ICRA RESEARCH SERVICES Corporate Ratings Indian Construction and Infrastructure Sector Revival expected with measures to ease project funding; Initiatives like InvIT are long term positive and can revive private sector participation Contacts: Rohit Inamdar +91 124 4545 847 rohit.inamdar@icraindia.com Shubham Jain +91 124 4545 306 shubhamj@icraindia.com Abhishek Gupta +91 124 4545 863 abhishek.gupta@icraindia.com Rajeshwar Burla +91 40 4067 6527 rajeshwar.burla@icraindia.com April 2015
WHAT S INSIDE? 1. Overview 2. Trends: New Projects and Projects under Implementation Trend in Construction GDP/GVA and GFCF Execution-related stresses continue with implementation-stalled projects at high levels though pace of stalling has slowed 3. Government s reform initiatives and focus on infrastructure Major initiatives undertaken like relaxation of FDI norms, diesel deregulation, coal block allocation 4. Funding Issues for the Construction/infrastructure sector Trend in Banking credit to infrastructure sector Measures taken to support infrastructure financing from banks Other avenues explored for funding infrastructure projects like Infra Debt Fund and InvITs 5. Performance of Companies in the sector 6. Outlook for the sector 7. Focus Area: Infrastructure Investment Trusts (InvITs) 8. Quarterly performance trend of publically-listed construction / infrastructure companies Consolidated Construction Consortium Limited ERA Infra Engineering Limited Hindustan Construction Company Limited NCC Limited Pratibha Industries Limited Sadbhav Engineering Limited Simplex Infrastructures Limited Page 2
Overview Government s reform and infrastructure building initiatives helping the sector though on-ground challenges remain Resolution of sizeable stalled projects could provide fillip to the construction sector Steps taken to ease Infrastructure funding issues Budget 2015-16 laid focus on infrastructure development The construction/infrastructure sector is likely to get major boost from the Government s focus on development of infrastructure in India. While the recovery in the sector is likely, it would be gradual as majority of players are still burdened with leveraged balance sheets and stalled or slow moving projects. Furthermore, if structural constraints like uncertainty in land acquisition, delays in approvals, and inadequacy of long term funding avenues are not tackled swiftly, the project implementation on the ground may not gather momentum, thereby delaying recovery in the infrastructure sector. In addition, aggressive bidding in the past and inability or limited ability to raise equity for BOT projects have also impacted viability of infrastructure projects. These impediments need to be overcome for project implementation to gather pace. Difficulty in achieving financial closure and overall weak macro-economic environment had also reduced the risk appetite of developers towards new projects. These factors, amongst others, have resulted in relatively modest growth in Gross Fixed Capital Formation (GFCF) and Construction GVA (Gross Value Added) in 9m- FY15. With the political stability, sharper focus on infrastructure development and improvement in economy, new projects announcements by both the public and private sector are likely to pickup in FY16. Movement in Stalled Projects The quantum of stalled projects continued to remain high during FY15 though the pace of new project stalling came down and revival of stalled projects increased in H2FY15. In January 2013, Project Monitoring Group (PMG) was set up in the Cabinet Secretariat to help such projects, both in the public and private sectors, by way of support in clearing the implementation bottlenecks. Till March 2015, PMG had accepted 511 projects with estimated investments of Rs. 25.4 trillion which were facing implementation hurdles. With the help of Cabinet Committee on Investment (CCI) issues related to 204 such projects worth Rs. 7 trillion have been resolved as per PMG data. However, another 307 projects with an investment of Rs. 18.4 trillion are still facing various bottlenecks which is impacting their progress. Apart from reviving stalled projects, plans to award major projects after acquiring land and requisite approvals under the plug and play model will significantly reduce execution delays and also attract higher private sector participation. Steps taken towards easing funding issues in Infrastructure sector Many steps have been taken to improve funding avenues to the infrastructure sector. The key policy measures include easing of FDI norms for Construction, Railways, and Defence, liberalization of ECB policy, and providing incentives to promote REITs and InvITs. RBI has also taken multiple steps to ease funding availability to infrastructure project. Some of the key ones include providing incentives to banks in the form of exemption from CRR/SLR for long term bonds raised to lend to infrastructure sector, flexibility in refinancing norms for infrastructure projects by way of 5/25 structure etc. Besides, the Union Budget has also allocated higher funds towards public sector infrastructure projects. Provisions for Infrastructure sector in Budget 2015-16 In the Budget 2015-16, the capital outlays for roads, and railways have been increased by Rs. 140.3 billion and Rs. 100.5 billion respectively which along with significantly higher Road Cess will enable higher public Page 3
spending towards these infrastructure projects. In total, investment in infrastructure is proposed to increase by Rs. 700 billion in FY16 (BE) over FY15 (RE). Recognizing the need of reviving private sector participation in infrastructure projects, Budget has proposed rebalancing of risks in PPP projects with Government taking up major risks, appointing an Expert Committee for analysing the possibility of and replacing multiple prior permissions with a pre-existing regulatory mechanism, and rationalizing dispute resolution mechanism. The budget also proposes to set-up 5 UMPPs totalling 20 GW in the plug-and-play mode wherein all clearances and linkages will be obtained before the award of project. It has also announced its intent towards some large infrastructure projects like building 100 smart cities and Sardar Patel Urban Housing Mission, which will provide long term infrastructure opportunities. In the railways sector, the focus is on faster execution of Dedicated Freight Corridor (DFC) which is an important on-going project. Gradual improvement in profitability, though growth in operating income remains muted Weak cash flows and leveraged balance sheets continue to pose challenges for many construction and infrastructure players Performance of Construction Companies The growth in operating income of construction companies (ICRA sample of 15 exchange-listed construction companies) during this period had remained muted which implies that execution is yet to pick up in a meaningful manner. This can be partly attributed to stretched financial position of many construction companies which has constrained resources for speeding up execution. In terms of profitability however, there has been gradual improvement observed in 9m-FY15, led by subsiding cost pressures particularly on subcontracting, raw-material and labor related costs. While the sustainability of improvement in operating profitability remains to be seen, without ramp-up in the scale of operations, the operating profits will not be sufficient to cover the interest expenses for most of the construction companies as has been the case in the last six quarters. The interest coverage ratio for sample of 15 companies had improved marginally to 0.62 times in Q3FY15 from 0.42 times in Q2FY15. The reversal in the interest rate cycle and lowering of interest rates will help ease the debt servicing burden; however, this alone will not be sufficient for improving credit metrics. Any significant improvement in liquidity profile and credit metrics of construction companies will take time and will be contingent on improvement in working capital cycle (by way of faster execution and release of stuck receivables/retention money), improvement in pace of execution and ability to raise long term funds by way of stake sale or equity placements. Some large players have raised and many are planning to raise funds via Qualified Institutional Placement (QIP)/Rights Issue/warrants/preference shares or sale of stake in subsidiaries. Outlook The recovery in the construction sector is expected to be gradual and would be linked with on-ground impact of the policy measures as well as availability of funding. With high leverage, ability to raise funds via stake sale in subsidiaries, monetization of assets, or dilution of equity will be key in improving liquidity and capital structure of construction companies that have been aggressive in the BOT space in past. Many companies including GMR Infrastructure, Jaiprakash Associates, NCC Ltd, IVRCL etc. have either raised or have plans of raising funds through equity route like Qualified Institutional Placement (QIP)/Rights issue/warrants/preference shares or sale of stake at the SPV or holding company level to reduce overall indebtedness at the Group level. The likely reversal in the interest rates cycle would also provide some respite. Page 4
InvITs can act as a longer term funding alternative for infrastructure sector Sector Feature: Construction and Infrastructure April 2015 Focus Area: Infrastructure Investment Trusts In order to improve funding options, alternate funding sources like Infrastructure Debt Funds (IDFs), Alternate Investment Funds (AIFs) were introduced in the past to tap into other source of savings like Insurance and Pension Funds so as to accelerate and enhance the flow of long term funds. In this regard, the recent initiative in the form of Infrastructure Investment Trusts (InvITs) may help in channelising long term funds into the sector and in releasing developers capital for further deployment in new projects. Moreover, InvITs could play a pivotal role in providing wider long-term refinance avenue thereby providing headroom for banks for new funding requirements. InvIT is proposed on the same lines as Real estate Investment Trust (REIT) and are dedicated towards infrastructure sector. However, in comparison to REIT, the capital appreciation aspect is limited in the case of InvITs as majority of the infrastructure assets have a finite life and low residual value at the end of the project life (except the accumulated cash). Unlike REITs where the investors also benefit from capital appreciation, the NAV of an InvIT is expected to decline gradually over the concession period of the underlying asset unless there is significant increase in revenues like toll collections in case of a toll road project. Due to this, the annual yield offered by an InvIT includes partial return of capital deployed by investors into InvIT. The marketability of InvITs will depend on the effective yield (adjusted for NAV) which can be offered. InvITs will face competition from REITs and other fixed-income products as well as high dividend-yield stocks. Investors in InvITs will benefit in the form of better liquidity by virtue of being publicly traded, while Sponsors will have better scalability (fund raising through follow-on offers) and access to capital markets. The challenge now is to make InvITs a more attractive option for parking operating infrastructure assets. This in turn will increase the ability of developers to undertake more infrastructure project development. The success of InvITs also depends on tax regime. As majority of the infrastructure projects are developed on PPP (Public Private Partnership) framework, they can only be indirectly held by InvIT through stake in the SPV holding the project. However, as taxation for SPVs are not pass-through and SPVs have to pay corporate and dividend distribution taxes, the efficiency of distribution of profits is constrained. Some respite in case of infrastructure projects can be the ten year tax-holiday which could result in savings during this period. Furthermore, some efficiency can be brought in by leveraging the SPV by way of InvIT infusing funds in SPV in the form of debt. The path for establishing REIT/InvITs has not been easy in other Asian countries also as it takes time to gain market acceptance. For an investor, InvIT provides opportunity to own a different asset class, though adjusted returns would be the key criterion for inflow of money towards InvITs. The success of InvIT in Indian context will also depend on alternatives available for sponsors as well as valuations and taxation aspects. Page 5
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