What are the best InvITs, infrastructure stocks and funds for your portfolio?

The government’s ambitious National Monetisation Pipeline (NMP) — to generate revenue by leasing out existing infrastructure assets to the private sector — has brought the spotlight back on the infrastructure sector.

The expected monetisation proceeds of ₹6 lakh crore (FY22-25), to an extent, will provide a boost to the government’s coffers for funding new infrastructure investments. With the opening up of the economy after Covid-19, things have begun looking up for infrastructure companies.

You have three possible routes — InvITs, infrastructure stocks and infrastructure-focused mutual funds — to take exposure. Here’s a choice of select picks for each of these routes.

If you want a regular inflow of income and are ready to take on some risk, you can invest in an InvIT or infrastructure investment trust.

What they are

An InvIT is an investment vehicle created by a sponsor (an infrastructure company) by transferring its operational assets to it, thereby freeing up its own capital for new projects. Investors in InvITs periodically receive a portion of the net distributable surplus (NDS). Besides, publicly issued InvITs are listed on the exchanges — their units trade like shares, offering scope for capital gain or loss to investors. InvITs are, thus, a hybrid product — offering features of both debt and equity.

The NDS largely comprises cash flows that the InvIT receives from its project SPVs in the form of a) interest b) dividends and c) principal repayments on loans extended by it. Any other income at the InvIT level, such as return on surplus cash invested by it, gets added. All expenses incurred at the InvIT level are deducted from the total cash flows to arrive at the NDS.

In June, SEBI lowered the minimum application amount from ₹1 lakh to ₹10,000-₹15,000 for an InvIT IPO and FPO. It also reduced the trading lot size from 100 units to 1 unit only.

Here are 2 InvITs worth investing in.

Where to invest

Powergrid InvIT, India Grid Trust and IRB InvIT Fund are the three publicly listed InvITs open to retail investors. Powergrid InvIT (listed in May 2021) has been sponsored by the state-owned Power Grid Corp of India, the country’s dominant power transmission company. India Grid Trust (listed in June 2017) has been sponsored by the global investment firm KKR and power transmission company Sterlite Power Transmission. These two, a play on the country’s power transmission sector, make for a good bet. India Grid Trust has been distributing ₹3 per unit every quarter since May 2018 (₹3.1 per unit in January 2021).

Sponsored by IRB Infrastructure Developers, IRB InvIT Fund, on the other hand, comprises toll-based road projects with collections dependent on traffic flow and prone to fluctuations. In the past, the NDS per unit has ranged from a high of ₹12.25 in FY19 to ₹10 in FY20 and then ₹8.5 in FY21. Covid-19 lockdowns hurt the distributable surplus in FY20 and FY21.

Risk mitigators

As per SEBI regulations, InvITs must invest at least 80 per cent of their assets in completed and income generating projects — a risk mitigator for investors. Power transmission projects also come with their own set of risk-alleviating factors. For example, transmission companies receive user charges, provided the system is up and running, irrespective of quantum of power transmitted. Also, once operational, transmission projects entail low running and maintenance costs.

Risk mitigation apart, an InvIT must have a healthy pipeline of potential projects to continue generating a surplus. India Grid Trust has been addingpower transmission assets since its inception, helping it multiply its revenue 3.7 times from ₹448 crore in FY18 to ₹1,675 crore by FY21.

With the NMP setting out a large asset monetisation target, one may see more InvITs coming into the market. It may be wise to keep some powder dry for future public issues.

Take note

But that said, InvITs cannot be likened to fixed income products such as bonds and fixed deposits. One, while SEBI mandates that investors be given at least 90 per cent of the NDS, there’s no guarantee on what this amount itself will be. So, the periodic payout (or yield) is not assured. This, along with the possibility of capital gain/loss on the sale of the listed InvIT units can impact your overall return.

Two, interest income from an InvIT is taxed at your income tax slab rate. The dividend income is taxed at your slab rate if the project SPVs have opted for the new concessional tax regime (under section 115BAA of the IT Act) and is tax-exempt, if they have not opted. The loan repayment represents return of capital and is not subject to tax. On sale of InvIT units held for up to 36 months, short-term capital gains tax of 15 per cent applies, provided STT has been paid. If the units are held for longer, long-term capital gains (exceeding ₹1 lakh a year including from all equity investments) on sale are taxed at 10 per cent, if STT has been paid.

If you have the patience to invest for the long term and compound your returns from the infrastructure theme, here are a few stock picks.

Larsen and Toubro

To bet on the steadily improving outlook — for the economy and the country’s infrastructure — invest in the stock of construction and engineering behemoth, Larsen & Toubro. The gradual recovery in industrial capex is another tailwind for the company. At ₹1,770, the stock discounts its FY23 earnings (Bloomberg consensus estimates) by 20.3 times, a few notches above its 3-year average multiple of 16.3 times. The company’s leadership position and multiple business positives make the stock a buy.

Infrastructure accounted for 45 per cent of the company’s FY21 revenue. Its large and diversified order book, an established execution track record, healthy balance sheet and strong financials inspire confidence (see table). L&T’s order book of ₹3.2 lakh crore as of June 2021 provides revenue visibility over the next couple of years.

PNC Infratech

PNC Infratech (PNC Infra) is well placed to benefit from the government’s planned road and highway development worth ₹15 lakh crore over next two years, thanks to its 20-year execution record and low leverage. The company had a net debt to equity ratio of 1.37 times (Mar 2021). Its revenue and profit have grown at a good pace (see table).

Its outstanding order book of ₹12,095 crore (book-to-bill ratio of 2.1 times) as of June 2021 offers ample revenue visibility. The management has guided for a 20 per cent (y-o-y) revenue growth assuming no third Covid wave and 13.5-14 per cent EBITDA margins for FY22.

At ₹355, the stock trades at a one-year forward P/E multiple of 18.9 times, above its 3-year average multiple of 13.6 times (based on Bloomberg consensus estimates). To play it safe, accumulate the stock on dips as PNC Infra is a smaller player and not as diversified as L&T.

EPC projects accounted for 85 per cent of PNC Infra’s FY21 revenue. The company is also executing 11 hybrid annuity model projects for which ₹600 crore of equity investment has been made.

Kalpataru Power Transmission

A leading power transmission and infrastructure EPC company, Kalpataru Power Transmission (KPTL) has presence across segments including power transmission, oil and gas pipelines, railways and highways.

Geographically too, KPTL is diversified, deriving 37 per cent of its FY21 revenue from international operations. With EPC contracts as its focus area, KPTL has been divesting its stakes in its non-core assets to bring down debt levels. As of March 2021, it had a consolidated net debt to equity ratio of 0.66 times (expected to ease further) down from just under 1 time a year ago. This, apart from a solid order book driving future revenue growth, lend comfort on the financials front.

A consolidated order book of ₹29,313 crore (book-to-bill ratio of 2.26 times) as of June-end 2021 provides revenue visibility over the next 18 to 21 months. This does not include orders worth ₹5,050 crore where KPTL is the lowest (L1) bidder. Apart from this, it is expecting tenders worth ₹40,000-45,000 crore in the next 6-9 months driven by Power Grid and state electricity boards, oil and gas players and the Indian Railways.

At ₹403, the stock trades at a one-year forward P/E multiple of 8.3 times, just a tad below its 3-year average multiple of 9.5 times, making it a buy.

If you prefer mutual funds over stocks to play the theme, go for infrastructure-focused funds. Such funds must invest at least 80 per cent of their net assets in infrastructure stocks. The definition of ‘infrastructure’ is, however, not cast in stone.

What to pick

Franklin Build India Fund (FBI Fund) is the category topper (see bar diagram). It focuses on India’s growth story and invests in financial services, industrials, social infrastructure, transportation and materials — going beyond what is traditionally understood as infrastructure. Banking has been the top sector for a long time, accounting for a quarter or more of the portfolio.

While the scheme invests in stocks of different market caps, large-cap stocks tend to dominate (61 per cent in August 2021). This has likely helped the scheme provide good downside protection. The downside capture ratio (DCR) of 55 per cent is the lowest in the category. The DCR indicates the extent of market downside captured by the scheme with reference to an index (here, the S&P BSE India Infrastructure) in the down-market years.

L&T Infrastructure Fund and Invesco India Infrastructure Fund are the other top performers in the category (see table). The two invest in companies across market cap, juggling their exposure amongst large, mid and small-cap stocks. Sector-wise, cement, construction, industrial products, and industrial capital goods have been among the top holdings for the L&T Fund across time. For the Invesco Fund, construction has been the mainstay with cement, industrial products and power among the top at different time periods.

Not for the faint-hearted

The concentrated exposure of thematic funds makes them riskier than other diversified funds. The timing of your entry and exit too matter.

So, cap your exposure and have an investment horizon of five years or longer. Over the last ten years, 1-year returns for the infrastructure fund category have been negative 41 per cent of the time and 3-year returns 14 per cent of the time. On the other hand, 5-year returns have been negative only 5 per cent of the time.