The construction industry is highly fragmented due to the presence of many organised as well as unorganised players. Across the industry, there are few long-term associations between contractors and clients, and there is a lack of economies of scale due to the uniqueness of projects. Smaller players possess better cost structures due to lower overheads.
The key listed construction companies contribute nearly 40 per cent of the industry’s output. The role of contractors has undergone a change with many of them making forays into infrastructure development. Subcontracting is gaining traction: a given project may be materialised via several small contracts. Some projects may require expertise in specific areas of construction, which a single contractor may not be capable of providing.
Indian Infrastructure analyses the annual financial performance of some construction companies selected on the basis of market capitalisation and diversified presence in the infrastructure space.
Overall growth in numbers
As per a sample of 41 companies tracked by India Infrastructure Research, the total revenue of 41 listed companies grew at a compound annual growth rate (CAGR) of 7.7 per cent between 2010-11 and 2014-15 and stood at approximately Rs 2,067 billion in 2014-15. Owing to the overall slow pace of project execution, the year-on-year revenue growth rates in the organised segment between 2010-11 and 2014-15 fell consistently. The highest level of 20 per cent was hit in 2010-11; growth reduced to 1.04 per cent during 2014-15, a year that saw a large number of stalled projects.
Out of the companies in India Infrastructure Research’s sample list, the data for value of plant and machinery was consistently available for 23 companies between 2010-11 and 2014-15. During this period, the value of plant and machinery for these 23 companies grew at a CAGR of 12.87 per cent, from Rs 181.38 billion in 2010-11 to Rs 294.33 billion in 2014-15. Since the sample size is small, median values have been considered too, in a bid to indicate the actual trend. The trend has been flattish in terms of the median book values of plant and machinery of these players across this period.
On the financial front, construction companies have been facing rising costs with respect to employee compensation, raw material procurement, and interest and other finance outgoes. Interest and finance costs grew sharply during 2010-11 to 2014-15. Even after the Reserve Bank of India (RBI) cut policy rates over the past 12-15 months, the interest rates remained persistently high as commercial banks did not transmit the rate cuts.
Financials of key players
India Infrastructure Research tracked the performance of the top 15 players in the construction space (based on market capitalisation). These include Larsen & Toubro (L&T), Sadbhav Engineering Limited, NCC Limited, Ashoka Buildcon Limited, J Kumar Infraprojects Limited, Jaiprakash Associates Limited, KNR Con-
structions Limited, Hindustan Construction Company (HCC), ITD Cementation India Limited and Gayatri Projects Limited. The order books of the majority of players reflect diversified portfolios. During the past fiscal year, order books did not grow much for many of the top players. In fact, many businesses experienced a dip in their order book position. L&T and ITD Cementation were among the few companies that saw some growth.
Overleveraged balance sheets kept players away from bidding for new projects. This was more pronounced in sectors such as roads where a number of players refrained from entering the build-operate-transfer (BOT) space which in turn impacted the volume of subcontracting. The scenario resulted in stressed cash flows, which meant that order backlogs were not cleared.
Unexecuted orders are most visible in sectors such as power and transportation. For instance, Ashoka Buildcon’s order book was dominated by the road and power generation and distribution segments; a major share of HCC’s order book was dominated by the transport, hydro power and water segments; L&T’s order inflow was led by the power segment; over half of NCC’s orders are spread across sectors such as building, roads, water and railways.
Due to the slowdown in project execution, income growth remained tepid. The 15 companies considered registered total revenues of Rs 1,580 billion for the year 2014-15, a small increase of about 5 per cent over the aggregate revenue reported in 2013-14.
Amongst the companies considered, nine registered a CAGR of over 10 per cent in their total income during the period between 2010-11 and 2014-15. In all, 12 companies registered a growth in their total income, while the remaining three witnessed a decline in the same (in terms of CAGR).
However, the supernormal surge posted by Welspun Enterprises is attributable to the amalgamation of Welspun Infra Projects, Welspun Plastics, and Welspun Infratech Limited. Companies such as NCC Limited, Sadbhav Engineering Limited and Ashoka Buildcon Limited posted an increase of over 25 per cent in 2014-15 vis-à-vis 2013-14. On the other hand, a fall of nearly around 20 per cent was posted by IL&FS Engineering and Construction Company Limited, Punj Lloyd, and Man Infraconstruction.
In attempting to gauge the ability of a firm to service outstanding debt, Indian Infrastructure Research has considered interest coverage ratio (ICR). ICR indicates if the firm is generating sufficient revenues to cover its interest expenses. Typically, a value of below 1.5 makes repayment ability questionable.
For the 15 companies considered, nearly half had ICR of below 1.5 in the past two fiscals. The recent rate cut by RBI, and the resulting reversal in the interest rate cycle will help ease the debt servicing burden; however, this alone will not sufficiently improve credit metrics. Improvement in the pace of project execution will be critical in determining the debt servicing ability.
As far as the profit margins are concerned, these have been impacted by big increases in the total expenditure while incomes have grown relatively slowly. Cost-side pressures from a depreciated rupee, burgeoning finance costs, along with rising input costs hit margins for the construction business. The stress was exacerbated by the muted pace of project execution. Players like L&T and Sadbhav Engineering reported falling operating profit margins (OPMs). For some players, such as Punj Lloyd and Jaiprakash, losses have increased. Others have seen improvements while remaining in the red.
During 2014-15, both the net profit margin (NPM) and OPM showed a decline. The median NPM of 15 companies as a share of their total expenditure stood at 0.57 per cent while the median OPM was 10.36 per cent. The declining trend of the NPM is reflective of high interest and tax outlays, which have persistently affected profit margins.
In addition, the extended working capital cycles and the need to support developer business have increased the quantum of debt with these companies, which, coupled with the higher overall cost of capital, have enhanced the interest burden and trimmed the NPM. With regard to the OPM, it is evident that increasing variable costs of operations over the years have depressed the operating profits of the companies.
The government’s emphasis on pushing through stalled projects, as well as its focus on enabling policy measures for infrastructure development, can be expected to translate into better order inflow and execution. This will be especially useful for companies that have funds tied up in stalled projects. The bulk of the interest is expected to be in the engineering, procurement and construction space, as the scenario for public-private partnerships remains difficult. The project pipeline across sectors is also robust.
It may be expected that financial bottom lines would improve for companies which have sufficient liquidity for execution of projects, due to the easing of commodity prices.
The trend of raising funds through the sale of equity/asset stakes has gained traction over the past 12-15 months. This has imparted some liquidity to construction players and helped in deleveraging balance sheets. The asset-light approach adopted by a number of players has aided in paring outstanding debt. Assuming that banks start to pass on interest rate cuts, and anticipating further rate cuts by RBI, the interest and financial outgo should reduce.