Rapid urbanisation means that India needs heavy investment in urban water, transportation and (affordable) housing infrastructure. Public reports suggest that in next 20 years India’s investment in urban infrastructure will be 20X its investment in the past decade. We believe unless funding, governance and policy challenges are addressed, investments could be lower than the required $1.2 tn. Construction companies and technology providers (in water/transportation) will be the key beneficiaries. Urbanisation amplifies infrastructure deficit Whilst the degree of urbanization in India is one of the lowest in the world (~30%), India’s urban population is growing at a rapid pace—340 mn in 2008 (290 mn in 2001) expected to grow to 536-590 mn by 2026-30 (source:
National Institute of Urban Affairs and World Bank). This pace of urbanisation has not only exposed India’s urban infrastructure deficit but also highlighted that the deficit backlog is increasing at a rapid pace. Government (GoI) sponsored and UN studies highlight that the severe supply deficits in basic urban services (water, sanitation, transportation and affordable housing) will rise 2-4X if investments continue at the current pace.
What does this mean for infrastructure companies?
GoI’s commitment to urban infra will increase materially. GoI embarked on an urban renewal mission (JNNURM) in 2005 and raised investment plans for urban water supply, sanitation (WSS), transportation and housing by 20X to Rs6.2 tn ($133 bn) in XIth plan from the Xth plan. Whilst the plan appears large, actual investment has been dismally low at $17 per capita/ annum in comparison to China’s US$116. McKinsey’s report, “India’s Urban Awakening,”
highlights that India needs to invest $1.2 tn ($130/capita/annum) in its cities over 2010-30, 20X the amount spent over the last decade.
• Investment will be the highest in urban transportation and affordable housing. As per the GoI and McKinsey studies, 82% of the capital spend on urban infrastructure will be on urban roads (17%), mass transit (33%) and affordable housing (33%). Whilst JNNURM presently gives WSS and slum development high importance, urban investment plans under the XIth plan, actually allocate 58% of funds to housing and 21% each to WSS and transportation. Affordable housing will continue to be a key focus area given that every 7th person in urban India is a slum dweller.
• Urban PPPs not a worthy bet, opportunity largest for construction and technology providers. PPP opportunities in urban mass transit/transportation have unattractive risk-reward balance given the limitations of charging for ‘public good’ services. However, PPP in smaller WSS schemes may be profitable for developers as citizens accept to pay for the improving quality of civic amenities. Hence, he main business opportunity from urban investments will be for construction companies ($14 bn annually for next five years) and technology providers building SS/transportation projects.
• Challenges—the usual evils: funding, governance, planning and policies. We continue to prefer builders over diversified developers We reiterate our preference for construction and ancillary companies over diversified developers given that the former have better visibility on earnings (vis-a-vis developers who are bidding for projects with risks outside their control). Our top picks amongst construction are CCCL (20% upside), IVRCL (16% upside) and HCC (38% upside). As the higher backlogs get translated to revenues and return ratios improve for these companies, we expect construction business to trade in the range of 12-15X one-year forward earnings. Potential equity placements/raisings by these companies at the ‘asset level’ could also act as positive stock price catalysts for the parent.
So, how can the infrastructure companies participate?
Whilst most of the opportunity for the infrastructure companies in the urban infrastructure will arise from the construction component, there will be a demand for technology and equipment in some segments, as it has done elsewhere, apart from pure construction and equipment supply contracts, the GoI is also planning to bring private investment into urban infrastructure through the PPP mode.
The construction opportunity from urban infrastructure
Whilst construction services will be the key demand segment in urban infrastructure creation, there will also be requirement of technology in water and sewage treatment plants, automated parking systems and mass rapid transportation systems. Whilst most of the urban infra segments are civil work intensive, water treatment and mass rapid transport require technology/equipment and this will be the other key opportunity segment for Indian and international companies.
Urban infrastructure PPP – unattractive risks versus rewards
The conventional path that cities have trodden to date has been to attempt all infrastructure jobs in the traditional manner of awarding contracts from year to year, ie. just like traditional construction contracts. Even with the help of government grants cities cannot use the traditional budgetary method to fund their entire infrastructure, hence the need for PPP.
How real is the urban opportunity?
Whilst the sheer scale of deficiency in urban infrastructure will require heavy investments, funding and governance issues will keep the investments staggered over the next couple of decades. Considering the fact that the urban infrastructure investments are also falling behind plans, we do not expect the US$1.2 tn envisaged by McKinsey study to be invested over next two decades.
However, even if we consider a 75% implementation ratio to the suggested investment plans, we expect Rs1 tn ($23 bn) to be invested annually in the next five years (2010-15) followed by
Rs1.6 tn ($35 bn) to be invested annually over the next five years (2015-20). These numbers are achievable and these are much closer to the investments suggested in the XIth plan: Rs6.2 tn ($133 bn) over 2007-12 i.e., Rs1.25 tn ($27 bn) annually. Given the high civil intensity of segments such as transportation and housing (which may also account for ~80% of total investments), we believe that urban infrastructure can create a construction business opportunity (considering 60% construction intensity) of Rs7.8 tn ($173 bn) over the next decade or $14 bn annually for next five years followed by another five years of demand for $21 bn annually of construction services.
Relative valuations of construction companies
Nearly all of the leading Indian EPC companies have taken up the role of developer in the last 3-4 years with some of them having large portfolios of roads, power assets and real estate. Roads remain the most common, followed by real estate and power projects. Given that the embedded valuation from these BOT assets may vary amongst these companies, comparing them on relative valuations sometimes does not make sense.
Moreover, if the BOT assets have contracted the EPC business to the parent EPC company, that may not be a true reflection of the competitive standing of these companies. We provide the relative valuations for these companies on a standalone basis after deducting the embedded value derived from holdings in listed entities and unlisted BOT or real estate assets. We use consensus estimates to calculate embedded value for all the companies.