Next pot of Gold!

www.carneliancapital.co.in

Team Carnelian

2 hours ago

6 min read

Time and again, we have been highlighting several structural opportunities

and emerging trends through our newsletters (link). We well understand
the second order impact of these and are big believers of the significant
wealth creation opportunities these will offer. This helps us in identifying
opportunities which are otherwise a bit difficult to get hold off.

To sum it, there are two big trends in making as we see - the Manufacturing
Shift and Infrastructure Spending. India is expected to double its
manufacturing GDP to USD 1tn by 2026 and simultaneously spend heavily
on infrastructure development. Both these have a significant multiplier
impact on the capex cycle. For almost 10 years now, India has been
suffering from a poor capex cycle and capital formation, which has led to
poor operating leverage for businesses which are catering to capex across
industries. That’s where lies another pot of gold!

We often use historical context to figure out future probabilities and we

have seen patterns unfolding very much the same way multiple times in
markets too. May be the reason lies in same cyclical pattern of the economy
and a lot of other related variables. While scanning the past cycles we came
across a very interesting historical setting which we believe is very similar
to the current times. 2003-2008 was one of the golden phases of the market
with BSE Sensex generating 6.56x returns, Capital Goods Index 21x, Small
Cap Index 15x, Metal index 13x and similar kind of returns with other
indices. Stock level returns were far more spectacular and, in many cases,
returns were even in the range of 25x-50x.

For the period 2003 - 2008, out of 440 companies having a Market Cap over
Rs.1,000crs, 36 companies gave returns > 50x, 26 companies greater than
25x and 47 companies > 10x.

Similar returns are long awaited as the variables which are key to such a
setting have been missing since a long time. Corporate capex recovery,
credit formation, benign demand environment across key sectors were few
missing links. Everyone is keenly waiting for the capex cycle recovery as it
is one of the most important economic factors and a critical component for
sustainable long term economic growth. In the absence of any meaningful
contribution from private capex since long, the burden of capital
expenditure was largely a key agenda for the government. Though the
government has largely played its part, superior economic growth is
missing since long for want of equal contribution from private and
household capex.

It was a lost decade for India when it comes to meaningful investments and
capex post 2003-08 which can largely be attributed to weaker balance
sheets of banks, elevated NPA’s (11.2% in 2018), leveraged balance-sheet of
corporates, excess real estate inventory, excess supply across sectors and
short-term impact of notable transformational initiatives like GST, RERA,
Demonetization etc., the cumulative impact of which resulted into a
significant drop in corporate and household capex.

Figure 1: Corporate and Household Capex at a glance

Figure 2: Gross NPA’s of Banks from FY 2015-2021



Though the intensity of capex was not at a desired level in the last decade,
lot of things were happening at a structural level which is setting the stage
just right for the next decade of high investment cycle. If we analyse the
current phase of the Indian economy, we find a lot of similarity with 2003-
2008. The first few years in that phase was marked by excess liquidity, low
inflation, bottoming out of NPA’s, improving commodity prices, strong
private participation from steel, cement and power sectors, positive global
outlook and a strong real estate market, which we interestingly are
observing in the current period too.

Table 3: Economic scenario overview: 2002-06 and 2021

The combined effect of all these factors in the early phase of 2002-2006
resulted into a spectacular growth in the overall capex cycle. Overall credit
had grown in excess of 26% during 2003-2008 and Gross capital
formation grew at 20% CAGR which resulted into a spectacular overall
growth rate of 15% CAGR in the economy.

We are very excited with the similar setting in current phase of the
economy and strongly believe a similar trend will play out; we derive a
lot of comfort from the following key attributes.

1) Saving arising out of corporate tax cuts (25.2% from 34%) and low
interest rate - It is estimated that corporates will save in excess of Rs 1.5tn
every year which largely went into deleveraging initially but going forward
it will boost capex significantly. Lower interest rates saving will further
contribute Rs 50bn per annum.

2) Green shoots in core sectors – Core sectors are already achieving

higher capability utilisation. Top 10 players in cement and steel sectors are
already touching more than 85% utilisation. Most of the key players have
announced a much higher level of incremental capex.


3) Improving asset quality and balance sheet of banks - Elevated NPA

was one of the single biggest reasons for inferior credit formation in the
system in the last 8-10 years as Banks themselves were struggling to
survive. Resolutions in key sectors, re-capitalisation, merger of weaker
banks, focus on asset quality and better lending practices, IBC code are
some of the steps which is leading to bottoming out of the NPA cycle. Ample
liquidity in the banking system coupled with lower interest rates and
improving demand environment should kickstart the much-needed
corporate credit cycle.

Figure 3: Snapshot of Bank’ BS health

4) Production linked incentive – Currently, the Government has

announced PLI schemes across 13 sectors such as Mobiles, Pharma,
electronics, Telecom, Auto and Auto Components, Specialty steel etc. which
is likely to lead to a capex of ~Rs.1.4tn over the next 2-3 years and reduce
the dependence on imports which is to the tune of ~Rs. 5tn (USD 70bn)
currently across 13 sectors. PLI will fast track the capex plans from the
private sector at least by two years.

5) Export & China +1 shift - Supply chain de-risking and geo-political

consideration will shift a lot of sourcing from China to other countries;
India is set to be one of the key beneficiaries of this shift and going to
generate a lot of additional business for Indian companies in the form of
export opportunity or import substitution. Infact we are so convinced about
this trend that we have a dedicated portfolio strategy “Carnelian Shift
Strategy” to ride this trend. (Link)

Figure 4: Overview of exports from 2008-21

6) Recovery in real estate sectors – RERA has brought about the much
need consolidation and implementation of best practices in the sector.
Lower interest rates, increasing affordability due to time correction, and
incentives in form of lower stamp duty, etc. has given it the much-needed
push. Early signs of demand revival are visible in the form of growing sales
from Q3-2020 onwards. Part of the Industry is also moving towards an asset
light model which should accelerate the overall project execution.

7) Infra spent – There is a significant push by the government on

infrastructure, which is evident from its increased allocation towards road,
metro projects, drinking water, Swatch Bharat, etc. There is a 29% increase
in the overall capex across various ministries. Similarly, there is a 13%
increase in planned capex for FY2022 in PSU capex.

Figure 5: Ministry wise capex for FY 2022

8) Others – Accelerated formalisation of economy, positive impact of

significant reforms (GST, IBC, etc.), significant growth in the service sector
(backed by IT), digital adoption and acceleration across the economy will
directly and indirectly improve consumption and capex.

We believe that with the improving demand environment and improved

utilisation coupled with de-leveraged corporate and bank balance sheet, the
economy will see a much-accelerated capex over next three years in
comparison to last 3 years. In our opinion, India is entering into a virtuous
cycle of capex and consumption and this cycle will keep expanding over a
period of time due to lot of favourable factors.

Figure 6: Snapshot of Indicative Incremental Capex

We have started hearing a lot of early announcements which is giving us
the confidence about the beginning of an enduring capex cycle.
Announcements are much bigger than historical benchmarks and are
giving us an early indication that Indian corporates are set for a bigger
game.

Table 4: Corporate Capex Announcements

We have no doubt in the upcoming capex cycle recovery and consequent

multiplier effect. Potential 3rd covid wave, a very high inflation, global
demand disruption on account of any reason can be a potential risk to our
hypothesis.


"History doesn't repeat itself, but it often rhymes." -Samuel Clemens

Investors have created serious wealth during 2002-2008 cycle and as

history repeats in pattern, we are very confident that the coming decade
will unfold in a much similar way. It is just beginning of a great India
story…-Good times will roll by…

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