Home > market > mark-to-market > Construction stocks up as legacy issues fixed

On Wednesday, stocks of cash-strapped construction firms rose from the abyss and galloped after nearly five years. They were reacting to news that the government would pay 75% of the pending amount in disputed projects where the arbitration was in their favour.

Shares of Hindustan Construction Co. Ltd (HCC) Ltd zoomed the most, by 20%, as analysts reckon that it would be the biggest beneficiary from this move. The firm reportedly has about 3,000 crore outstanding in its favour from legacy infrastructure projects. Worse, given that the amount has been outstanding for some years now, it has increased working capital needs and interest costs, which in turn have weighed on profit.

HCC is not the only one in trouble. Others like Gammon India Ltd, IVRCL Ltd and Punj Lloyd Ltd are bound to breathe easy with this order. Their stocks rallied by double digits too. In fact, IVRCL and Punj Lloyd have been sitting ducks, written off by investors for many years, with stocks touching the abyss, trading at 5 and 21, respectively. Of course, the latter has some private sector and overseas projects too in jeopardy.

Others like Patel Engineering Ltd, Simplex Infrastructure Ltd and Jaiprakash Associates Ltd too are victims of the government’s rapid tendering activity in the pre-2008 infrastructure boom.

Also Read: Govt sets rules for speedy redressal of construction sector disputes

How will these firms gain? Given that the government will deposit 75% of the pending amount in an escrow account of the contractor, the firm could then use the money to cut debt or meet commitments for ongoing projects. For instance, HCC has a huge order book that provides revenue visibility for two-three years. IVRCL’s interest cost, which is almost a fourth of its sales, is a huge drag.

Lowering debt will lower interest costs for the contractor. It will egg on lenders to lend money for future projects. According to the government’s media statement, about 70,000 crore is stuck in arbitration. This is the result of projects stalled between 2011 and 2014. And strangely, out of a total 347 arbitral projects, 309 decisions are in favour of the contractor/concessionaire.

Importantly, “if payments are released, the contractor’s cash flows will improve enabling them to bid for new projects. Further, with better cash flows, incremental debt needs itself will come down", says Kunal Sheth, analyst at Prabhudas Lilladher Pvt. Ltd.

At present, most of these firms with stuck legacy projects have an interest cover less than or barely equal to 1. This means that they are unable to service debt, let alone repay it.

The new measure, along with other moves like solving the problem of stressed assets with the banks and bringing in greater transparency in future projects, should see a fresh wave of interest in construction stocks. However, one must tread with caution given that while the intent is commendable, government agencies like the National Highways Authority of India must be willing—and have the liquidity—to settle these claims.

On another note, mid-sized firms have been making greater headway in the recent round of road contracts awarded. (See: Roads: the old order changeth) These are safer havens within the construction universe, as they are not shackled by such issues like the large firms. Some of these like Sadbhav Engineering Ltd and Ashoka Buildcon Ltd, which rallied earlier in the year on bagging new orders, did not react to this news.

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