Mid-sized construction firms race ahead in road sector
While it’s true that behemoths such as Larsen and Toubro Ltd are symbolic of infrastructure development in the country, ironically 2017 has been a year when mid-sized firms rose to the spotlight. Indeed, they ticked all the boxes on revenue growth, profits and order flows. Their stock prices have accordingly rallied to outperform the returns of benchmark indices and infrastructure giants.
To name a few, Sadbhav Engineering Ltd’s shares returned 37% in a year, while the shares of PNC Infratech Ltd and KNR Constructions Ltd returned 82% and 63%, respectively.
What is driving this investor frenzy? Primarily, it is the government’s thrust on infrastructure, mainly roads, bridges, railways and waterways, with the highest allocation being to roads. Of course, these firms are the newer lot that learnt from the mistakes of the older ones. So did the authorities and regulators in the sector who faltered on clearances and procedures in the early years before they got their act together.
The recent awards in the road sector have been smooth sailing, especially with the shift from the BOT (build-operate-transfer) to EPC (engineering, procurement and construction) framework and to HAM (Hybrid Annuity Model) by the National Highways Authority of India (NHAI).
Firms such as PNC Infratech, KNR Constructions, Ashoka Buildcon Ltd and NCC Ltd (formerly Nagarjuna Construction Co. Ltd) have order books that should drive revenue growth for the next two-three years. While earlier firms got stuck with cost overruns due to project delays, these have clocked stable revenue growth of 15-20% over the last couple of years. Timely execution of projects, therefore, has enabled healthy profit margins and cash flows that are reflected in a decent interest cover for these firms.
Of course, performance in the recent quarters was impacted by macroeconomic developments such as demonetisation and the goods and services tax.
A Nomura Securities report says that the government is set to award 50,000km of road projects valued at Rs5 trillion in the next two years. “NHAI has awarded more than 55% of the projects under HAM, 35% under EPC and 10% under BOT toll in FY2017,” adds the report.
Further, that the government is sorting out land acquisition and environment clearance issues prior to the awards is reassuring for developers, banks and financiers, and investors.
Meanwhile, the offer to roll out a TOT (toll-operate-transfer) model for maintenance of existing highways is another carrot for developers. A report by Crisil Research forecasts a reasonable 12-13% internal rate of return for participants in TOT projects based on NHAI’s estimated “concession value” for the first bundle of nine projects offered.
That said, improved prospects are limited only to firms that are predominantly road developers. There is little hope in other infrastructure segments like power that is still reeling with overcapacity. Irrigation and railways too are yet to gain momentum.
However, the road segment also has its share of problems. Funding, be it debt or equity, is tough for new projects given that many financial institutions burnt their fingers when road developers got sucked into a debt trap about a decade ago. Besides, even in the TOT model, returns could be erratic if the toll traffic intensity reduces due to unforeseen factors.
That apart, competition in the EPC segment is now rising, with scores of mid-sized companies willing to seize the opportunity in the country’s infrastructure development. This could again spiral into a trend of unviable bids seen a decade ago.
Meanwhile, some firms such as Simplex Infrastructures Ltd with exposure to affordable housing, building construction and urban infrastructure are betting on the government’s push in these areas too. The caveat here could be the outcome of the next general election that is not too far away.