The government’s move to liberalize foreign investment will improve investor sentiment and, in the longer run, bring benefits to firms in these sectors. Still, the government could have been bolder.
In pharmaceuticals, for instance, the limit could have been increased to 100% instead of 74%. Similarly, in aviation, foreign airlines’ investment remains capped at 49%. The government is allowing overseas investment in food retailing and e-commerce, but only for locally produced goods. It is difficult to imagine food retailers who don’t stock imported goods, when even the local kirana store does.
Also, investment is one aspect but government policy and its execution is crucial. In pharmaceuticals, companies are calling for more predictability on price controls, which is disrupting business. In defence, companies complain that order flows are thin. Still, there is no doubt these measures can improve the operating environment for these sectors.
Pharmaceuticals
The pharma industry is in a different shape compared with 2011, when the brownfield foreign direct investment (FDI) policy was introduced. The widening net of price controls has put a question mark on growth and profitability in the domestic market, especially among the larger drug makers. Revenue growth in the US generic market has slowed, too. Back in 2011, the industry was firing on both these cylinders. That’s why allowing 74% FDI via acquisitions under the automatic route may not see a rush of deals. Still, on paper, a foreign company can now buy a majority stake without waiting for government approval. So, who’s looking to sell?
Promoters of the top 10 listed pharmaceutical companies are unlikely to sell. Even with the recent performance-related hiccups, their business model is still in good shape and expected to recover. Still, a price that is too good to pass may tempt them. But that will be rare. That’s why shares of top guns such as Sun Pharmaceutical Industries Ltd, Dr Reddy’s Laboratories Ltd and Lupin Ltd were relatively cold to this news. But small and mid-sized companies may see more interest both from promoters and buyers. If foreign companies see an attractive fit, there might be some deals that could happen. That would be the space to watch for.
Defence
Shares of companies that supply defence equipment, such as Bharat Electronics Ltd, Reliance Defence and Engineering Ltd and Premier Explosives Ltd, gained after the government raised FDI limits in the defence sector and did away with the access to technology condition.
Higher ownership may encourage foreign defence equipment makers to open production centres in India. This can widen the vendor base for local companies, increase competition among suppliers for business, and also lead to better compliance with offset obligations.
Offset rules require local sourcing of components. With the government no longer insisting on technology transfer, foreign original equipment manufacturers may be open to developing a local vendor base, with or without Indian partners.
Also, companies such as Bharat Electronics take up turnkey orders to develop full systems. A significant portion of these large contracts are sourced from third-party vendors and foreign companies. If foreign companies open shop in India, more localization can improve the contractor’s profitability.
Greater ownership control may also see more joint ventures. Several domestic companies have obtained supplier licences, but lack of expertise has held them back from developing production facilities. Easing of ownership rules can help local companies give a strong push to such ventures. However, defence orders continue to be sporadic and approvals come with a lag. Policy changes without visibility on the revenue front may still make investors hesitant to invest.
Aviation
The increase in FDI limit to 100% in airlines is positive for the aviation sector. Small wonder then that the stocks of InterGlobe Aviation Ltd (IndiGo), Jet Airways (India) Ltd and SpiceJet Ltd rose in the range of 6-7.4% on Monday.
Analysts believe this development will be more beneficial for Jet Airways and SpiceJet, if they are looking for funds, considering their relatively weaker balance sheets. As of 31 March, Jet Airways had a consolidated negative net worth of Rs.5,210 crore and its total borrowings were Rs.9,231 crore. Currently, Etihad Airways PJSC holds a 24% stake in Jet Airways. As of 31 March, SpiceJet’s net worth was negative, at Rs.631 crore and its borrowings were Rs.1,028 crore.
