INDIA UNDER BHARATMALA Connecting India’s Road network INFRASTRUCTURE ROADS & HIGHWAYS SECTOR REPORT Infrastructure – Roads and Highways Road sector to look up post a forgettable FY19 The Road sector has faced rough weather in FY19 owing to a) overall Overall awarding nosedives in FY19 for Road projects weakness in project awarding, b) delays in financial closure for Awarding Construction Hybrid Annuity projects, and c) poor response to second bundle of (km per day) 50 47 Toll Operate Transfer (TOT) projects. Although most decent-sized 44 45 road contractors have achieved financial closure for their projects, 40 issues like receipt of appointed date yet remain as industry woes. 35 30 28 27 FY19 ended with awarding and construction of 5,489 km and 30 22 23 constructed 10,855 km respectively (FY18 awards at 17,055 km and 25 17 construction at 9,829 km). 20 15 12 However, the tender pipeline and commentary from contractors 15 suggest FY20 to be better in terms of project awarding. The existing 10 heavy order backlog of contractors and strong tender pipeline places 5 the sector in a sweet spot. Our top picks in this space are PNC 0 Infratech and HG Infra. FY15 FY16 FY17 FY18 FY19 Source: Media Reports, YES Sec – Research; Data for Ministry of Roads including NHAI Road sector FY19 highlights – Awarding muted; Construction robust After ending FY18 with massive order awarding of 17,055 km, some Exhibit 2: Stock coverage Rev PAT slowdown was expected. However, awarding literally dried up in Mcap CMP Target CAGR CAGR P/E Company (Rs. (+/-) Rating FY19 and now expected to be awarded from H2 FY20. The NHAI (Rs)* (Rs) FY19- FY19- FY21 bn) tender pipeline remains huge at ~Rs.620 bn that provides comfort. 21 21 Road construction continues to head north with FY19 seeing PNC 51 199 263 32% BUY 37% 12% 13x creation of 10,855 km (>2x of FY15 run-rate). This has been HG Infra 17 262 386 47% BUY 23% 35% 8x Sadbhav primarily due to healthy awarding over last few years and success 41 240 297 24% BUY 22% 31% 13x Engg of Hybrid annuity business model. KNR 39 275 304 10% HOLD 17% (3%) 16x Dilip NOT The weakness in awarding during FY19 is unlikely to impact the 55 400 NA NA 13% 1% 7x industry significantly as most contractors in listed space are sitting Buildcon RATED Source: YES Sec – Research; CMP as on June 25, 2019 on robust order books and can absorb few quarters of weak order inflows. June 26, 2019 Research Analyst: Alok Deora [email protected] | Lokesh Kashikar [email protected] Head of Research: Amar Ambani [email protected] (For important information about YES SECURITIES (INDIA) LTD. and other disclosures, refer to the end of this material.) Infrastructure – Roads and Highways Highway Monetization – Mixed bag experience; BOT-toll likely Contractors sitting on robust order book positions - muted to comeback in FY20 awarding seems blessing in disguise for select players While the first TOT package garnered ~55% premium than Ministry’s While project awarding has slowed down in FY19, it is unlikely to estimates and provided upfront funds of ~Rs.97bn, the 2nd package significantly impact contractors. This is primarily because of the huge failed to generate similar response and had to be scrapped. The Ministry unexecuted orderbook in hand. They would rather be able to focus on to tender more such packages and expects to generate decent chunk execution, and would be better placed to bag new orders as they come from this route in next few years. NHAI is expected to roll out BOT-Toll up for awarding in later part of FY20. This would avoid a situation of projects in FY20 after the negligible awards during last 2 years through order book pumping up and contractors unable to execute at desired this route. This is primarily to control finances of the Ministry. pace. We, therefore, believe it’s a blessing in disguise for the select large listed contractors who can fully focus on execution and be better Industry concerns – Appointed date and Land acquisition prepared for upcoming round of order awarding. For projects awarded in FY18, contractors have witnessed delays in receiving financial closure for their HAM projects as well as Exhibit 4: Contractors sitting on robust order backlog postponements in the receipt of appointed dates for projects due to land OB/Sales availability issues. The reluctance of banks to lend especially after (Km per day) liquidity tightening saw delays in the getting the financial closure for 5 4.2 the projects. Land acquisition has been a major issue for projects where 4.5 we have seen delays in receiving appointed date. This is leading to 4 3.2 delay is execution and revenue recognition for several companies. 3.5 3.1 2.8 3 2.5 2.3 Exhibit 3: Current project status of major companies 2.5 FC 2 Company HAM portfolio Appointed date received received* 1.5 KNR 6 4 3 1 PNC Infra 7 7 6 0.5 Sadbhav Eng. 12 12 8 0 Dilip 12 12 7 PNC KNR Sadbhav Dilip HG Infra Ashoka Buildcon Ashoka 8 7 5 Source: Company, YES Sec – Research; OB/Sales = Current Order book divided by FY19 Buildcon Standalone revenues HG Infra 3 1 1 Source: Company, YES Sec – Research; Includes projects where FC documents have been submitted to authorities 2 Infrastructure – Roads and Highways HAM continues to work well from NHAI perspective; may Amendment in EPC concession agreement to lead to higher cost continue to dominate the awarding in next two years – unlikely to impact bidding interest from contractors The HAM model has been significantly successful during the last few MoRTH has proposed modifications in the model concession years despite issues related to financial closure. This has encouraged agreement (MCA) to ease out execution issues in EPC projects. private sector participation and eased pressure on NHAI as initial outgo However, provisions such as higher interest rate on mobilization (during construction) from NHAI is only 40%, as against 100% in EPC. advances, amended terms for retention money is likely to increase While BOT-toll projects are likely to see some pickup as Ministry tries contractors’ overall interest cost. Despite this, we believe EPC projects to balance its finances, HAM would also continue to be large share of to remain on contractors’ prime focus considering its asset-light nature. the projects to be awarded in FY20/21. The contractors would likely factor in this cost while bidding. Exhibit 6: Key highlights of new MCA HAM a big hit since launch; drives NHAI awards Particular Details BOT EPC HAM Obligations of Minimum 90% of the required RoW within 30 days from date of Authority agreement, in contiguous stretches of minimum 5 km 100% 8% If appointed date not received within 90 days from the signing Deemed 90% of agreement and submission of performance security, the Termination 80% 40% Authority would pay damages equivalent to 1% of the Contract 46% upon delay 70% 56% Price (3% in case of standalone bridge projects) 60% Bank rate+3%, equal to 10% of the contract price (additional 5% 72% Advance for purchase of key construction equipment). For that, contactor 50% Payment must submit Bank Guarantee equivalent to 110% of required 40% amount. Earlier, interest charges were equal to bank rate. 30% 60% 35% 51% Authority to deduct 6% from every payment of work due to 20% contractor as guarantee money subject to maximum amount of Retention retention money not to exceed 5% of contract price. However, 10% 20% money 9% 0% 3% the clause of retention money refunds against bank guarantee FY16 FY17 FY18 FY19E removed, which will lead to higher working capital. For flexible pavement: 5 years, maintenance charge- Source: NHAI, YES Sec – Research 0/0.5%/1% of BPC for years 1st/2nd, 3rd and 4th/ 5th resp. For rigid pavement: 10 years, maintenance charge- Maintenance 0.25%/0.5%/ 0.75% of BPC for years 1st to 3rd/ 4th to 7th/8th to 10th resp. Bridge/Tunnel: 10 years, maintenance charge -0.25%/0.5% for 1st to 5th/6th to 10th resp. Source: MoRTH, YES Sec – Research 3 Infrastructure – Roads and Highways Debt picture of NHAI shows rising D/E while still being within 2nd Bundle of TOT scrapped post poor response; eyes on next comfort zone; all eyes on fund raise through TOT TOT bundle NHAI absolute debt and D/E has been on the rise during the last few While the first bundle of TOT fetched a whopping ~55% premium over years. This has been primarily due to large number of big ticket projects the NHAI base price, the second bundle has fallen apart with highest being awarded by NHAI. Even in FY18, NHAI was the key driver of bid at 14% discount to NHAI base price. This was primarily due to a Road project awarding with awards of Rs.1.2 trn being given out. few weak tolls stretches in the bundle wherein the traffic may be sub- However, the D/E is still within the comfort zone and below 1x. Also, par. Also, liquidity constraints in the system could have dissuaded a NHAI is significantly eyeing funds from the TOT route and awarding few players from participating. This has been a big set back at a stage projects through BOT-toll route which would ease some pressure on when the Ministry is looking to raise funds through Monetization of NHAI finances. National Highways and reducing dependence on budgetary support and borrowings. The Ministry has now invited bids for and new TOT Exhibit 7: NHAI’s D/E increasing but within comfort zone bundle and looking to raise ~Rs.50 bn.