Infrastructure - Taking Stock; and Looking Ahead : The industry has never seen as much work in the pipeline since the last 15 years.
The construction sector, the most visible opportunity, saw a sharp rally of the stocks in this sector in 2017 on the back of execution potential, political stability and reasonable inflation expectations. Industry participants are unanimously bullish on an opportunity that is estimated in excess of Rs 18 lakh crore across roads, railways, buildings and factories (B&F), metros, affordable housing and other sub-sectors of infrastructure over the coming five-six years. Road traffic is set to grow sustainably in the next two years and the overall environment remains favorable for the sector. Read On...
Capital expenditure programs and state governments' budgets are becoming bigger and it is worth paying attention to them in the current times. Perhaps, progress on the inland waterway projects may be a bit slow-moving and certainly, the planned capacity should be higher than 40 million tons per annum (MTPA).
With respect to urban infrastructure projects, urban local bodies (ULB) do not have the capacity to execute the Smart Cities mission or even 24*7 pressurised water supply systems for entire towns and cities. So far, states that have been active on this front, though, are Andhra Pradesh, Telengana, Bihar, Jharkhand, Madhya Pradesh and Uttar Pradesh. Industry executives expect the upcoming Union Budget 2018 to focus on irrigation, cold storage and agri-logistics.
While the government's capital expenditure is useful, the real efficiency actually comes from private sector capex and one can expect more bang for the buck. This is significant to note since the return on public, private, partnership (PPP) is important with a majority of work yet to be taken up.
Opportunities galore on contracting front; order inflows to spike in next 6 months
Construction companies and developers are extremely buoyant about the push on infrastructure and expect to fill their order books substantially. According to analysts, this order inflow volume should support a compounded annual growth rate (CAGR) of 12-15% with respect to execution.
The Bharatmala programme alone is worth about Rs 7 lakh crore while over Rs 2 lakh crore of orders is expected from state governments and public works departments (PWD) on roads and bridges. The urban transport and railways segment should be an opportunity worth about Rs 3 lakh crore, given the thrust on metros for all towns with a population greater than 1 million. With initiatives like Housing for All and Smart Cities, B&F, too, would easily emerge as an opportunity worth Rs 3 lakh crore.
However, currently, there is a dearth of orders on the factories front, and this can only take off when private sector capex picks up. Credit growth is low and not yet to the desired level. Most building orders are expected from institutions like NBCC, ESIC, HSCC, CPWD, several credible public works departments (PWD), Coal India, Indian Army, NTPC, Railways, EIL and select private sector players.
Airports, irrigation, water and other escalations across the board would be another Rs 3 lakh crore opportunity. Based on the website of the National Highways Authority of India (NHAI), the industry may expect 35/34 HAM/EPC projects spanning 1,581km/994 km and worth Rs 36,000cr/Rs 26000 crore to be bid out in the next six months.
Rohan Suryavanshi director, strategy and planning at Dilip Buildcon says the government has been proactive as far as the infrastructure segment is concerned. He said, “Whether it was allowing developers to exit projects, improving arbitration procedures, introducing a new developer-friendly hybrid annuity model (HAM), and now, tabling the amendments to the Specific Relief Act (SRA) in Parliament, which is expected to be passed in the winter session itself, I commend the government for all the initiatives it has taken and introducing such a feel-good atmosphere for the private sector after many years.”
Moreover, given the recent leadership and ministry changes, works across track laying, signaling, overhead electrification, station development, railway bridges and metro lines are expected, with larger contract awards of Rs 1000 crore and more. Vimal Kejriwal, managing director and chief executive officer, KEC International, says, the Railways has already started floating tenders for such works. He said, “There was a slowdown in the number of projects being tendered and awarded immediately after the roll out of the Goods and Services Tax (GST) due to uncertainty over many taxation issues. A vast majority of these have been cleared up by the government and we are seeing many tenders for projects that are being floated now by both Indian Railways, Power Grid Corporation (PGC) and other entities. I expect projects awarded will really increase from the fourth quarter onward.”
Industry observers say participation by the private sector in the PPP model will be critical to raise much-needed capital and create efficient business platforms. Devam Modi, research director at Equirus Securities believes private sector capex in the infra sector will be more effective than the government or public-sector led initiatives. However, says Modi, private sector developers and investors are still reeling from balance-sheet overhangs due to policy paralysis and aggressive bidding. He explained, “Demand has moved slower than most expectations and industry-wide capacity utilisation is still at 71% as per the Reserve Bank of India’s (RBI) Order Books, Inventories and Capacity Utilisation survey (OBICUS). Consequently, I expect PPP models based on low or minimal market risk to work better. Models such as HAM, annuity, and sale and lease back have low revenue risk, and I believe private sector players with balance sheet strength and execution capabilities will participate actively.”
A word of caution
Although everything seems in place for speeding ahead in 2018, analysts also advise a word of caution while extrapolating valuations, particularly for engineering, procurement and construction (EPC) companies. Alok Deora, vice president at IIFL Wealth says given the nature of the project contracting business, it is possible for EPC-focused companies to report revenue and front-end margins during a project till the order book continues to grow rapidly. He explained, “A continuous surge in the EPC business, in the net debt and in high levels of core working capital indicate that the business is not generating cash, and one should be apprehensive of valuing such businesses aggressively.” Over the years, the market has rewarded good EPC companies; most of them are now chasing growth and are quite aggressively focused on building their order books.
While competitive intensity is high, the industry has never seen as much work in the pipeline since the last 15 years. The road sector is the main area where capex is being pushed, and NHAI is one government body where there are enough funds for large expansions. In fact, the pick-up in awards in the transportation segment has helped to swell up order books of EPC developers. So much so, that the order books for some of them are currently at their highest. Deora says even if awarding were close to 70-80% of the target, the opportunity available for these players would be huge and the top line growth should be strong over the next few years. In fact, the average construction order book to sales for road companies which used to hover at 1.5 times revenue, already stands at 2.5-3 times the revenues. What's more, some of the pure-play EPC players with strong balance sheets are sitting on order books of 3.5-4 times revenue, and some even at 7 times the revenue!
However, Deora says a key concern is companies growing too fast to create a market cap, resulting in overlooking hidden issues in the current growth of companies. He said, “There is high flexibility in booking margins on a contract. Several contracts are known to have high margins in the initial phase and margin crashes or overruns become evident when the work nears completion. One should observe movement in net debt very closely and also pay attention to core working capital.” These factors, says Deora, can throw early warning signals for companies reporting higher-than-actual on-ground margins by manipulating overall project-portfolio level margins. These signals can never be 100% as there is a high degree of opacity in the sector. However, Deora’s advice is that experienced and pedigree companies which are growing at a steady rate are more reliable.
Indian Railways
Over the past few years, highways have been the main focus area in the transport sector. With Rs 7 lakh crore earmarked for it in the next five-six years, there is clearly a major thrust there. Nonetheless, Indian Railways, too, is seeing a renewed thrust as well as the Ude Desh ka Aam Nagrik (UDAN) scheme for regional air connectivity. While project awards are expected to pick up in these two segments, some measures have also been taken to amend old rules such as allowing lease period for station development up to 99 years (from 35 years earlier), to provide comfort to participating private companies. While the Swiss challenge method of awarding projects is slow and cumbersome, for now though, the Ministry of Railways has not scrapped this method altogether.
The Life Insurance Corporation (LIC) has provided Rs 1.5 lakh crore to Railways and expects it to push programmes like electrification, track laying, and station redevelopment. The Railways also wants to award all projects by the end of CY2018. In fact, the Indian Railways plans to set up a $5 billion Railways of India Development Fund (RIDF), which will serve as an institutional mechanism for the Railways to arrange funds from the market to finance various infrastructure projects.
The electrification programme is expected to be completed in the next four-five years and the packages are expected to increase to 300-500 km from 30-35 km at present. Bridge construction can also be a sizeable opportunity. There are a large number of owned bridges that are classified under the replacement category. However, Railways does not provide funding to replace them.
In the past few decades, the roads network has taken traffic away from Indian Railways. Now, the main bulk traffic that remains with the railways is for coal, fertilizers and wheat. That is no wonder, what with freight trains not even having a time table till date. Average travel speeds, too, are abysmal at 15-20 km/hr. The share of railways in traffic should certainly be more from the low levels at present. Once operational, the dedicated freight corridor (DFC) being implemented by DFCC is expected to change these dynamics in favour of Railways. However, the impact of projects like the DFC cannot be generalised, says Abhaya Agarwal, PPP leader at Ernst & Young. Agarwal said, “The DFC could impact traffic going from the national capital region (NCR) to the ports. One has to see the alignment and planning of DFC and accordingly understand that there could be routes which could face competition and also routes which could get feeder traffic from the same. In general, bigger vehicles or modes of transport will lose to high-frequency smaller vehicles or modes of transport in shorter distances. One should be careful of owning roads parallel to a coast or other infra developments which could have a high corridor of influence.”
Analysts point out the Railways has been slow to change since they did not want to cede operational control. However, the scenario is fast changing. The monetisation programme is expected to include revenue and reverse leasing of infrastructure. Investing in these annuity assets will be a large opportunity.
Conclusion
As the year ends and we look forward to 2018, it is always interesting to look at some important variables and numbers.
Notably, this year, India and Japan joined hands for infrastructure development in India's north-eastern states and are also setting up an India-Japan Coordination Forum for Development of North East to undertake strategic infrastructure projects in the northeast. The Ambassador of Japan to India, Kenji Hiramatsu, has conveyed Government of Japan's inclination to invest and offer any other feasible support for various ongoing as well as upcoming development and infrastructure projects in this region.
Sweden is interested in smart cities development in India and has put forward a Common Plan of Action for developing sustainable and environment-friendly public transport solutions and solid waste management for the smart cities under development. Of course, the agreement for smart cities as well as semi high-speed railways with France predates the agreement with Sweden.
And while there is much talk about the brick-and-mortar physical infrastructure assets, what about the internet infrastructure? This is not lagging, by any means. Under the Digital India initiative, the Government of India is devising a plan to provide wi-fi facility to 550,000 villages by March 2019 at an estimated cost of Rs 3,700 crore. The Airports Authority of India (AAI) plans to increase its capital expenditure for 2017-18 by 25% to Rs 2,500 crore, primarily to expand capacity at 12 airports to accommodate an increase air traffic.
Towards the end of 2017, in October, road projects worth Rs 7 lakh crore were approved under the Bharatmala programme to build an 83,677-km road network in the country. Just to put this in perspective, the ongoing highway building programme – the National Highways Development Plan (NHDP) – launched by the Atal Bihari Vajpayee government in 1998, has constructed roughly 25,000 km over the past two decades. In contrast, the Bharatmala programme aims to construct more than three times this length in one-third the time, by FY2022.
Also, in August 2017, a new Metro Rail Policy was announced to boost private investment in the sector. No wonder then, the infrastructure sector has emerged as a key driver for the Indian economy. The improved construction activity over the last three-four years and a decline in the number of stalled projects clearly indicate that the government has got its act together. The sector is responsible for propelling India’s overall development and enjoys intense focus with respect to new policies initiated to ensure a time-bound creation of world-class infrastructure. The size of the opportunity and the new model of contracts has already drawn several new players to the sector in the year gone by. Little known and mid-sized companies have started building a presence and there will be more to come. The government may be constrained by its own fiscal deficit target, especially considering the increase in compensation under the Land Acquisition, Resettlement and Rehabilitation Bill (LARR) 2013, which provides for compensation of four times the value of the land being acquired in rural areas and twice the value in urban areas. This may prove a constraint but 2018 promises to be an all-action year for infrastructure.
- TradeBriefs Bureau -
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