Infra stocks to continue their upward trend, surpassing capital goods shares

Infrastructure (infra) stocks are set to outpace capital goods shares in the near future due to their stronger valuation position and robust growth outlook. While both sectors have shown impressive gains over the past three years, the capital goods sector has seen a sharper increase, largely due to its leaner capital requirements and quicker cash conversion cycle. This sector has benefited from a higher rate of earnings growth and better balance sheets, contributing to its strong performance and high valuations.

Performance Comparison

Over the past three years, capital goods stocks have surged, tripling in value, while infra stocks have doubled. The capital goods sector’s recent success can be attributed to its ability to achieve strong earnings with lower capital requirements compared to infrastructure companies. Capital goods companies generally experience quicker cash flows due to shorter inventory and production cycles, as well as timely fund disbursements, typically within two to four months. This efficiency has resulted in higher utilization rates and significant earnings upgrades, further boosting investor confidence.

Index 1-Year Return (%) 3-Year Return (%) 3-Year CAGR (%)

Nifty 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 Growth Drivers for Infrastructure

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

The newly elected government has emphasized infrastructure development, with a 100-day agenda that includes awarding 3,000 km of highway projects. This agenda highlights the government's commitment to infra growth, supported by a planned ₹1 trillion investment in new railway coaches and significant modernization projects.

Valuation Insights

On the valuation front, the BSE Infrastructure Index is trading at a one-year forward price-to-earnings (P/E) ratio of 18x, which, although premium, aligns with the country's overall valuation. The Nifty Infrastructure Index reflects similar valuations. Given the sector's strong growth potential and earnings outlook, these premium valuations are justified and likely to sustain 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 optimistic outlook and robust earnings growth projections suggest that it will continue to attract investor interest.

Sectoral Outlook

The outlook for infrastructure companies, particularly in the engineering, procurement, and construction (EPC) space, remains positive. Road construction, railway expansion, cement production, and affordable housing are expected to be major growth drivers. The government’s capex has been robust, with 85% of the FY24 budget already spent, and substantial projects such as the modernization of 40,000 railway bogies and the construction of 3 crore homes under the Pradhan Mantri Awas Yojana (PMAY) are expected to have significant multiplier effects.

For the capital goods sector, the average orderbook-to-sales ratio stands at a comfortable 2x, with expectations of 18% CAGR growth in topline revenue and 24% CAGR in earnings per share (EPS) over the FY24–26 period. While the sector faces challenges such as potential margin contractions due to high raw material costs, the forecasted high volume growth is expected to sustain healthy operating margins.

Infra stocks are in a better position for future gains due to their robust growth prospects and relatively lower valuations compared to capital goods stocks. Investors may find infra stocks more attractive given the current market dynamics and the strong policy support for infrastructure development in India.