Valuations Yet To Capture Business Revival Of Construction Firms

The operating performance of eight out of 10 companies that BloombergQuint analysed improved during the period compared with the five years through March 2014. While execution of orders led to a rise in operating income, focus on working capital improved their debt profiles. A better macroeconomic environment and the introduction of hybrid annuity model, where 40 percent of the cost is borne by the government, too, improved the sector’s performance.

There has been some help from judicial reforms as well. Progress in arbitration, said an EY report, has helped restore financial viability for some players. The arbitration refers to dues pending on projects where there may have been delays or changes, charges for which are being contested by the government agency. New government guidelines in 2016 directed government agencies to pay 75 percent of arbitral award amounts to an escrow account against margin-free bank guarantee in cases where the award is challenged. While the relief on this account has not been uniform yet it has provided some succour to the sector say companies that BloombergQuint spoke to.

Shubham Jain, group head and vice president at ICRA, said smoother execution and faster receivable recovery has contributed to improved performance. “More PE (private equity) deals, increased focus on engineering, procurement and construction awards, introduction of HAM (hybrid annuity model) projects and improvement in arbitration proceedings has underpinned the profitability of most construction companies.”

For the analysis, BloombergQuint selected:

• Top companies that build roads, metro transit systems, buildings and irrigation systems based on their market value.
• The ones for which data on financial performance is available for the last 10 years.

Here’s how the infrastructure companies have fared:

Profitability

Barring Sadbhav Engineering Ltd. and Gayatri Projects Ltd., profitability improved for all construction companies. Building contractors’ profits grew at a faster pace compared with engineering and road contractors.

Greater Revenue Visibility

A large inflow of orders and better execution led to improved operating profits for the sector. The order books of most companies for the year ended March 2019 are at four times book-to-sales ratio, providing high revenue visibility. All companies, except Simplex Infrastructures Ltd. and Sadbhav Engineering, reported better revenue outlook in the five years through March 2019 compared with the preceding five-year period.

Building contractors grew the most, led by NBCC Ltd., with orderbooks expanding across segments.

Ease of doing business improved in terms of faster approvals, implementation and transparency, Suketu Shah, executive director of Man Infraconstruction Ltd., told BloombergQuint. “Along with efficiency in banking process, fairness in due diligence process also had led to better performance of construction companies.”

Most of the companies pared debt due to improved capability to service obligations—and strict control over working capital requirements.

Improved Balance Sheets

The debt-to-equity ratio of all construction companies improved substantially over the last five years.

A Phillip Capital report in March said as much. Companies, as per the report, have significantly repaired their balance sheets by divesting non-core assets, selling land parcels, raising equity capital and focusing on controlling working capital.

The report also said payment delays by various government bodies and external issues like land acquisition and environmental clearances led to ballooning of working capital needs, weighing on the companies’ balance sheets in the five-year period through 2014.

Improvement in balance sheets has been substantial for building contractors and universal engineering contractors.

YD Murthy, executive vice president of NCC, attributed it to focus on affordable segments and government subsidies. “Thrust on affordable housing segment and related subsidies has led to faster execution for building construction companies like NCC since one-third of the cost is borne by the central government, another third by the state government and remaining one third is easily tied up by banking finance.”

The debt-to-equity ratio of most road construction companies remained under control despite an influx of orders and their execution in the past few years.

That may have to do with the reduced risk allocation for the private sector since the advent of engineering procurement construction and hybrid annuity models, according to Vinayak Chatterjee, chairman of Feedback Infra Pvt. Ltd. “Swift communication with bankers for sorting prickly loan issues and a strong facilitative role in pending road projects led to phenomenal growth for the road sector companies.”

Alok Deora, vice president of Yes Securities (India) Ltd., agreed. Minimal equity requirements for HAM model, he said, allowed more developers to participate without stretching their balance sheet significantly. With decent balance sheets and proven execution capabilities, most developers today are well placed to witness strong growth in the next couple of years, he said.

Interest coverage ratio—a measure of a company’s margin of safety for servicing interest—of such companies has either improved or remained stable.

Valuations Low, Outlook Bright

Despite their improved financials, infrastructure companies are trading at a discount to their five-year average price-to-earnings ratio, according to Bloomberg. While the discount is widest for Simplex Infrastructures, it’s the narrowest for Sadbhav Engineering. The sharp correction in infrastructure stocks in the last 12 months led to discounted valuations.

JMC Projects and KNR Construction, in contrast, trade at a premium to their five-year averages.

The outlook is bright. “Roads, railways and building: these themes of 2014-2019 led the infrastructure cycle. The path ahead looks no different,” said Rohit Natrajan, associate vice president at Antique Stock Broking. “The days ahead are brighter than we think.”