It appears that infrastructure firms, especially in the construction and build-operate-transfer (BOT) space, are caught in a quagmire.

The budget this year has been supportive in improving money supply into the sector through higher limits for foreign institutional investors in corporate bonds. But, poor performance in the last few quarters has affected stocks in the sector, with most of them registering negative returns ranging from 30-50% in the last nine months, at a time when the CNX Midcap Index of the National Stock Exchange is down only 2%.

Also See Out of Favour (PDF)

Shares of key firms such as Hindustan Construction Co. Ltd, IVRCL Infrastructures and Projects Ltd, Nagarjuna Construction Co. Ltd and Madhucon Projects Ltd are down to one-fourth their prices at the peak-2008 level.

Investor sentiment does not appear upbeat. This could hamper the firms’ ability to raise equity for new projects. Most BOT projects require one-third equity funding, with the balance being funded through debt. In 2009 and 2010, the firms raised funds through the private equity and qualified institutional placement route, both at the holding firm and project levels. But rise in scale, complexity and the number of BOT projects in the firms’ portfolio has led to execution challenges.

A report by Fitch Ratings on the infrastructure sector says that while working capital positions are likely to remain stable and increase in proportion to revenue, cash flow from operations will continue to be negative.

Delays in clearances and the consequent delay in completion lowers the rate of return on projects. An analyst from a leading Mumbai-based investment research firm adds that lower-than-expected returns of about 12-14% (expected 18%) have dampened even long-term investor interest.

Of course, firms are resorting to other instruments such as convertible debentures to raise funds. But these come at a cost. For now, most are reeling under the pressure of high interest costs due to extended working capital cycles. In the December quarter, interest costs as a percentage of sales rose by 200-250 basis points. As a result, net profits of most firms fell considerably.

While the revenues have risen at a decent pace, future prospects are far from bright. A Sharekhan report shows order inflows have more than halved in the third quarter of fiscal 2011 against Rs81,000 crore in the fourth quarter of fiscal 2010. With five states going to the polls in the next few months, order inflows in some segments may be poor for the next two quarters.

Given these odds, it is unlikely shares in the sector will recover soon.

Graphic by Sandeep Bhatnagar/Mint

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