence to these companies to go ahead and do a lot of brownfield and greenfield capex. We think that is already underway.

Is this going to further accelerate over the next two to three years because there are at least six or seven industries where India is also going to benefit big time because of the global alternate supply chain that we have seen because of the challenges in the geopolitical environment over the last two, three years?

There is export demand in spite of the global economy probably slowing down. The export demand in some of these industries like auto ancillaries, chemicals, pharmaceuticals, engineering, electronics manufacturing, textiles across the board are going to benefit a lot. Plus, the domestic demand continues to remain vibrant. So capex from some of these companies will continue over the next two, three, four years even in a further accelerated fashion.

There is an interesting saying about capital goods companies. When they tend to deliver earnings, nobody can match their estimates; they tend to see only upgrades. Do you believe we are in an earnings upgrade cycle for some of these capex heavy names?

Absolutely, we are very clear that in the next three to five years, earnings growth will probably be much higher than a lot of estimates are there as of today. Nevertheless, markets are already discounting their valuation ratios.

Today they may look very expensive but as and when the earnings come, they may look reasonable or marginally expensive. Markets are discounting at least 40-50% of that. The balance 40-50% is a function of how things evolve because whether we like it or not, India has always been a two step forward, one step backwards story. It is just a question of how things evolve over the next six to 12 months.

In terms of how things are moving as far as infrastructure is concerned, one part is capex and one part is cement. Do you think infrastructure is something where you will see better numbers coming in with a lag effect?

It is very rational to think like that and infrastructure should also pick up quite well. The only challenge with infrastructure has been the cash flow generation. They generally tend to have very good order books, they also tend to execute their order books over a period of time; but as minority shareholders, when we try to figure out what is their cash flow generation, how is it actually culminating into higher ROCEs, ROEs with most of the companies, we tend to face some challenges.

In the previous cycle, infra companies or capital goods companies were very aggressive bidders. We saw new players coming in bidding for new projects quite aggressively. A lot of existing companies had debt and receivable issues. All these issues have been sorted out over the last 15 years and a fresh round of bidding is coming. Is that why it is rational?

Well there is some rationality because a lot of these companies have burnt their fingers in the past by being aggressive. So there is no second thought on that. There is much more rational bidding at this point in time and that is the good part. But when it comes to thse large infrastructure projects, execution is a very critical thing and a delay of a few quarters can put a lot of things on the backburner. That is why I say that India has always been a story of two step forward, one step backward. For whatever reasons, something or other holds us back in terms of acceleration of growth. So that is the biggest challenge that we see when it comes to infrastructure businesses.

How would you look at the auto sector?

Auto this year is definitely going to do better. In most of the segments, be it passenger vehicles, commercial vehicles or two-wheelers across the board, we are seeing growth. Not only that, in some of the segments like passenger vehicles, we will probably see all-time high numbers and cross 4 million which is an all-time high for India. Over the last seven-eight years, the growth has not been very great, it has probably been single digits. So it comes to the same point where India is a two step forward, one step backward story.
But I think the other good thing about at this point of time is that within the auto ancillary space today the global supply chains are really looking at Indian companies and that is a very big opportunity that we are seeing and in fact this has been an opportunity for a while.

When we talk to a lot of portfolio companies, the sense that we get is that this opportunity is today culminating into a hard core order book. It is just a question of two or three quarters and we will see some significant amount of top line growth for some of these auto ancillary companies, even on the domestic side. The way the income levels are rising, clearly this trend should continue for at least next two to three years.