Road To Riches

The word infrastructure might conjure up images of projects stuck or construction abandoned. But road construction in the country is an entirely different story. The significant ramp-up of road projects has seen road construction players drive in the fast lane. Order books have risen to all-time highs, with many companies having orders about four times their sales, which gives earnings assurance for the next three-four years. Road construction stocks have started reacting favourably to this. Some, such as KNR Constructions and Dilip Buildcon, have been surging for quite some time. Others have started rising only recently. For instance, IRB Infrastructure has risen 40 per cent in the past three months.

Companies in this space have started seeing a small but evident re-rating of their valuations. As against the past price multiple average of 14 times, many are trading at earnings multiples of 18-20 times, showing investors' faith. But that's not the entire story. The increase in order book is driving markets to believe that a further upturn in valuation is possible. For instance, the sector is seeing an order uptick due to a 7 per cent increase (7,400 km) in the length of national highways. "A pick-up in conversion of state highways to national highways, recent reduction in threshold for upgrading to four-lane roads and eventual financial deleveraging can yield 18 times one-year forward earnings multiple for the sector. The sector is trading at 14 times 2019/20 estimated earnings, suggesting good potential in the next one year," says Aditya Mongia, an analyst tracking the sector at Kotak Securities.

Drivers of Revival

The biggest issue plaguing the sector was policy inaction, resulting in a large number of projects getting stalled. However, that has now reversed, with the government clearing stalled projects and breathing new life into the sector. In the latest Economic Survey, the government said there were about 482 stalled projects worth `3.17 lakh crore facing issues such as cost and time overruns. However, the government said that due to policy intervention, 88 per cent of these have now been put back on track.

"The proportion of under-construction, high-risk highway projects has shrunk significantly, from 53 per cent two years ago to 21 per cent now, after a slew of steps initiated by the National Highways Authority of India (NHAI). These include notably shorter timelines for right-of-way and approvals, loan support from the NHAI for languishing projects, termination of stuck projects and their subsequent re-awarding, and affording a change in sponsor," says a Crisil report.

Because of this, the liquidity position of companies has improved and companies that were starving for funds have started getting back on their feet. Their credit rating has also improved, enabling them to borrow or swap existing loans at lower rates and strengthen their balance sheets. Besides, the government has made significant changes in bidding policies to revive the interest of developers who were stuck because of stressed balance sheets.

At one time, there were no takers for the projects, especially in the built-operate-transfer, or BOT, space, which required large debt and equity funding. Having seen the down cycle, the interest in new bids was reduced to two-three operators. This has now gone up to double digits. The market had become so cautious that everyone wanted to sell and exit.

But things changed with the government tweaking projects in the hybrid annuity model (HAM) category - in this, the government contributes 40per cent cost in the first five years through annuity. The remaining payment is made on the basis of the assets created and the performance of the developer. Today 98 per cent of the projects are awarded in this category. With this, a large part of funding and risk of toll collection is absorbed by the government, a win-win situation for developers as they can book revenue faster and are not faced with a huge risk. Further, out of about 17,000 km of highways constructed in 2017/18, nearly 13,449 km were constructed under the EPC model, which is impressive given that EPC does not require significant funding and developers do not have to take the risk of operating the project and collecting the toll, which may be volatile because of economic and political uncertainties, as seen during de-monetisation and GST implementation.

Nevertheless, the NHAI is busy mopping up money for future funding. It recently monetised 650 km of roads, valued at about `10,000 crore. It further plans to divest 4,500 km to raise about `1 lakh crore to support its ambitious road-construction plans. This is good news for private developers and road-construction companies which lack adequate financial resources.

Road Ahead

What is encouraging is that the pace of awarding projects has increased considerably. In the last fiscal, the road ministry awarded projects of about 17,055 km, up 7 per cent from 2016/17. This is far better than the average NHAI project-awarding of about 2,860 km in the last five years. Highway construction has quickened to 27 km per day in 2017/18; it was about 16.6 km in 2015/16. Interestingly, the government is now aiming at 40 km a day, which will be huge in terms of opportunities for companies in the sector. "The awarding of contracts, led by HAM and toll-operate- transfer models is expected to continue given the announcement and subsequent implementation of the Bharatmala project," says Crisil in its note.

The road ministry and the government had earlier indicated an investment of about `7 lakh crore in the next five years to build 85,000 km roads, including about 35,000 km under its flagship programme, the Bharatmala Pariyojana. "With the government's massive plan to build 83,677 km of roads in the next five years, we believe project awarding would maintain the momentum. The NHAI chairman has guided for awarding 4,000 km in Q1 FY19 and 8,000 km in FY19. Bids for 232 projects (11,200 km) worth `2 lakh crore have already been invited," says Rita Tahilramani, Sector Analyst, SBICAP Securities.

Key Beneficiaries

This opens up vast opportunities for companies with clean balance sheets, ability to raise funds and good execution capabilities. "The strong award momentum in the sector in the past couple of months highlights the government's commitment to the Bharatmala programme. Companies with strong execution capabilities and risk-management processes should be long-term winners," says Girish Achhipalia, who tracks the sector at Morgan Stanley.

The road sector in India is rapidly scaling new heights with the highest-ever project-awarding of 17,055 km, and road construction touching 9,829 km in FY18. This momentum has picked up pace after the October 2017 announcement of the Bharatmala scheme. While tenders for 232 projects (11,200 km) worth `2 lakh crore have already been floated, the NHAI chairman has guided for awarding 8,000 km in FY19. "We believe that good contractors with strong financials, such as Sadbhav Engineering, KNR Constructions, Dilip Buildcon, PNC Infratech, Ashoka Buildcon and HG Infra, will continue to benefit from growth in the roads sector," says Rita Tahilramani, sector analyst, SBICAP Securities.

Companies such as Dilip Buildcon, Ashoka Buildcon, J. Kumar, KNR Construction and several other smaller operators have been growing rapidly. Moreover, many of these are at a debt-to-equity ratio of less than one, with the best working-capital cycle in the industry. They not only possess balance-sheet strength to undertake larger projects but have also demonstrated strong execution capabilities, which would allow them to deliver strong growth in the coming years.