Infra valuations have hit rock bottom, will bounce back henceforth

As reports say that FY2012 was the year when project completion was its highest ever, is the spiral of low confidence-locked funds-low valuations-slow completion finally a thing of the past? Sanjay Sachdev, President and CEO, Tata Asset Management explains to Shashidhar Nanjundaiah from a fund manager’s perspective what factors have been responsible for the infrastructure sectors’ swinging fortunes over the past three years, and projects a high-growth trajectory starting now.

Clearly your Tata Infrastructure Fund (TIF) has really worked for you and that has kind of gained the confidence that you want to see in investors.
Each country needs to develop its asset class on its own and can’t import it. Tata Infrastructure fund, laun­ched in November 2004 was India’s first dedicated infra­structure fund.

In November 2004, when we launched the first dedicated Infrastructure Fund. Infrastructure has been one of the most neglected areas in this country for the last 30-40 years, so we have been behind the curve, be­hind poorer countries that did not have any infra­structure in the 1960s and have now overtaken us. Since 2002-03, there has been a new found awareness and there has been responsible thinking in the government circles. We launched that fund in that context and we were right on the button.

As a first mover in this how did you plan this?
At that time, we had the ability to sense the expectations of investors. Investors will always want to be a part of the future of the country, and the fund caught the fascination of investors, delivering subst­antive returns from 2004-2009. Since the post-
February 2009 slowdown, we have probably seen the worst of the infrastructure in terms of valuation and a debacle and the direction of infrastructure category in this country.

The Tata Indoglobal Infrastructure Fund (TIIF) and Tata Growing Economies Infra Fund (TGEIF) (Plan A & B) have given negative returns since their inception. What are the reasons?
The schemes were launched in October 2007 and February 2008, when sentiment and markets across the world were steadily rising. The subsequent finan­cial market meltdown followed by liquidity crisis had an adverse effect on infrastructure stocks leading to the under­performance of the entire infra­structure sector. While we understand that this period has tested the patience of investors, our views are based on sound fundamental research carried out by our research team. On the other hand, some global events that go beyond everyone’s expectations, are termed as “market risk”.

The TIF and your other infra funds have large exposures ranging from 10 per cent to 17 per cent to the banking sector, that too in two large private sector banks, ICICI Bank and HDFC Bank. What is the rationale behind for an infra fund taking such large exposures to two banks?
Banking sector is the lifeline of any economic acti­vity. Infrastructure projects by its very nature are highly capital intensive and they require funding at all stages of their activity namely, project finance, working capital requirements etc. We therefore believe a sound banking system, satisfying both, long-term as well as short-term infrastructure financing needs, is one of the important pre-requisites for success of the sector.

How are you planning to align with the 12th Plan based on your experience in funds?
Unfortunately, in the last two years the government has not done much to encourage infrastructure sector, whether through tax breaks or by creating vehicles or mechanisms for better funding. Reserve Bank of India (RBI) has raised rates. As the cost of capital has gone up, the old contracts calculated at certain margins and certain calculations are affected, impacting the valua­tions of those companies. Many of these companies, which enjoyed high valuations earlier, have lost almost 70-90 per cent of their valuation. So now we are setting a scenario in April 2012, three years later after 2009 the debacle—2009-10, 2010-11 and 2011-12 (probably the worst year). Three years later, we are now setting a scenario where the last three years are not reflective of the coming three.

So the worst is over?
In our opinion the worst is definitely over. But how far we can come out of it and how fast is what is at debate.

What would the recovery hinge on?
One is the directional move of the rate cycle. That is clearly on its way down. At least it has stabilised. The RBI has stated that they will not raise rates. We hope the repo rate will come down [Editor’s note: This interview was conducted before the RBI reduced the repo rate by 50 points]. I think it is not the 25 points, but the trend that will create a much more larger sort of a confidence building mechanism …and that will have a huge impact.

You would think that somebody could have anticipated the troughs and crests of the economy before rolling up their sleeves and dirtying their hands…
There are two impacts: external and internal. You might prepare yourself by cutting costs and re-jigging operative expenses, but you cannot escape the external problems. Infrastructure companies, many of whom were also counting on their overseas operations and invest­ments, have suffered. Secondly, the rate cycle was some­thing that nobody could predict.

So they were uncontrollable?
Yes.

External Commercial Borrowings (ECBs) have been applauded for their potential contribution to infrastructure, yet they have not really formed a huge base. Why? Do you think this scepticism will change?
The problem is the opportunity. Before the 2009 crisis, borrowing from overseas was an easy way to raise resources. Today there is no market for ECBs because European companies are themselves dead in water. So for them to consider giving any lending to somebody in India and taking a risk is substantive.

Has that been your experience as well?
Yes. When we interact and talk to many companies in infrastructure, that is what we get to know. The bottom line is the companies are starved of capital today. They cannot borrow from banks because they have gone and over borrowed in some cases. They cannot do ECBs. So they are like in a rock and a hard place.

So what is the recourse there right now?
Recourse is negotiating contracts, reducing your workload, readapting.

In highways BOT, for example, companies have been suspected sometimes of going after projects where viability is not as gung ho as they predict. Premium contracts that now seem to be in fashion these days. So can you please expand on “reducing workload”?
Walking away from a contract. That’s what can you do. People have slowed down the completion of their contracts that is how they save on cost. There is no other way because NHAI has to give them money. They are saving costs by not having to hire so many people to do the job.

So slowdown on procurement and hiring, and stretch payments over longer terms?
Yes. They are slowing down delivery dates.

Has equity financing been up to the mark in our country?
There is a huge gap there. In infrastructure, the focus has mostly been on debt: Even promoters are not been very willing to look at partnerships on equity side, because the expectations on equity side are much higher, especially after investors have seen a cycle with some amazing valuations back in 2007-08.

But are we getting back up there?
Yes, although I do not know if it will come back to the 2007-08 rates. Infrastructure funds appear to be on a slow upswing in recent months. The last three months have been a lot better for the infrastructure sector because valuations are up. Perfor­mance has been an issue for the last three years only because the government has not been able to deliver. But the opportunity for investors today would be the highest in infrastructure sector for the next three years.

How about rates of return?
The returns are going to be a lot better in infra­st­ructure than many other sectors as a majority of the projects in the pipeline are now falling due for commissioning.

Since the seeds were sown three or four years ago?
Yes: Now that the [economic] carnage is over as far as the valuations are concerned. Companies have suffered very low valuations and hit rock bottom, so they can only go up from here. Stocks that used to trade at Rs 300 three years ago are running at Rs 35-40. You are getting it at 90 per cent lower valuation of what it was then. It is difficult not to make money, going forward.

How do you see the rate of growth for infrastructure?
The rate of growth for infrastructure will exceed nor­mal growth in India. So we expect between 18-20 per cent growth. We believe long-term investors clearly recognise that infrastructure funds should be part of their core portfolio as an asset allocation strategy. The expectations from the sector are also reasonably low at this point of time because of last 2-3 years of under­performance by the sector. We therefore believe that this is the sector which can surprise the long-term investors positively with some of the head winds receding like softening of interest rates, better avai­lability of funds, removal of certain bottlenecks going forward.

Which infrastructure sectors have found the best investment opportunities?
Looking at India’s current infrastructure deficit amo­ngst various sectors, the following have potential: Power, roads, airports, seaports, and educational insti­tutions. Another potential area is urban infrastructure as India’s urbanisation is likely to exceed 40 per cent by 2030. This would generate demand for infrastructure projects related to water, sewerage, public transport, low-cost housing etc.

How have you seen the evolution of some of these better managed sectors, and why are they better than the rest of them?
I think some of the regulatory departments of Gover­n­ment of India have been a little more proactive. Speci­fically NHAI can do a lot better and they are compara­tively a lot better than other departments, and the re­sults reflect that.

What are your thoughts, now that your fund is nine years old, your thoughts on the kinds of modes of delivery that our country has adopted in infrastructure?
There is more to that. You look at every aspect of infra­structure piece whether it is the Posco project or anything is all taken lot more time and effort than nece­ssary. So when government encourages investment these kinds of events can happen much faster and they can be supported and you also have issue in terms of how certain sectors are relatively better off. But it is not across the board.

Indeed, that is one of the things that I find relevant here: Do you believe we may have adopted across the board something that is not applicable across the board?
Absolutely. I totally agree with you and that is where the issue is.

Can you give me an example of that? For example, something that will apply for roads will surely not apply for waste water management in a city.
Or even power. Whether it is transmission or dis­tribution across the board, there are lots of issues. So power projects are all stuck up. Policy I would say clarity in terms of policy as far as execution is concerned is an area of concern for us as a nation which is where a lot more can be done.