Road construction sector is one infrastructure play that offers strong visibility in Revenue and Earnings growth in India. Fy 18 saw strong traction in road construction companies that were able to execute projects on time and were able to win orders floated by the NHAI. The balance sheet profile also saw improvement with a few companies seeing credit rating upgrades. The projects were able to move at a fast pace on the back of faster land acquisitions and environmental and other clearances.
We are overweight on stocks in the road construction segment of the Infrastructure sector since the last couple of years and going by the performance since the time of recommendation of the three Companies in our ‘strong core’ portfolios, that have risen by 286%, 148% and 47%, they will continue to outperform the market due to robust order book, strong revenue visibility and Government’s initiative through new programmes.
India has a total road network of 5.5 mn kilometers, comprising of national & state highways and urban & rural roads. National Highways account for 2% of the total road network and carries over 40% of the total traffic.During the Q1Fy19 highway construction witnessed growth of 26 km per day which translated to 2345 km of roads during April-June quarter. Average cost to lay 1 km of road in India costs Rs. 100 million approximately with out land acquisition costs, 2345 km of roads will generate top-line of approximately Rs. 110 billion for this sector during Q1Fy19.
The construction of highways have reached 9,829 km during FY 2017-18, with an all-time high average pace of 27 km per day. This represents 20% growth over the last year, when 8,231 km were constructed. 17,055 km road length was awarded in the year, against 15,948 km last year. Expenditure of USD 18 bn was incurred on construction of national highways during the year 2017-18.
Government, on 24th October 2017, announced the biggest road construction programme in Indian history to create 84,000 kms of roads over the period of next 5 years with a total investment of Rs 6920 billion. Among the 84,000 kms of total roads, 34,800 kms of National Highways will be built under ‘Bharatmala Pariyojana scheme- Phase I’ with a total investment of Rs 5350 billion.
The government has given a massive push to infrastructure sector by allocating Rs 1210 billion for infrastructure in the Union Budget 2018-19. Government will spend around Rs 1000 billion during FY 18-20 to build roads in the country under Pradhan Mantri Gram Sadak Yojana scheme (PMGSY). The government also plans to invest USD 22.4 bn towards road infrastructure in North-East region during 2018-2020.
The National Highways Authority of India (NHAI) plans to build 50,000 km of roads worth USD 250 billion by 2022 as part of a long-term goal of doubling the length of the national highway network to 200,000 km.
Government is also planning to recycle assets through the toll-operate-transfer (ToT) model which has been taken up by the NHAI for 100 highways. The first bundle of 9 highways with an aggregate length of about 680 km was monetised successfully for an investment of USD 1.45 bn.
In the financial year 2017-18, the Ministry of Road and Transport (MoRTH ) awarded projects of around 17,000 km, of which 7,397 km was awarded by NHAI.
MoRTH has targeted to award 20,000 km in the current fiscal, up by 25 per cent from last fiscal. The highway construction target for the Financial Year 2018-19 has been pegged at 16,420 km, and construction target has been fixed at 45 km per day. MoRTH constructed an average of 27 km of National Highways daily during Fy18, the highest ever achieved by the ministry. In 2016-17, it was 22.74 km as against 16.62 km in the year before (2015-16).
Fiscal 2018 was remarkable for the entire road construction sector. Road Construction companies were able to execute at a higher pace as most of the projects now come with strict execution timelines and minimal obstacles on ground in terms of land acquisition & funding.
After introduction of Hybrid Model (HAM) the Government has reduced the financial stress & interest payments for Road Construction companies. At present, three different models –PPP Annuity, PPP Toll and EPC (Engineering, Procurement and Construction) were followed by the government to encourage private sector participation. Under HAM model, Government will contribute 40% of the project cost in the initial time frame through annual payments. The remaining payment (60%) is chipped in by the road construction company in the form of equity or bank loan. Revenue collection (Toll) would be the responsibility of the National Highways Authority of India (NHAI). Advantage of HAM model is, financial risk is shared by the Government and leaves the road construction company with enough liquidity. Launch of the new model (Hybrid Annuity Model) is due to the many problems with the existing ones. Large number of stalled projects are blocking infrastructure projects and at the same time adding to NPAs (Non- Performing Assets) of the banking system. In this context, the Government of India has introduced Hybrid Annuity Model (HAM) to rejuvenate PPP.
Road Construction sector has witnessed credit ratings upgraded for most of the companies in last one year. The biggest contributor for rating up-gradation was reduction in interest cost resulting in some companies turning into profits or cutting their losses significantly and strong order book inflow shows revenue visibility for next 3 years.
Improvement in Financials
Above table, shows Road Construction companies revenue growth and fall in interest payments (relative comparison with revenue growth). One of the reasons why these companies are able to grow earnings at a higher pace is due to reduction in the interest cost. For any construction company interest payment is a big lever for earnings growth because of their dependency on borrowed funds. Companies like IRB Infra, which despite 3% decline in sales saw 29% growth in earnings led by approximately 27% reduction in its interest cost. In addition to the revenues generated from operations, Significant bonus amount paid by Government on early completion of projects contributed to improvement in profitability. This sector is also witnessing traction from Foreign Direct Investments and is expected to grow at a faster pace going ahead.
Industry Tailwinds to Continue Contributing to Growth for Road Construction Companies
The BJP led NDA Government at the Centre continues to have a strong focus on the development of infrastructure especially in the road construction segment of the industry. With growth speeding up in awarding of contracts as well as its implementation and execution through the Public Private Partnership (PPP) via the newly introduced Hybrid Annuity Model, infrastructure companies especially in the road construction segment would continue to keep adding to their order books and would continue to deliver on their financial performance for the next few years.