With the Government increasing the outlay on highways and railways in Budget 2016-17, order inflows in the construction sector are likely to grow.

The Centre has increased the allocation for highways by 28 per cent and has targeted award of 10,000 km of highways in FY17. Further, it has laid out ambitious targets for spending on other infrastructure sectors and irrigation, drinking water supply, housing and power supply, which would entail significant opportunities for the sector over the medium term.

Companies in the construction sector continued to witness negative cash flows from operations (CFO) in FY16, which is likely to improve gradually to near zero levels in FY17 as more orders procured during the last two years are executed, according to India Ratings and Research (Ind-Ra).

According to Vinay Betala, Associate Director, India Ratings, “The competitive intensity for new orders had reduced over the last two years. Hence, margins on such orders are expected to be higher.”

Prudent accumulation of orders with a close correlation between the capacity to execute and order book size will be crucial to improvements in cash flows and credit metrics of individual companies. Therefore, India Ratings expects companies to focus on margins and funding while bidding for new projects and to limit their order books near current levels as a multiple of revenue, which will provide for a moderate growth in revenue along with improvement in cash flow margins.

Negative cash flows from operations are a legacy of the aggressive bidding seen during FY10-FY12 when companies focussed on building their order books. In such orders, EBITDA margins were very close or even lower than retention money margins in some cases, leading to negative operational cash flows.

Also, companies did not focus on funding by the customer, resulting in long receivables and inventory holding periods. The construction sector’s receivable days has widened by 33 per cent to 141 days and the inventory holding period has risen by close to 9 per cent to 124 days in the last five years.

As highlighted in the report, Construction Sector to See Gradual Improvement in FY17, liquidity remains weak as indicated by a negative CFO. Difficult borrowing conditions due to weak balance sheets are also seen to affect liquidity. Companies with strong liquidity, however, will continue to have a significant advantage over their peers.

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