Home >Markets >Mark To Market >Why construction firms’ stocks may continue to see stony days ahead

The government’s spending on infrastructure is declining. Construction firms, particularly those with order books skewed towards government contracts, have barely picked up in FY20. “Against 28% growth in government infrastructure spending in FY19 (revised estimates), we are set for a massive slowdown in FY20 (budget estimates) to 6% owing to restricted fiscal space," said Emkay Global Financial Services Ltd in a report on 8 March.

With the problem rooted in deteriorating central and states’ finances, the situation may not turn around soon.

Not so surprisingly, the slight upturn in road contract awards in February failed to excite investors. Shares of Dilip Buildcon Ltd, Ashoka Buildcon Ltd, Sadbhav Engineering Ltd and KNR Constructions Ltd tumbled 30-40% since April.

Even diversified conglomerate Larsen and Toubro’s stock is down 20%, because of the looming macroeconomic gloom.

That said, Q3 FY20 brought some hope, with improved execution after a weak monsoon-dampened Q2. Fortunately, costs too were controlled, giving a leg-up to operating margins.

Analysts forecast a further improvement in Q4. “Despite the challenging environment, execution of road projects is likely to exceed 10,000 km," said Rajeshwar Burla, vice president and associate head (corporate ratings) at Icra Ltd.

Graphic by Naveen Kumar Saini/Mint
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Graphic by Naveen Kumar Saini/Mint

That is because most firms catering to the roads sector are riding on a strong order book-to-bill ratio of 2.2-2.3 times trailing 12-month revenue. “However, if awards don’t pick up in Q4, the impact would be felt on the revenue of construction firms from the second half of next year (FY21)," said Burla.

Sector analysts forecast awards to be constrained, at 5,500- 5,750 km, given land acquisition and funding challenges. The largest overhang for the sector is a slowdown in business activity. This puts toll revenue addition in build-operate-transfer and toll-operate-transfer projects at risk.

To tackle these concerns and diversify sector risk, some firms are altering course to include other infrastructure sub-segments. For instance, Ashoka Buildcon plans to secure a fifth of its new orders from Indian Railways in the next two years. HG Infra Engineering Ltd aims to get orders worth 1,000 crore from Indian Railways in FY21.

Meanwhile, analysts are optimistic that the attempts by some firms to monetize existing road assets should help lower leverage and free up capital for future projects. However, this may not yield results in the near-term given the tight liquidity in the economy and the caution towards infrastructure in general.

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