Weathering the Storm

The road sector’s journey through unprecedented times

The road sector has faced unanticipated disruptions on account of Covid-19. The impact ranges from derailed project execution to revenue losses due to suspension of toll collection and a marked reduction in traffic. The pandemic is also likely to have a strong impact on the National Highways Authority of India’s (NHAI) asset monetisation strategy through infrastructure investment trusts (InvITs) and the toll-operate-transfer (TOT) model. A number of developers and contractors have invoked the force majeure clause. The debate around whether the pandemic is to be considered a political or non-political event has further worsened the operating environment for stakeholders. On their part, the Ministry of Road Transport and Highways (MoRTH) and NHAI have initiated a series of measures that have lent some confidence to contractors and developers. Despite the odds, the government seems confident of achieving its targets, while the industry holds a cautiously optimistic stance due to strained liquidity and stressed balance sheets. Going forward, the crisis is likely to become a key factor in determining upcoming contracting trends in the industry and the funding avenues available with the government.

Hand-holding along the way

A number of measures were announced to mitigate the impact of the crisis. The government extended completion timelines by up to six months for contractors. Besides, a standstill period of six months was announced for contractors and public-private partnership concessionaires, with no associated penalties for not meeting project milestones.

The government has also agreed to ease companies’ cash flow position by partially releasing bank guarantees. The Reserve Bank of India (RBI) provided a moratorium of six months on term loans up to August 31, 2020. With the moratium period over, the RBI is all set to announce the corporate loan restructing norms soon. In addition to time extensions, NHAI is also offering Covid-19 loans to private concessionaires at an interest rate of 2 per cent more than the bank rate. During March 2020, it made total payments worth Rs 250 billion to contractors, including Rs 100 billion paid at the time when the entire country was under lockdown. Besides, with support from different state governments, important construction activities were resumed during the lockdown itself. Despite labour availability issues, the authority has almost reached normalcy in operations now, and is hopeful of achieving its award and construction targets for the current fiscal year.

Both the MoRTH and NHAI have migrated from a milestone-based payments system to a monthly payment mode. The authority has also been working on expediting the settlement of disputes through conciliation. Through this route, NHAI has settled claims worth about Rs 133.5 billion for Rs 37.4 billion since 2017-18.

How construction took a hit

Construction activity has been rather muted in the first quarter of 2020-21. It came to a standstill in April 2020 soon after the government announced the nationwide lockdown. Only about 847 km of highways were constructed during April-May 2020, as compared to 1,692 km during April-May 2019. Project execution improved significantly in June 2020, with an additional 976 km constructed during the month, as compared to 463 km constructed in June 2019. Overall, MoRTH has already surpassed the highway construction target of 2,771 km for April-August 2020, by about 410 km. Cumulative awards also rose to 3,300 km in this period, from 1,367 km in the year-ago period. However, project execution in 2020-21 is expected to be lower by 15-20 per cent against the target of 10,250 km. Even after the lifting of the lockdown, widespread labour migration and supply chain disruptions continued to hamper road construction. Although material and equipment procurement are not an issue any longer, labour shortages and working capital constraints continue to pose serious challenges for contractors. Developers believe that the golden period of construction (February to mid-June) has been lost due to the Covid-19 pandemic and second-quarter construction activity will be impacted due to the monsoons. Overall, a delay of up to six months is expected in projects. Construction has to be speeded up in the third and fourth quarters of this fiscal year. While the government has given three-six month time extensions for projects, operation and maintenance (O&M) costs and interest payments are still piling up.

Meanwhile, the government’s ambitious BharatmalaPariyojana is also expected to be delayed by about three years. While projects under Phase I of the programme were initially targeted to be completed by 2022, they are now expected to be awarded by 2022-23, while construction work is now targeted to be completed by 2024-25.

Impact on traffic and toll collections

On the operational front, the nationwide lockdown has had serious implications for road traffic and toll collections of highway developers. Toll collections were completely suspended for 25 days during the lockdown, causing a slump in toll revenues. However, despite slow traffic growth with the lifting of the lockdown, as of June 2020, average toll collections have improved to over 90 per cent of pre-Covid levels. Overall, toll collections are expected to decline by 11-17 per cent in 2020-21 on account of the Covid-19 pandemic.

The MoRTH has announced force majeure in light of the pandemic, while NHAI has laid guidelines for compensation to road developers in individual concession agreements. However, uncertainty still looms with respect to the extent of compensation that will be given to toll operators. Concessionaires have concerns regarding the government not declaring the toll collection suspension period as a political event under the force majeure clause. Given the unavoidable fixed costs, the pandemic is also expected to have an impact on overall profitability, liquidity and cash flows. Operations in the second quarter of 2020-21 are expected to remain subdued due to the difficulty in project execution during the monsoon season.

Effect on asset monetisation

Covid-19 has had a severe impact on at least the medium-term viability of projects. Traffic studies will now have to be revisited to take the pandemic into account. The impact of the crisis on GDP is still uncertain, as a result of which market interest for the upcoming toll-operate-transfer (TOT) bundles is hard to ascertain. Investor interest in the TOT model is thus expected to be limited for some time. Low rates of tolling could impact the valuation of TOT projects as well. Therefore, a complete structural assessment is required.

Bid due dates for TOT Bundle IV have already been extended multiple times on account of investor requests for more time to assess market conditions prior to bidding for the projects. As of now, the bid submission date for the bundle has been set at September 30, 2020. Besides, sale proceeds for the TOT Bundle III, which were expected to conclude by April 2020, got delayed since Cube Highways, the highest bidder, could not close the Rs 35 billion financing deal with the State Bank of India until September 8, 2020, as a result of the Covid-induced traffic uncertainty.

Meanwhile, a few investors and industry experts believe that NHAI should do away with the concept of an initial estimated concession value for TOT bundles and allow bidders to bid freely for the bundles. Besides, the highway stretches included in the TOT bundles need to be chosen with greater due diligence to ease the operational difficulties involved. Investors, on the other hand, are optimistic about NHAI’s upcoming InvIT. However, this too will be fraught with delays.

Bid delays on account of Covid-19

The loss on account of sluggish toll collections and labour/material shortages, coupled with swelling order books, has magnified liquidity issues faced by highway developers, limiting their ability to bid for new projects. Bid submission deadlines for the majority of upcoming highway projects have witnessed multiple extensions over the past few months.

India Infrastructure Research tracked about 40 NHAI projects that are at the bidding stage and for which bids have had to be extended as a result of the Covid-19 crisis. The average bid extension has been calculated since early March 2020 to get a broad idea of the pandemic’s impact on upcoming projects. As per the analysis, so far, the maximum delay in bids has been recorded at about six months, while the minimum delay has been recorded at about 35 days. On average, projects at the bidding stage have recorded a delay of approximately five months.

Outlook in the aftermath

The impact of Covid-19 is likely to be felt in 2021-22 as well. The industry expects normalcy to set in 2022-23 onwards. As for the next two years, traffic growth is expected to hover at 5-6 per cent. While Covid-19 has impacted the pace of construction in the current fiscal year, the ministry aims to reach a construction rate of 30 km per day in the next couple of years.

During 2020-21, NHAI has set an award target of 4,500 km and plans to construct about 4,000 km of roads. As the Covid-19 crisis has had a strong impact on the road sector, it will take at least 15-18 months to regain lost ground. Having said that, the long-term outlook for the sector still remains positive with investments planned under the National Infrastructure Pipeline set to provide a boost to the sector. However, the pace of recovery and future market sentiment will be contingent on the adequacy of the relief measures provided by the government. While the upcoming InvIT is considered to be well timed on the part of NHAI to raise funds for upcoming projects, investor interest in the new TOT bundles needs to be gauged well, given the uncertainty surrounding future traffic trends. Besides, despite the modest progress made by NHAI in resolving disputes through conciliation, more needs to be done to fast-track dispute resolution in case of arbitration.

The road sector is expected to be the biggest driver of merger and acquisition activity in the next few years. While there are several operational projects that the government has identified for monetisation, the ongoing hybrid annuity model projects will also offer lucrative acquisition opportunities to investors three-four years down the line.

Deeksha Soni and Rolica Bhatnagar

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