Road construction companies began 2020 on a high note with booming stock prices, following the announcement of the National Infrastructure Pipeline (NIP). However, most of their gains now have been eroded in the recent market carnage.

The rout in stock prices reflects the bleak prospects of most companies in the sector, which are expected to worsen further due to the Covid-19-induced lockdown. Many experts are now beginning to compare the current slowdown in the construction sector to 2008 and 2013, when many players with weak financials were forced to exit the industry.

How were the road construction companies placed before the Covid-19 pandemic? How does the lockdown impact their business? What are the key parameters that will drive business growth going forward? Read on to find out.

A road block in FY20

The road construction sector space had already been reeling during the first nine months of FY20.

Companies faced execution delays due to multiple reasons such as embargoes related to pollution control and State-level political upheavals.

Even the toll revenues (on completed projects) were weak owing to lower highway traffic due to the economic slowdown in the country.

Hence, consolidated revenues of the companies (barring PNC Infratech) saw a meagre growth of 2-13 per cent y-o-y in the first nine months of FY20, much lower than the compounded average growth rate (CAGR) of 11- 36 per cent from FY15 to FY19.

PNC Infratech recorded a 70 per cent spike in its consolidated revenues, largely due to its strong executional capabilities that fetched it early-completion bonuses worth ₹678 crore in the first nine months of FY20.

Also, with the slowdown in the awarding of orders by the Centre, companies reported a decline of 4-49 per cent in their outstanding order book in December 2019, compared with March 2019 levels.

Only KNR Constructions managed to record an increase of 47 per cent during the same period, thanks to its diversified portfolio.

Lockdown blues

Just when the companies had pinned their hopes on revival in the March quarter, the pandemic, followed by the nationwide lockdown, came as a slap in the face. Road construction projects will be among the first to benefit from the gradual lifting of lockdown restrictions, but execution is expected to be slow.

This is because, one, the reverse migration of workforce could hit the construction companies hard.

However, companies such as Larsen and Toubro that have retained most of their workers in camps, could fare better.

Two, even if the lockdown is completely lifted by June or July, the South-West monsoon can hamper construction work.

That apart, after a complete halt in toll revenue collection during the lockdown, toll traffic is expected to remain tepid for most part of FY21 as well.

Further adding to the woes, order inflows are also expected to remain weak going ahead, given the Centre’s stretched finances and higher healthcare spends.

The Centre’s instruction to the Ministry of Road Transport and Highways (MoRTH) to cut down its expenditure for the first quarter of FY21 to 20 per cent of the budgeted amount will further impede order flows.

The silver lining is that the existing order books of most companies guarantee revenue visibility for 1-4 years.

Also, it is expected that the government would prefer to revive this segment at the earliest due to its employment-generation capabilities.

The larger concern in the near term could be the stress on the working capital of these companies. Given the skeletal workforce at most government departments, payment from the government could get delayed.

Companies in the road construction space, with heavy dependence on States and the Centre for their receivables, were already seeing a stretch in working capital requirements.

This is only expected to intensify further in the coming quarters.

The existing leverage profile could be the key determining factor for companies while dealing with the near-term challenges in liquidity and finances.



Less the leverage, the better

Unfortunately, most companies in the road construction space are heavily debt-laden.

This is because, during the initial years of public-private partnership (PPP) in road and highway construction, from 2010 to 2013, the Centre mostly awarded contracts under the build-operate-transfer (BOT) model.

Under this model, the developer had to bear the cost of construction, and the returns (toll revenue for a given period) only flowed in after the completion of the project. Companies had to borrow heavily to finance the construction cost.

Also, due to the competitive bidding process, most projects (mainly BOT) awarded during FY10-FY13 promised a handsome premium to the National Highways Authority of India (NHAI).

Private bidders, however, had to pay for their aggressive bidding, soon after. Many of these projects subsequently sought premium deferment due to substantially weak traffic. For a few, this even led to project cancellations. According to an ICRA report, in FY12, not only did the order awarding by NHAI hit a record high, but project cancellations, too, increased 49 per cent; this is the highest ever in a year.

The BOT model soon turned unviable for the private developers. While on one hand, order books flourished, on the other hand, execution suffered due to poor availability of land and prolonged delays in getting other approvals. Soon, companies were in a debt trap, unable to meet the surging interest burden, which even led to the insolvency of many players such as IVRCL and Lanco Infratech (both currently under liquidation).

Hence, in a bid to revive the appalling state of PPP projects, the Centre introduced the Hybrid Annuity Model (HAM) — where the Centre (NHAI) contributes 40 per cent of the project cost — in January 2016.

This, coupled with the launch of the Bharatmala Pariyojana — the Centre’s flagship road and highways programme — led to a surge in order-awarding by the NHAI, with 30 per cent growth (CAGR) over FY16-18. Following this, the order books of the companies in the listed space grew 12-49 per cent (CAGR) over FY16-18. However, during these years, the companies continued to assume more debt. The consolidated debt of all companies, barring Gayatri Projects and KNR Constructions, surged by 30-60 per cent over FY15-19.

Dilip Buildcon, for instance, saw a two-fold jump in its consolidated debt to ₹7,400 crore in FY19 from ₹3,511 crore in FY15. However, the company’s debt-to-equity ratio improved to 2.45 times in FY19, from 4 times in FY15. This was thanks to the strong growth in profits (a surge of 58 per cent CAGR over FY15-19) and a capital infusion of ₹430 crore in FY17.

However, with an interest cover ratio of just 1.8 times in the first nine months of FY20, the company might not be the best in class. The interest cover ratio, arrived after dividing the operating profits by finance costs, helps ascertain the interest-servicing capacity of a company.

While both KNR Constructions and Gayatri Projects reined in their debt intake, the former stands out in terms of its interest-servicing capacity.

While the company’s consolidated debt increased by a meagre 3 per cent over FY15-19, its interest cover ratio of more than 6 per cent reflects both sound profitability and a healthy leverage profile.

The next best would be PNC Infratech, with a debt-equity ratio of just 0.9 times (as of September 2019) and an interest coverage ratio of 3.7 times (in the first nine months of FY20).

Ashoka Buildcon and Sadbhav Engineering have emerged as the worst among the lot. While their net debt-to- equity ratios spiked as high as 20.1 times and 13.2 times, respectively, in FY19 (from 2.8 times and 4.4 times, respectively, in FY15), their interest cover ratio remained below 1.5 times.

Bottom-line: Given their better leverage profiles and interest-servicing capacitie, KNR Constructions and PNC Infratech fare better than their peers.


Asset sale to reduce debt

A few companies, however, took shelter in one of the key policy changes of the Centre, in a bid to ease their debt burden. The policy change permitted a private contractor to divest up to 100 per cent of its equity stake in a project after two years.

Hence, in the past couple of years, the road construction space saw healthy stake sales to private equity players, much of which fructified only in FY20. For instance, Sadbhav Engineering recently completed a 100 per cent stake sale in eight of its HAM projects to Indinfravit Trust in March 2020. Not only did it help the company earn 1.7 times return on its initial equity investment in the projects, but also cut down its consolidated debt to just ₹ 5,990 crore, from ₹ 11,497 crore as of December 2019.

Similarly, Cube Highways and Infrastructure, one of the key PE investors looking for investments in Indian road assets, signed several share purchase agreements with Dilip Buildcon, PNC Infratech and KNR Constructions.

For Dilip Buildcon, Cube helped ease funding requirements of ₹278 crore in five HAM projects and pumped in another ₹424 crore as a consideration for its current equity stake in those projects.

KNR Constructions and PNC Infratech were disburdened from funding requirements of ₹1,800 crore and ₹300 crore, respectively.

Ashoka Buildcon, however, continues to reel under pressure, despite being able to sell stakes in its BOT projects as early as 2012. The requirement to pay a specified return to SBI Macquarie, which bought 34 per cent stake in the company’s BOT projects, continues to be an overhang.

The company also needs to raise another ₹4,500 crore for the seven HAM projects in its portfolio.

Bottom-line: Stake sale in existing projects puts Sadbhav Engineering in a slightly better position than another debt-laden peer — Ashoka Buildcon.

Preferred project models

While the introduction of HAM was expected to ease the debt burden of the private companies, it could only help a bit. This is because the developers still had to arrange for 60 per cent of the project cost, and for the remaining 40 per cent, the NHAI would reimburse the company in five instalments, based on the stage of project completion.

Also, the annuities (a compensation for toll revenue) only flowed to the developers after the completion of the project, akin to the BOT model.

Hence, with mounting debt on their balance sheets, companies could not accept more HAM contracts. Due to this, the engineering-procurement-construction (EPC) contracts — which had been the norm before the introduction of BOT — began gradually picking up steam from FY18.

EPC contracts are plain-vanilla construction contracts in which the developer is paid solely based on the stage of project completion and receives absolutely no share in the toll revenue of the highway constructed.

From sub-50 per cent in FY18, the share of EPC contracts surged to 72 per cent in FY20, in the contracts awarded by NHAI.

But soon, with increasing EPC contracts, the NHAI’s debt also ballooned from ₹24,000 crore in FY14 to more than ₹2.3-lakh crore in FY20.

This was because the only sources of funds for the NHAI are Budget allocations and market borrowings.

Given the current state of NHAI’s debt position, coupled with the increasing fiscal pressure on the Centre, most analysts expect the NHAI to turn back to HAM- or BOT-based contracts — passing on the burden of raising finances on to the private players. However, this might not be a welcome move, given the debt profile of most companies and reluctance of most banks to offer loans to road contractors. For instance, Ashoka Buildcon, which has about ₹5,881 crore of debt (consolidated) on its balance sheet, might not be able to even bid for HAM or BOT contracts, due to its lower likelihood of securing bank finances.

Bottom-line: Given their debt profile, KNR Constructions, L&T, PNC Infratech and Gayatri Projects are in a better position to participate in the bids, if the NHAI does shift its focus towards HAM or BOT contracts. If the EPC-based awarding were to continue, all companies stand to gain.

Diversification is key

To secure itself from an event where the Centre shifts away from awarding EPC road contracts, companies are attempting to diversify their order book to maintain a steady flow of revenue.

Gayatri Projects, which has now emerged as a 100 per cent EPC company, has added projects from irrigation and mining sectors as well — contributing about 21 per cent and 4 per cent, respectively, to the company’s outstanding order book.

Other companies such as KNR Constructions (28 per cent of order book), Dilip Buildcon (6 per cent) and Sadbhav Engineering (3 per cent) also have added irrigation-based contracts to their portfolio. Ashoka Buildcon and PNC Infratech are eyeing metro and other railway contracts to diversify their portfolio.

For L&T, where infrastructure already contributed only 53 per cent of its entire order book, has now started acquiring varied projects under the infrastructure segment, aside from transportation infrastructure projects. These include water and effluent treatment, and smart world and communication.

The Centre began 2020 with a big bang announcement — the NIP.

Projecting the required infrastructural spends to be about ₹102-lakh crore under the NIP, the Centre set out a five-year timeline for more than 6,800 projects. Of the total projected capital expenditure — which includes a near 22 per cent required to be chipped in by private players — the Centre has earmarked just about 19 per cent towards roads.

Other prominent sectors such as energy (24 per cent), railways (13 per cent), urban infrastructure (16 per cent) and irrigation (8 per cent) are expected to garner equal impetus under the NIP.

Given this, companies with a much-diversified portfolio, such as L&T and KNR Constructions, stand to benefit, even if the NHAI further slows its order awarding in FY21.

The final word

Based on the above parameters — working capital efficiency, leverage profile and order book diversity — L&T, KNR Constructions and PNC Infratech have better financial strength to tide over the near-term threats facing the road construction sector.