Stable Outlook

Improving the preparedness of the road sector

The government has been taking a number of initiatives to help the road construction industry mitigate the impact of Covid-19. With recovery setting in, the outlook for the sector seems stable. Rajeshwar Burla, vice-president and co-group head, corporate ratings, ICRA Limited, shares his views on the impact of Covid-19 on the road sector, key government initiatives and the sector outlook…

Liquidity boosting measures by MoRTH supported road contractors

Over the past seven years, the government has focused on addressing various project execution bottlenecks. Most of these measures were fully implemented by the end of financial year 2015 and, therefore, financial year 2016 saw a sharp 37 per cent pick-up in execution, with the execution rate reaching 16.6 km per day for the Ministry of Road Transport and Highways (MoRTH). Thereafter, with healthy new project awards and a continued focus on debottlenecking, the pace of execution increased further to 29.7 km per day in financial year 2019 before declining to 28 km per day in financial year 2020 due to the impact of Covid-19 in March 2020.

To mitigate the adverse impact of Covid-19 on road contractors, MoRTH has initiated a slew of relief measures including a shift from milestone-based billing (typically ranging between 45 and 75 days) to monthly billing and release of retention money/performance security in proportion to the work already executed. These initiatives have helped in reducing the cash conversion cycle, while also getting performance guarantees and associated margin monies released for the executed portion of the projects. Notwithstanding the high cost of remobilising labour, many road contractors made special arrangements to facilitate a return of labour due to an improved cash conversion cycle from MoRTH/ National Highways Authority of India (NHAI) projects. Project execution, which was down 73 per cent on a year-on-year basis in April 2020 due to the nationwide lockdown, picked up pace from June 2020, ably supported by liquidity boosting measures from MoRTH and NHAI. Execution in financial year 2021 stood at 13,327 km, 30 per cent higher than the 10,237 km recorded in financial year 2020. Overall, execution grew at a compound annual growth rate (CAGR) of about 20 per cent during financial years 2015-21. Execution in the four-month period April-July of financial year 2022 stood at 2,927 km as against 2,434 km during the same four-month period of financial year 2021.

While the second wave of Covid-19 caused some disruption in overall construction activity in the country, the performance of most mid- and large-sized road construction companies is not expected to be impacted materially due to this. Most of the road projects are located in remote areas, or at a distance from metros and large cities. Given that the sector had faced more intense effects during the first wave of Covid, most companies have improved their preparedness in terms of labour and raw material availability. Furthermore, unlike the first wave, there has been no nationwide lockdown and only localised restrictions have been imposed, with exemptions for construction activities.

The strong pipeline of under-construction projects, limited impact of the second wave on road construction activity and massive increase in budgetary allocations are expected to support the pace of execution of road projects. Consequently, highway construction is likely to surpass 40 km per day in financial year 2022.

MoRTH execution

Increased competitive intensity in central government-funded road projects with a relaxation in bidding eligibility criteria

MoRTH has provided relaxations in the eligibility criteria of bidders for hybrid annuity model (HAM)/engineering, procurement and construction (EPC) projects, which has, in turn, resulted in increased competitive intensity over the past few months with the entry of new players into the road sector from other sectors (stadiums, hospitals, hotels, smart cities, warehouses/silos, oil and gas) as well as an increase in the bidding eligibility of existing players. Lower state capex, reduced private sector opportunities and higher opportunities in the road sector have pushed more entities towards the road sector.

ICRA Ratings expects the central government spend on infrastructure to be maintained, given the positive multiplier effect that infrastructure building would have on the overall economy, notwithstanding the adverse impact of the Covid-induced slowdown on economic activity.

Therefore, competition in the road sector is expected to remain at an elevated level with more contractors fulfilling the relaxed eligibility criteria. The EPC mode continues to remain extremely competitive, with many bidders quoting at a discount of as much as 30-35 per cent to NHAI’s base price. BOT (HAM) has also witnessed heightened competition, resulting in the average premium to the NHAI cost reducing to around 15 per cent from 25-30 per cent earlier, and even negative operations and maintenance bids in some cases. The number of bidders has surpassed 40 (of which 30 were qualified) for some of the EPC projects and 10-15 (compared to 5-10 earlier) for HAM projects.

Increased competition in EPC and HAM projects would adversely impact the profitability of the contracting companies. This apart, the increase in the prices of key raw materials would further impact the profitability of both EPC and HAM projects. While the impact of the price increase on the profitability of EPC projects is expected to be limited, as price escalation is covered in EPC agreements to a large extent, the impact would be much higher on HAM project returns, notwithstanding the inflation-linked adjustment to bid project costs.

The aggressive bidding may also lead to projects getting delayed or stuck, as lower profitability would constrain the contractor’s ability to absorb time and cost overruns. Such overruns could be due to various reasons, including a steep increase in commodity prices, a change in scope, delays in land acquisition and approvals, and force majeure events.

Bidding discipline remains key for road contractors to maintain adequate profitability and avoid a build-up of stress on the working capital cycle.

Quarterly toll collection estimates for FY2021 (%)

Strong bounce-back witnessed for toll road assets post the Covid first wave-induced shock

In financial year 2021, the unabated rise in Covid-19 infections during the unlock phase, localised reimposition of lockdowns in several states, and heavy monsoons in many parts of the country interrupted the recovery in commercial traffic till July 2020. Covid fears, along with limited availability of public transport, led to a steady and significant increase in passenger vehicular movement. The sharp pick-up in the manufacturing and construction sectors contributed to a healthy rise in commercial vehicular movement. The quick recovery has arrested major slippages in the credit profile of toll road assets. Overall, toll collections for national highway projects declined by 3-5 per cent in financial year 2021.

Year-on-year (YoY) and month-on-month (MoM) trends in the generation of GST e-way bills

Toll roads likely to witness 12-14 per cent revenue growth in financial year 2022

With the sudden and severe onset of the second wave of the pandemic, toll collections were again on the downward trajectory in April and May 2021. Toll collections reduced by around 10 per cent in April 2021 over March 2021 and are estimated to decline by 25-30 per cent in May 2021 over April 2021.

However, unlike the earlier wave where there was a nationwide lockdown and toll suspension, this time the lockdowns are more regional, with relaxations for both manufacturing and construction activities and movement of goods. As a result, the impact on overall toll collections is less severe as compared to last year.

With the fall in the number of Covid cases from the third week of May 2021, the states relaxed the lockdown restrictions in a gradual manner. FASTag data shows a rebound in toll collections. After witnessing a de-growth of 10 per cent and 23 per cent respectively in April and May 2021, they witnessed a growth of 21 per cent and 16 per cent in June and July 2021 respectively. Despite hitting a speed breaker in the form of the second wave of Covid, toll road projects are expected to witness a 12-14 per cent growth in financial year 2022 on the back of a low base and an inflation-linked increase in toll rates.

MoM trends in FASTag collection

Asset monetisation remains the key to funding the ongoing Bharatmala programme

The role of monetisation of mature operational assets is important in meeting the funding requirements of the ongoing Bharatmala programme. While the toll-operate-transfer (TOT) and infrastructure investment trust (InvIT) routes are being pursued actively, timely monetisation remains important.

The average cost of award for the Bharatmala Pariyojana stood at Rs 238 million per km, which is 54 per cent higher than the initial estimated cost of Rs 155 million per km. This is largely on account of a steep increase in land acquisition costs and prudent bidding by developers. The total outlay towards the Bharatmala Pariyojana is now estimated at upwards of Rs 9.6 trillion, as against Rs 6.9 trillion earlier. In this context, the success of NHAI’s asset monetisation programme – both TOT and InvIT – will be critical in plugging cost escalations.

Outlook remains stable

A significant pipeline of road projects to be awarded under the Bharatmala programme over the next three years would boost the order book of medium- to large-sized developers. The reduced bank guarantee requirement for a major part of financial year 2022 and the reduced working capital cycle for MoRTH/ NHAI projects are expected to support the liquidity. Further, good growth in toll collections for toll road projects in financial year 2022 is expected to result in improved credit metrics. However, the lack of bidding discipline would be a credit negative, which would exert pressure on the profitability and working capital indicators of contractors. Overall, the outlook for the next 12-18 months is stable.

Rajeshwar BurlaRajeshwar Burla, vice-president and co-group head, corporate ratings, ICRA Limited

 

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