Infrastructure – the key to unlocking India

After spending summer in the nostril-stinging clean environs of the Nordics and the curated efficiency of Singapore, it was good to make a long trip to hectic India.

I’ve had a significant investment exposure to India within the portfolio since 2012. While it still remains a large part of our fund (+15% overweight versus the index), I have pared our exposure in the past couple of months. Respect for the cost of capital in the long run and significant barriers to entry allow good businesses to flourish. As such, India is a market that fits our investment philosophy very well. But in the past 12-18 months almost every Asian or EM-focused fund manager has started to sing from the same positive hymn book. That makes me nervous.

Anyway, I drew the following conclusions from my trip:

  • Progress on infrastructure is excruciatingly slow – there is a big difference between the execution of projects within the government and private sector
  • Financial inclusion for the masses is making remarkable strides thanks to government initiatives, including the opening of bank accounts, linkage with the Aadhaar card (a unique 12-digit biometric and demographic-linked centralised database card) and a proliferation of well-managed micro finance lenders
  • The effects of a crackdown on policy and high-level corruption are, anecdotally at least, palpable, with negative effects on economic activity, especially property construction and land transactions
  • The rural economy has slowed as the current government has moderated the rise in farm support prices while plugging leakages from subsidy schemes
  • Government finances are in much better shape courtesy of significant hikes in indirect taxes
  • For corporate India in general, volume growth is scarce but margins are robust. For growth to revive, the Government needs to aggressively spend on infrastructure

The DFC will be transformational…

Keen readers might recollect that I have previously expounded on a project called the Dedicated Freight Corridor (DFC), a much-needed plan to build a parallel railway track dedicated to carrying freight traffic.

As a recap, the current tracks carry both passenger and freight traffic. Passenger trains get priority to the detriment of freight.  Average speeds for freight trains are abysmal, resulting in long delays and inefficient logistics. Over the decades, railways have lost share to road transport, which is more expensive and more polluting than rail.

Once the DFC is built, with the double-stacking of wagons and a doubling of average speeds, the project will be transformational.

…but is very, very late

The DFC will enable more competitive transport relative to road transport. If the goods and services tax does become a reality (uniformity of tax rates across state boundaries would truly make India a common market), this, in conjunction with the DFC, will allow companies to better manage their warehousing and distribution centres, inventory holding periods and delivery times.

Initially scheduled to be ready by 2017, it was evident there is a long delay. My gut feel is it’s possibly on a 2020 schedule. This project is run by the Indian Railways and is symptomatic of the way a government organisation functions. To add to this, there still remains some 5-7% of land area that is yet to be acquired. The DFC will happen, only much later than I had previously expected.

In stark contrast is the Hazira port developed by Adani Ports and SEZ (APS), India’s largest private multi-port operator, in Gujarat. Several years ago, Royal Dutch Shell built two LNG-receiving terminals on a site that was leased to the oil giant by the Gujarat state government. As a condition of the lease, Shell had to develop a non-LNG port, for which it scouted for sub-lessees. Several national and international players, including Port Authority of Singapore, refused, as the technical challenges of handling cross-tide conditions at the mouth of the harbour made it a difficult prospect.

APS, which has several ports in Gujarat and the rest of India, took the concession. Completed in a span of just two years, by 2012, in its first year of operation, it handled 1.1mt (million tonnes) of cargo, rising to 3.5mt in 2013, 7.2mt in 2014, and is likely to hit 18-20mt by 2019. There are suggestions that Mr Adani, the founder of APS, enjoys privileges due to his past association with Prime Minister Modi, which other business groups do not. Clearly I cannot vouch for the veracity of these allegations, but, even if there is truth to them, the stunning speed with which ports have been built and operationalised by that group is unheard of in India. (As an aside, APS’s high debt levels and its cross-dealings with group entities make me wary to own the stock.)

Sticking with India but challenges remain

While India’s rural economy has largely slowed, the urban markets are so far in a relatively better state. Yet, across industries, volume growth is very anaemic. Companies are reporting much higher margins as a result of falling commodity prices and a reduction in competitive pressures, but, in general, growth is scarce. The well-managed businesses are still delivering decent top line and profit growth after having survived several such tough operating environments. But, even for these companies, it is going to be incrementally challenging. Many expected that falling commodity prices, especially oil, would mean a bonanza for Indian consumers. In reality, they have not enjoyed any benefits, because the Government increased indirect taxes on petroleum, although governmental finances are in much better shape as a result.

As income growth has moderated and credit growth (except for MFIs) is muted, expectations remain high for large government outlays on road construction, railways and defence, in particular. By the end of the year, public sector employees will get a hefty revision in salaries as part of their five-year wage negotiations. It looks like government largesse is the main hope for revival in economic activity. But progress currently is slow.

As to our portfolio, on balance, if our current holdings do deliver on expectations, I remain a happy shareholder. Unless we find compelling opportunities, given where valuations are for the well-managed businesses, it is more likely that our exposure to India will remain around current levels or lower.