WOTS #12

Textbooks have long taught investors about two forms of companies in a capitalist society - Business to Business (also known as enterprise, B2B) and Business to Consumer (B2C). However, many people forget that there is a third category of companies - Business to Government (B2G) where spending programs can be really large and stable. For instance, I was amazed to know that the US defense budget ($766b) is almost as big as the global ad market ($875b).

In India, the last decade of 2010-2020 had shown B2G focused companies as laggards due to many reasons - slow awards of projects (budgets were tight), challenged on-ground execution (including land acquisition) and stretched payment cycles (Govt budgets work on "cash" basis - so paying late was important to "achieve" budgets). This meant such companies did not have a predictable revenue, needed lots of working capital and thus did not have good return ratios driving poor multiples.

What has happened since 2021?

Since COVID, the Government tax collection has scaled up quite strongly growing in double digits vs the single digit growth over the last few years.

Thanks to growing income and controlled subsidy spending, the Government has dramatically scaled up - almost 3x from ~INR 4L crore in FY21 to ~INR 11L crore in FY25e (CAGR of ~30%)!

The big components of this capex spend are:

• Roads ~26%
• Railways ~24%
• Defense ~16%
• Transfer to States ~13%

Incredibly the Government fell short of its FY24e capex spending target of INR 10L crore by ~5% but has raised its spending target for 9MFY25 (a short year given elections in May 2024) indicating it is literally "forcing" its departments to "spend' on capital expenditure projects.

This sudden spurt of growth has meant concerted effort to "clear files", remove on-ground obstacles around execution and push bureaucrats to undertake bigger development projects. Not surprisingly, we have witnessed companies in these sectors see jumps in order books and project awards driving earnings upgrades and stock price jumps:

While I have picked a representative sample across general infra, roads, housing, defense and water, this graph looks similar across various companies in each of these infra sub-sectors.

While the bear argument is simple - Governments have been historically unpredictable in spending, infrastructure involves complex projects with lot of execution risk and the Government is a poor paymaster; I am reminded of the famous quip Joan Robinson made, "Whatever you can say about India, the opposite is also true."

Perhaps this time the Government is stepping in ahead of the curve, making up for slower business and consumer spending by boosting the economy. It is not unreasonable to believe that the Government spend growth will continue to grow in-line with Nominal GDP (say low-teens) for the next few years. Many of these companies operate in monopolistic/ oligopolistic industry structures and have been untracked for years, positioning themselves well for interesting investment opportunities over the next few years.