Shares of construction firms have rallied on the back of strong execution and the resultant improvement in revenue growth over the last few quarters. Road construction firms, such as PNC Infratech Ltd, KNR Constructions Ltd, Sadbhav Engineering Ltd and NCC Ltd, have gained 32%, 35%, 22% and 11%, respectively, since January. During the same time, the Nifty Midcap index lost 4%.
It is now time for investors to exercise some caution. Apart from lower order flows due to the code of conduct rules during the general elections, rising debt due to project-linked delays may be akin to potholes in the road ahead.
While companies had robust order booking, especially in the roads segment, between FY17 and FY18, the last fiscal year was a bit dull. True, these firms are still sitting on order books that amount to two to three times their annual revenues. However, delays in financial closure of some projects and land acquisition issues are affecting operations.
As a consequence, they have seen continued rise in debt. According to a note by Centrum Broking Ltd, “Debt levels for construction companies rose in Q4FY19 led by front-ended equity and working capital requirements, particularly in the hybrid annuity model (HAM) projects."
Debt levels increased for most companies on a year-on-year (y-o-y) basis. Net consolidated debt in Q4FY19 for PNC Infratech and KNR Constructions jumped by a significant 37% and 34% y-o-y, respectively, even as it rose substantially for many others in the listed universe.
The rise in balance sheet leverage is mirrored in higher debt-equity ratio.
For instance, Sadbhav’s stand-alone debt is not of grave concern. However, its consolidated net debt-equity of about 10.6 in FY19 is a worry. The Street is also concerned about high stock pledges by the company’s promoters, all of which show stress on cash flows that could impact execution.
Construction firms’ efforts to monetize existing and completed projects is expected to ease stress on working capital and deleverage balance sheets. For instance, Sadbhav is close to selling its nine build-operate-transfer (BOT) assets. Ashoka Buildcon plans to divest some assets, while NCC and PNC were already successful in monetizing some projects.
The worry is that if balance sheet leverage increases, firms may be constrained to participate in future opportunities. Industry experts are hopeful of an increase in work tenders over the next few months and a higher impetus to infrastructure projects, which typically happens after a new government assumes office. Investors have been hoping these factors would provide tailwinds for construction firms to move higher. But if things don’t work out as planned, the rally in the last few months may be stemmed.