Infra shares continue their upward trend, outperforming capital goods stocks

Infrastructure (infrastructure) stocks are likely to outperform capital goods stocks in the near future due to their stronger valuation position and solid growth prospects. While both sectors have shown impressive gains over the last three years, the capital goods sector has seen sharper growth, mainly due to lower capital requirements and a faster cash conversion cycle. The sector has benefited from higher earnings growth and improved balance sheets, which have contributed to its strong performance and high valuations.

Performance comparison

Over the past three years, the value of capital goods stocks has tripled and the value of infrastructure stocks has doubled. The recent success of the capital goods sector can be attributed to its ability to earn high profits with lower capital requirements compared to infrastructure companies. Companies in the capital goods industry generally experience faster cash flows due to shorter inventory and production cycles, as well as timely cash disbursements, typically within two to four months. These efficiencies resulted in higher resource utilization rates and significant earnings growth, further boosting investor confidence.

Index 1-year return (%) 3-year return (%) 3-year CAGR (%)

Nice infrastructure 60 100 26

BSE India Infrastructure 110 156 37

BSE Capital Goods 80,208,46

BSE Sensex 22 46 13

NSE Nifty 25 48 14

Key factors for infrastructure growth

The future of the infrastructure sector seems promising due to several positive factors. The daily road construction completion rate increased by 20% in FY24 and the National Highways Authority of India (NHAI) has significantly increased its funding with a budget allocation of ₹2.78 trillion for FY25. This increase is expected to expand the order books companies and will stimulate further development. Moreover, India’s gross fixed capital formation reached 33.5% of GDP, the highest in 11 years, indicating heavy investment in this sector.

The newly elected government has placed emphasis on infrastructure development, implementing a 100-day program that included awarding contracts for 3,000 km of highway projects. This program underlines the Government’s commitment to infrastructure development, supported by a planned £1 trillion investment in new rail carriages and significant modernization projects.

Valuation insights

On the valuation front, the BSE Infrastructure Index is trading at a forward price-to-earnings (P/E) ratio of 18 times, which, while premium, is in line with the country’s overall valuation. Nifty Infrastructure Index reflects similar valuations. Given the sector’s strong growth potential and earnings prospects, the above premium valuations are reasonable and are likely to continue in the coming years.

In contrast, the capital goods sector is currently trading at a higher valuation, with a one-year forward P/E of 40x. Despite these premium valuations, the sector’s upbeat outlook and solid earnings growth forecasts suggest it will continue to attract investor interest.

Sector perspective

The outlook for infrastructure companies, especially those in the engineering, procurement and construction (EPC) industry, remains positive. Road construction, railway expansion, cement production and affordable housing are expected to be the main growth drivers. The government’s capital expenditure is significant – 85% of the FY24 budget has already been spent and significant projects such as modernization of 40,000 rail bogies and construction of houses worth Rs 3 crore under Pradhan Mantri Awas Yojana (PMAY) are expected to deliver significant multiplier effects .

In the capital goods sector, the average order-to-sales ratio is at a comfortable 2x, with earnings per share (EPS) expected to grow at 18% CAGR and earnings per share (EPS) at 24% over 24-26. While the sector faces challenges such as potential margin decline due to high raw material costs, the forecast strong volume growth is expected to maintain healthy operating margins.

Infra stocks are better positioned for future earnings due to solid growth prospects and relatively lower valuations compared to capital goods stocks. Investors may find infrastructure stocks more attractive given the current market dynamics and strong political support for infrastructure development in India.