From a high of 219 in early January, the IL&FS Transportation Networks Ltd (ITNL) stock has lost more than a quarter of its value. The benchmark S&P BSE Mid-cap index in the same period lost 19%. The sharp fall in the share price is a bit perplexing. The company’s order book of 14,700 crore provides revenue visibility for three years. What seems to be bothering investors is the quality of earnings. As the company executes more projects, its earnings are increasingly coming under pressure due to rising debt.

Borrowings during the last fiscal year rose 40% to 14,359 crore. This led to a 53% jump in interest costs. With finance charges already eating up three-fifths of operating profits, the fear is that a slowdown in revenue or spike in borrowings could have an adverse impact on the company’s finances.

To execute the projects in hand, the company needs 2,400 crore over the next three years. The management plans to fund the capital expenditure through a combination of internal accruals, debt and securitization of the operational assets. The company currently earns toll revenue of 4 crore per day. When all projects are completed by 2016-17, the toll revenue is slated to increase three times to 12 crore per day. While that is a good three-four years away, in the meantime, the company has to depend on the construction business and fee income to generate capital for projects in the pipeline.

The existing order book provides strong revenue visibility for the construction business. But what is worrying some analysts is the slowdown in ordering activity and the steady fall in high-margin fee income earned by providing consultancy services to its own projects as well as those of others. As investments in the domestic economy came to a standstill, fee income is slowing. According to Tata Securities Ltd, fee income as a percentage of stand-alone revenue fell from 10% in the December quarter to 7% in the last quarter of 2012-13. A note from Emkay Global Financial Services Ltd said that fee income contribution to total revenue dropped four percentage points to 17% in the last fiscal year.

Commissioning of new projects—nine assets are expected to become operational in the current fiscal year—will bring in extra revenue. But the toll and annuity collections from these projects will hardly be sufficient to make up for the fall in fee income. Also, the outlook for fee income in the current fiscal is not that encouraging.

According to Emkay Global Financial Services, the company has already recognized the fee income from three-four new projects. “With only 3-3.5 bn (billion) of residual fee income to be booked on current backlog we see that the company will have to significantly depend on new order wins for fee income growth. However, with muted awarding scenario at NHAI (National Highways Authority of India) we see limited possibility of substantially higher order inflows," Emkay Global Financial Services analysts said in a note. They expressed the concern that lower fee income may force the company to take on more debt to fund capital expenditure in the medium term.

A drop in interest rates would have eased interest-cost pressure on the company. But the rupee depreciation has made the interest rate cut a distant possibility. The management expects the consolidated debt-to-equity ratio to peak at 4-4.5 times. While the ratio currently stands at 3.8 times, focus on securitization of the assets can help the company ward off debt concerns.

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