All the three pillars of our India Urbanization theme – infrastructure, consumption, and housing – have shown solid improvement in underlying trends since we launched our idea in late-2014. Given supportive government policies, we remain convinced that the theme will continue to deliver good alpha-generating opportunities for long-term investors. In 2017, the theme delivered a return of 44.9%, and we believe the recent soft patch (YTD –0.8% vs. BSE 100’s +0.6%) could be a good buying opportunity for investors.
BUY Companies that could benefit from faster urbanization and quality of life improvement
India is at the cusp of faster urbanization, supported by, among others, an attractive demography, changing spending habits, and favorable government policies. We believe these companies will enjoy above-average growth opportunities, and investors should buy with a long-term view.
Focus on long-term structural themes to weather this volatility
In this volatile environment, we recommend that investors build their equity portfolios around structural themes such as “Urbanizing India“ to gain superior returns. Consumer behavior is changing fast and so are government priorities. We have already seen a significant push to revive India’s ailing infrastructure, thanks to improved government finances (we have discussed this in detail in our previous reports). Nevertheless, rising oil prices and concerns about inflation are raising doubts about the sustainability and execution of these initiatives in the mind of investors, but we believe a broader framework is in place, and private sector participation along with digital initiatives is helping in the faster execution of these reforms. Overall, healthcare, sanitation, housing, and connectivity are getting due attention from the government. We continue to expect much faster urbanizing trends in India over the next decade and there are clear winners in this space that investors should not miss.
Infrastructure to have a multiplier effect on growth
The trend of significant underinvestment in India’s infrastructure is reversing. In this Research Alert, we highlight developments and potential opportunities that investors should consider from a 2–3 years’ perspective. Roads, railways and public utilities (power, airports and metro rail) should continue to attract substantial investments.
Dismal state of India’s infrastructure plaguing growth
Underdeveloped infrastructure is one of the biggest bottlenecks to India achieving its growth potential. For instance, around 70% of goods within the country is transported via roads as the railways is facing significant capacity constraints. The situation is so bad that trains transporting goods run at an average speed of ~25 kmph. This leads to significant inefficiency in the system, hurting exports and pushing inflation higher. According to the Associated Chambers of Commerce and Industry of India (Assocham), logistics cost for India is 14% of GDP, vs. 6%–8% for countries with better infrastructure, making India’s exports relatively expensive. Besides this, local suppliers do not get proper pricing for their produce due to inaccessibility. A government study shows harvest and post-harvest losses for major agricultural produce are valued at INR 926 bn (calculated using production data of 2012–13 at 2014 wholesale prices).
India creating more headroom for infra development
As per IMF projections, India needs to spend on average 8.1% of GDP on infrastructure development per year from the current fiscal year to 2022, compared to just over 5% a few years ago (see Figure 2). While the government finances are stretched and it is difficult to expect over 8% spending on infra, the policy framework is fast changing to attract private capital. Moreover, the government is finding innovative ways to finance these projects. This accelerated spending along with policy support and international financing could potentially transform India’s infrastructure landscape.
Road sector could see record ordering and execution in FY 2019
In the last fiscal year ending March 2018, the government (National Highways Authority of India (NHAI) + Ministry of Road Transport and Highways (MORTH)) awarded record ~ 17,000 km of roads and constructed ~10,000 km of roads (see Figure 3). Next year, the government has set a target to increase road award and construction to about 20,000 km and 16,000 km, respectively. NHAI had invited bids for new highway projects worth over INR 1.7 trn (~USD 25.5 bn) at the beginning of the year and we have seen significant progress so far. The sector’s visibility has improved as the government has already announced the Bharatmala project, under which it plans to construct 83,677 km of roads by 2022. In 2019, the Road ministry expects to fund it with INR 710 bn in budgetary support and around INR 1.5 trn raised via monetizing 100 highway projects. It has already monetized nine projects and raised INR 100 bn. The remaining funding can come via NHAI issuing bonds, including masala bonds.
We believe that road construction companies should continue to see good performance given visibility and traction in execution. Moreover, the new highways are now being built largely using cement instead of traditional bitumen, helping incremental cement demand as well.
Railways envisages INR 8.6 trn investments in five years to March 2020
The Ministry of Railways has laid out an investment plan of Rs 8.6 trn (~USD 140 bn) for five years starting March 2015. Capital allocation for railways in FY 2018–19 has been pegged at INR 1.48 trn (+13% YoY) with a large part of the capex allocated to capacity expansion.
The progress on the Dedicated Freight Corridor (DFC) project has been satisfactory. The project is 40% complete as of January 2018 (~ INR 350 bn already spent, including on land acquisition, compared to total estimated cost of INR 880 bn as per 2015 estimates) and 100% of the civil construction work has been awarded. In terms of land acquisition, 98.1% of the land has been acquired except in the Sonanagar-Dankuni section where the authorities are facing acquisition issues and protest from locals. We expect delays in full commissioning of the project vs. its initial commencement target of December 2020, but phase-wise commissioning starting 2020 is possible. We believe, once this 2,822 km DFC stretch (Western: 1,504 km; Eastern: 1,318 km) is operational, it will significantly help to improve overall economic activity as it will decongest rail traffic materially. Further, the DFC aims to improve the overall speed of freight trains to ~75 kmph from the current ~25 per kmph.
Metro projects can attract ~ INR 2.5 trn investments in five years
With the new Metro Rail Policy 2017 in place, execution is expected to pick up as the policy clearly defines center and state relationship. It puts onus on states to improve viability of metro rail projects. Currently, total 370 km (Delhi: 217 km) of metro lines are operational in eight cities; and total 595 km are in progress/planning stages in 13 cities, including the existing eight cities. If we consider average spending of INR 4.0 bn per km, the total spending on metros could be ~ INR 2.5 trn (USD 36 bn) over the next five years.
India’s aviation market is set to become the third largest globally by 2020
India is the world’s fastest-growing domestic aviation market for three years in a row now. In 2017, India’s Revenue Passenger Kilometer (RPK) grew 17.5% versus the global average of 7%. Air traffic growth has been accelerating further with over 20%+ growth witnessed YTD in 2018. As per the World Travel and Tourism Council, India’s spending on business and leisure travel is estimated at USD 10.3 bn and USD 181.6 bn, respectively, in 2017, which is forecasted to rise to USD 39.9 bn and USD 203.5 bn by 2026. India’s air passenger traffic is expected to reach 421 million by 2020, third largest in the world, from the FY 2017 figure of 265 million.
To connect underserved areas, the government has launched a scheme called Ude Desh ka Aam Nagrik (UDAN) last year, under which the Ministry of Civil Aviation has already awarded 128 routes connecting 70 airports in the first round of bidding. To accommodate rising passenger traffic, under the Nabh Nirman (NextGen Airport for Bharat) project announced this year, the government aims to expand airport capacity by more than five times to handle a billion trips in a year by constructing 100 new airports in the next 10 years (around INR 2.0 trn opportunity). We believe that the airline industry as a whole (airport developers, airline carriers) offers good growth opportunities.
Consumption: Shift toward premiumization visible
India’s per capita income growth is expected to accelerate, suggesting huge opportunities for consumer durables, entertainment, retail, financials and food industries. Rising internet and smartphone penetration and increasing access to electricity are driving significant changes in consumer preferences.
India’s per capita income growth accelerating
India’s per capita income showed a CAGR of 5.5% between 2010 and 2015 and is expected to accelerate to reach USD 2,208 by 2019 as per a forecast by the International Monetary Fund. The forecast is in line with our view that the per capita income is set to accelerate as the urbanization rate rises from 33% to 40%. Currently, India is on the verge of experiencing a consumption boom given 33% of India’s population now resides in urban areas and around 65% of the country’s 1.4 bn population is below 35 years of age. India has the highest number of millennial population (aged between 15 and 35 years), and given the increasing access to smartphones and internet, consumer behavior is fast changing. We believe the biggest beneficiaries of these trends would not only be consumer discretionary companies in sectors such as retail, food, auto, travel and tourism, luxury, and entertainment but also companies that help address changes in investment and credit habits.
Consumer durables market expected to reach INR 1.4 trn by 2020
Penetration of consumer durables remains abysmally low in Indian households compared with other countries. However, the market shows ample scope for growth given rising disposable income, increasing affordability, changing lifestyles and supportive regulatory changes, and attracts foreign brands and capital. With urban markets accounting for two-thirds of total consumer durables revenues, we expect better access to credit along with booming e-commerce to provide the necessary impetus for an increase in sales growth in coming years. According to India’s Ministry of Commerce, the consumer durables market is expected to reach INR 1.4 trn (USD 20.6 bn) in value by 2020 from INR 831 bn (USD 12.5 bn) in 2016, suggesting a CAGR of 13%. In this context, companies that are well entrenched in specific categories and have strong brands and wide distribution networks should benefit.
Premiumization gathering pace
Exposure to global lifestyles, aspirational customers, and an increasing presence of international brands have resulted in luxury no longer being viewed only as a “status symbol” but as a viable lifestyle for a great many high-income households in India. The Associated Chambers of Commerce and Industry of India expects India’s luxury goods market to reach USD 30 bn in value by 2018, and we expect the market to continue to grow at 25%–35% over the next several years. Although strictly luxury goods may still be affordable only to a few ultra-rich households, the premiumization trend is growing and is influencing multiple categories including electronics, durable goods, footwear, transportation, and even regular staple/FMCG food items. People in India are increasingly looking to switch to better products such as inverter ACs, fully automatic washing machines and premium smartphones, among other such goods. We take a closer look at the trends in the passenger vehicle market in India. The value share of entry-level cars has declined to 12% in FY 2017 from 20% in FY 2007, while the share of premium hatch/compact UV has gone up to 54% from 19% during the same period.
Housing sector at the cusp of a revival
It is widely known that the Indian government had set an ambitious target under the Housing for all 2022 scheme; however, the progress has been dismal so far. The government has upped its ante by increasing budgetary allocation this fiscal year to INR 645 bn from INR 290 bn last year. As the general election is approaching (sometime in Q2 2019), we expect the low-cost housing construction activity to pick up pace.
Housing construction could gather steam ahead of general elections
As per KPMG, India needs to construct 110 million new houses (70% in the affordable category) by 2022 to meet a growing demand for housing in the country. The government has already launched its “Housing for all 2022” scheme to encourage private players as well as state governments to meet this shortfall. Please refer to our India Urbanization (vol 4) Alert for more details on the scheme and related announcements to support the low-cost housing sector. The progress of the PMAY as of 22 January 2018 seems dismal. Since its launch, investments amounting to INR 2.1 trn have been committed and 3.7 million housing units are currently under consideration. However, the actual completed units are just 0.3 million compared with a requirement of at least 1.0 million units p.a. Apart from land shortages, the main reason behind this delay is a lack of proper funding. The central government has so far released only INR 132 bn out of the committed INR 577 bn. The government has recently announced an increase in budgetary allocation to INR 645 bn (+122% YoY), which we believe should be significant enough to jumpstart some of the stalled projects.
We prefer housing finance companies that cater to low-cost housing needs
As per ICRA, a credit rating agency, the affordable housing portfolio has continued to grow at a fast pace of 24% YoY in 2017, compared with an overall mortgage sector loan growth of only around 18%. The housing finance market is expected to double over the next five years, pushing penetration of mortgages to about 12%–14% by 2022 from the current level of about 10%.
With improving transparency and accountability along with greater affordability, we expect the Indian real estate market to see higher volumes going forward, especially for organized players with strong balance sheets. As per a report by Anarock Property Consultants, residential sales across the top-seven cities in India rose by 10% YoY in the March 2018 quarter to 49,200 units, largely driven by Hyderabad, Bengaluru and the National Capital Region (46%, 35%, and 25% respectively), while property sales remained subdued in the Mumbai Metropolitan Region, Pune, and Chennai (-5%, –11%, and –15%, respectively). Although the recovery in the overall residential sector is still nascent, we are encouraged by the growth seen in the affordable housing category. Residential sales in the sub-INR 3.0 m category saw a jump of 33% YoY in the second half of CY 2017. In the March quarter, around 74% of the new launches were priced at around INR 8.0 m. Given the encouraging growth trends already seen in the affordable housing space, we prefer non-banking financial companies (NBFC) that cater to the segment over banks. We continue to believe that housing finance companies are well positioned to benefit from this structural theme as mortgage penetration and affordable housing projects are likely to pick up.