Capital Allocation Takes Centre Stage For CEOs

What defines a great CEO?

While there’s no simple answer, two traits certainly stand out: First, being an effective leader and second, a skilled capital allocator. While the former is hard to pin down with certainty, it’s clear that India Inc. is making significant strides in the latter.

“A CEO’s role is getting more and more complex and multi-dimensional. Just in the past few years, they’ve had to cope with a global pandemic, busted supply chains, wars, stubborn inflation, and many other disruptions. Any one of these alone is enough to derail a CEO’s agenda!” says Rajat Dhawan, managing partner (India), McKinsey & Company, who believes recent years have been a defining era for leadership.

Yet, a closer look at the numbers by Fortune India reveals a spirit of resilience: India Inc. has not just weathered the storm but quietly mastered the art of capital allocation. So much so that the popular refrain — the private investment cycle has been stuttering, held back by cautious capital deployment — appears increasingly out of sync with reality.

Over the past five years, corporate India has demonstrated a calibrated and balanced approach to capital allocation, with gross block (plant, machinery, buildings, campuses, fleet etc) of listed 1,356 companies expanding to ₹86.36 lakh crore ($1.05 trillion) compounding at 11.08% over FY19-FY24. This measured asset expansion has closely aligned with a steady 9.52% growth in net sales, indicating that firms are not over-investing but rather building capacity in line with demand (See: Is the animal spirit coming back?). The focus has been on ensuring that investments support growth without creating excess capacity.

As a result, amid gross block expansion, the focus on optimising assets and driving operational efficiency has allowed profit growth to outpace both sales and asset expansion. What’s pertinent to note is that finance costs — both over 5-and 10-year periods — compounded at 8%, underscoring the deleveraging spree seen by corporates over the past decade.

An outcome of this thoughtful investment strategy combined with strong operational performance has prompted the Street to reward companies generously, leading to their cumulative market cap compounding at 21.91% over the past five years.

In an era where regulatory changes, rising market volatility, and global disruptions can quickly shift the playing field, CEOs are now required to exercise second-order thinking — anticipating not just immediate outcomes but long-term consequences of their investment decisions.

The approach is all-pervasive across sectors.

Different Strokes…

Excluding BFSI, over the past five years (FY19-FY24), different sectors have exhibited varying patterns of investment in gross block relative to their sales growth, revealing strategic differences in how industries are positioning themselves for the future.

Capital-intensive sectors such as aviation have seen the highest gross block but that is largely led by one player, InterGlobe Aviation, whose fleet, besides other facilities, has surged from 217 to 367 aircraft. Apart from aviation, retail, and FMCG stand out for their significant investments in physical infrastructure. With gross block growth outpacing sales by a wide margin — 29.1 bps, 13.6 bps, and 10.9 bps, respectively — these sectors are laying the groundwork for long-term capacity expansion, anticipating future demand. Other sectors, including auto ancillaries, hospitality, refineries, and chemicals, also reflect this trend, though with more measured investments. Their modest gross block growth (4-6 bps higher than sales) suggests steady, demand-driven expansion, balancing investment with existing capacities. (See: Mix and match).

At the other end, several sectors, particularly telecom equipment services, power generation, and textiles, have shown sales outpacing gross block growth, signalling either a shift towards asset-light models or improved utilisation of existing assets. This trend is even more pronounced in non-ferrous metals, steel, and agro chemicals, where the gap between sales and infrastructure investment growth (up to -6.8 bps) suggests sectors capitalising on efficiency rather than expanding physical capacities. Putting the gross block numbers of steel and energy sectors in perspective, Prashant Jain, founder and CIO of 3P Investment Managers, says, “Back at its peak (2007), crude oil was $140 per barrel. Now, 16-17 years later, it is $70. Hot-rolled steel prices were at $800 a tonne back then, now it’s $400-$500. So, we shouldn’t compare it to that base.”

The divergent gross block trend highlights that some sectors are betting heavily on future growth by expanding capacity, while others focus on optimising existing resources to boost sales and returns. Manish Bhandari, founder & portfolio manager, Vallum Capital, whose PMS fund delivered a stellar return of 45.7% in FY24 vs 30% for the Nifty, also attributes the 11% CAGR pick-up to an incentivised macro environment, especially taxation, and the China +1 strategy. Corporate tax rates were slashed to an effective rate of 25.17% for existing companies and 15% for new companies, which resulted in increased investments. Further, post-Covid when global supply chains got disrupted, China+1 gained prominence, which is visible in the gross block addition of chemicals (+15% CAGR) and auto ancillaries (+14% CAGR). More importantly, production-linked incentive schemes — which were rolled out beginning 2020 — further fuelled capacity addition.

Concurring with the view, Jain says, “During Covid, everything came to a halt. But over the past two-three years, capital expenditure has seen an uptick. Look at companies such as ABB and Siemens, they are growing faster; their order books are solid. So, from a low base, things are indeed getting better.”

The Consumption Paradox

But while the data does reveal calibrated capital allocation across sectors, it also highlights a more nuanced reality: India’s private sector isn’t immune to broader economic headwinds. “Companies are investing, and many are performing well, yet consumption demand hasn’t exactly kept pace,” says Devina Mehra, co-founder of First Global, capturing this complexity. This paradox is most evident in inventory levels, which remain stubbornly high, lingering above 60% for nine straight quarters. Far from the healthier pre-pandemic period, when inventory-to-sales ratios hovered between 49% and 55%, the recent rise to 65.4% in Q4FY24 signals weak consumer demand.

The Reserve Bank of India, in its August 2024 bulletin, had indicated high capacity utilisation and healthy corporate balance sheets as signs that private investment should surge. Mehra, however, points out, “Why would I invest when a quarter of my capacity is lying idle?” Why the capacity utilisation number itself may not be comprehensive can be gauged from the fact that the sample size of respondent companies since 2014 has more than halved from 1,421 in June 2014 to 832 in March 2024, after hitting a low of 406 in 2020. In other words, capacity utilisation levels on a smaller scale might appear exaggerated (See: Distorted reality).

Moreover, high frequency indicators from rural wages, core inflation to staples volume growth, all indicate continued stress on India’s consumption recovery. Even in sectors where capital has been deployed more effectively, the shadow of high inventories looms large. Despite an impressive gross block CAGR of 30.8%, retail in particular, with a PAT CAGR of 17.9%, seems poised for greater profitability, but only if consumption demand catches up with the capital deployed.

But what’s driving this lag in consumption? According to Mehra, the issue goes far deeper than a temporary post-pandemic slowdown. She points to a structural shift in income distribution. “Income has only gone up for the top 20% of India,” she notes. “For the lower 60%, incomes have fallen — most dramatically for the bottom 20%.” This downward drift, which began around 2016 — long before the pandemic — reveals a troubling dynamic: The poor are not only falling behind in relative terms, but their absolute incomes have also deteriorated.

As a result, routine expenditures — excluding big-ticket items such as healthcare or weddings — are now higher than incomes for the bottom 60% of India, leaving them with no surplus. This stark reality explains the so-called premiumisation trend that has become a buzzword among finance and business commentators. “Most sales across industries, from cars to underwear, are now concentrated in the most expensive products,” rues Mehra. Meanwhile, entry level products, those typically consumed by the lower income brackets, see sluggish sales, a clear reflection of the widening income inequality. In fact, entry-level car sales have more than halved since FY20 to 1.52 lakh units, amid stagnant incomes and spiralling cost inflation.

Jain, though, counters the view. “The sale of second-hand cars in India, as a proportion of new cars, is increasing. Why spend ₹6-8 lakhs on a brand-new Alto or similar car when you can buy a two-year-old Swift at a lower price with better comfort and prestige?”

The view is backed by hard facts.

In 2020, the used car market in India stood at 4.2 million units; 50% higher than the new car industry of 2.8 million units. Only in FY24 did new car sales cross 4.2 million units! According to Cars24, sales of cars valued above ₹8 lakh surged 14% between 2018 and 2023.

What is fuelling consumption, in part, is also the spectacular rise in retail credit. Of ₹90.3 lakh crore consumption loan portfolio as of FY24, personal loans surged 26%, both two-wheeler and consumer loans surged 34%, respectively, and so did microfinance lending at 27%, according to a CRIF High Mark report. “Over the past five to seven years, Indians have been spending more than their income, driven by consumer loans. Currently, the RBI is putting pressure to slow down consumer loans. That’s what we need to understand better,” explains Jain.

The Big Picture

In the larger scheme of things, the data point to a dual reality for India Inc. On one hand, companies are becoming better capital allocators, strategically deploying funds in sectors where growth seems inevitable, even if delayed. “Capex is being deployed in new-age businesses where one gets value. Who gives value to a steel plant these days? Also, these numbers (Fortune India Best CEO study) look at listed companies. Unlisted MNCs are also investing heavily. For instance, look at the investments made in global capability centres,” says Bhandari.

Interestingly, FDI inflows received in the past 10 years (April 2014 to March 2024) at $667 billion amount to 67% of the overall FDI flows seen over the past 24 years. However, over the same period, M&A deals stood at $847 billion, which means the FDI flow includes M&A deals. Thus net-net, the investment cycle has been less about greenfield creation and more about consolidation capital. Bhandari sees a sound logic for the same: “M&A produces better returns v/s capex.”

In fact, McKinsey’s research into M&A strategies has repeatedly reaffirmed that it is not the total value of transactions but the deal pattern that drives shareholder returns. A decade-long analysis (from 2013 to 2022) of 85 top Indian companies, found that ‘programmatic acquirers’ — those that did at least one or two small or medium-sized deals a year along the same theme — generated higher wealth in the long term and gave higher median annual returns to shareholders.

Thus, the private sector, in some sense, hasn’t been poor in investments — they’ve already invested more than what their sales increase justifies. In August, a paper by the RBI states that private sector capital expenditure is expected to increase by 54% in a year, reaching ₹2.45 lakh crore in FY25, against ₹1.59 lakh crore in FY24. A chunk (55%) of the expenditure is in the infra space comprising largely power, roads and bridges.

Mehra is, however, circumspect. “The real issue is job creation. Without jobs, sustained consumption growth is difficult.” This weakness in consumption demand — manifested in high inventories — continues to act as a spoiler on an otherwise robust investment cycle.

But this is exactly an environment that will separate the men from the boys. A study by McKinsey — analysing over 20 years of data on 7,800 CEOs from 3,500 public companies across 70 countries — states that excellent CEOs are those who have made bold moves. They reframed the game in five areas: Purposeful M&As, innovation investments, raising productivity, building differentiators, and rigorous resource reallocation. “Excellent CEOs sail on stormy seas, keeping the trade-offs in mind, while those — who make too few or too late big moves — fall behind the pack,” says Dhawan.

The boldness of India Inc.’s CEOs will increasingly hinge on their ability to embrace second-order thinking — those who master it will surge ahead, while those who hesitate may find themselves left behind.