Road developers are sitting pretty on a huge pile of orders, what with roads ministry awarding 17,000km of projects in FY2018. What’s more, road project targets for next fiscal year are pegged at 20,000km. This brings good tidings for the construction sector. A recent report from Crisil Ltd says that the order book of ₹ 1.3 trillion, for 66 construction companies under its rating scanner, is three times their current revenue. This assures a 20% compounded annual growth rate in revenue until 2020.
However, whether the sector can cope with the travails of execution is something to worry about. Only a handful of them have lapped up most of the recent projects. That too, these are all mid-sized firms for whom financial closures and working capital management could be a stretch. Any slips in the road to execution and project completion could destabilize growth and forecasts. For instance, Dilip Buildcon Ltd has an order book of ₹ 20,000 crore that is 10 times its net worth (shareholders’ equity). Others such as PNC Infratech Ltd, Ashoka Buildcon and Sadbhav Engineering, too, are similarly poised (see chart). The past track record where land acquisition and legacy projects finally dragged the sector down is also a niggling worry for investors.
According to Care Ratings, the key is funding from banks. Given the state of public sector banks and the cautious approach of private banks for funding infra projects, financial closure for these projects could be slower than the number of road projects coming up.
This may be the reason why construction stocks have fallen in the last six months, in spite of buoyancy in equity markets. Shares of Dilip Buildcon, Sadbhav Engineering and PNC Infratech have fallen by more than 20% since January.
Optimists say that most project orders are normally taken as special purpose vehicles (SPVs) and do not directly impact the standalone entity’s profile. But if a multitude of SPVs run into rough weather, there could be trouble. A recent case in point was the downgrade of IL&FS Transportation Networks Ltd (ITNL) after default in payments by nodal authorities. Media reports quoted the firm as saying that it was trying to raise debt through non-convertible debentures, as other routes were not easy.
However, the travails of ITNL are linked to the problems in the build-operate-transfer (BOT) model. Since then, roads are awarded on the new hybrid annuity model (HAM), where the government bears a fourth of the project cost in the first lap of the project and fund raising may not be an issue. The other model, toll-operate-transfer, is mainly long term asset monetizing, which does not entail execution.
Sushmita Majumdar, director, Crisil Ratings, says, “To maintain growth in order book and credit profiles, companies will need to raise funds either by selling HAM assets, or through the capital market, or from private equity funds." Meanwhile, the fact that 40 out of 45 HAM projects awarded have completed financial closure is a sign of hope for the sector. The years ahead will be crucial to see if, after financial closure, the firms meet the execution milestones to generate stable cash flows and healthy, consistent returns.