Capital investments in business


India Inc, is high in investments of their businesses and there’s no doubt about that. Going by the announcement over the last 3months alone, it is estimated that a potential US$150 billion can flow into the Indian economy. Some of the sectors which are the recipients of these investments include:

1. Energy: Energy is by far the most important input for a growing economy. It has been estimated that even if India must grow at the rate of 6% per annum, its power generation capacity must double within the next 5-7 years. There are a few companies which are undertaking capital investments in this sector. The plans are pegged at approximately Rs. 17,000 crore, Rs. 15,000 crore and Rs. 11,500 crore respectively.

2. Steel: Leading companies in this industry are planning to plunge into capacity expansion. Around Rs. 1.27 lakh crore of capital investment announcement have been made in this sector, where in Tata Steel intends to invest Rs. 70,000 crore.

3. Oil Refining: Oil refining activity is expected to see capital investment of more than Rs 68,000 crore in the coming years. In this sector, Reliance’s investment strategy seems to be the most ambitious. It’s refining capacity is being doubled with an investment of Rs. 25,000 crore. Assets being created include another huge refinery in Jamnagar by Reliance Petroleum Ltd, that would come up by December 2008.

4. Real Estate: The Indian real estate industry is witnessing a lot of investment interest from India Inc. Companies already in the real estate business like DLF and Ansal Properties India limited have expressed capital investment plans of Rs. 30,000 crore each, across various cities in India.

Additionally, Special Economic Zones (SEZs) in India have also attracted large portion of private capital investments in the last two and a half months. Diverse companies ranging from gems and jewellery to computer hardware have announced capital investments totaling to around Rs. 42,000 crore in SEZs.

Analyzing the Impact

While all this is great for the economy what are the implications for the companies investing? The analysis is discussed in brief in the following paragraphs,

The management must make it clear whether the incremental investment will be directed towards expanding the current capacity of the exiting business or towards entering a completely new line of business. This relevant because the growth rate in percentage terms of the existing business may not rise even if capacities are increased. However, a diversification of business may lead to higher returns as well as a reduction in business risk. Then again, diversification may involve higher risks and lower returns initially since the promoters and the management could be new to the business, there could be a possibility of a gestation period, etc.

Interest codes in case of primarily debt funding can act as a major drag on corporate profitability and hence, can be viewed as an extremely negative signal in the short run. So, examine the funding patterns for the investment very closely. Generally, companies that finance their expansion/diversification plans from internal accruals should be viewed positively as they do not incur any additional cost of raising capital.

One of the oldest, most fundamental and still relevant theories is that investment must create assets. Asset creation will help a company add value in the long term. Over and above relevant machinery and technology, tangible assets such as land and buildings increase the value of the company in an era of rising real estate prices. Intangible assets such as brands increase the brand value and market share.

While all the investment plans on the drawing board could mean the birth of genuine global giants in India, getting carried away by big announcements and fancy numbers would be foolhardy. An investor must pay attention to only those that foretell value addition for companies in the long run.