While the road sector is arguably in a sweet spot, land acquisition is unquestionably the biggest hurdle afflicting roads development.
Stock prices of road developers have corrected lately, as much as 30 per cent this financial year. Given the aggressive thrust on the roads building programme by the government, this seems surprising. Look a little closer, and one finds that investors have taken money out of road stocks on concerns over funding challenges. With banks and developers, both limited in their ability to absorb more projects under the Hybrid Annuity Model (HAM), sentiment has taken a bit of a beating.
Over the past few months, the financing of HAM projects have been challenging, particularly with developers struggling to put up the required equity. It hasn't helped banks that are also placed under the Prompt Corrective Action (PCA) framework, limiting the extent to which they can extend loans. Vishwas Udgirkar, Partner, Deloitte India said that the problem is a systemic one. He explained, 'Banks are constrained by the PCA framework. Credit growth has become a problem. This is separate from the additional issues that are specific to the roads or other infrastructure sectors.'
The CEO of a mid-sized roads developer, who declined to be named, added that securing finance in the form of bank guarantees for Engineering, Procurement and construction (EPC) projects has also become a problem.
Another major concern of investors which has led to the correction in stock prices of road companies lately is also related to order inflows for these companies in FY19-FY20 and consequently, revenue visibility for FY21. Investors are worried that after a bumper FY18, order intake for these companies would tank in FY19-20. While the current order books of road companies are healthy with good revenue visibility for FY19-FY20, many investors believe that the outlook for FY21 top line is cloudy due to concerns around order-accretion over next couple of years. In fact, investors suggest many are either building in de-growth for FY21 revenue or marginal growth of 5-10 per cent.
However, analysts believe that these concerns, while justified to an extent, are overdone. According to an analyst with a domestic brokerage, FY19 order-wins have the potential to surprise the market due to the potential for road companies to enter into partnerships with financial institutions and diversification benefits, which have enabled road companies to reduce their dependence on NHAI awards, thereby allowing them to grow their order books, nonetheless.
To be sure, companies are sitting on order books that are at historical or near historical levels. 'Even after assuming conservative order inflow for FY19-20, there is a good revenue visibility for FY21,' said Rohan Suryavanshi, Director, Dilip Buildcon. From the government's viewpoint, while FY18 marked stellar project awards (up 100 per cent by value), observers believe FY19 may be a period of consolidation. While 84 out of the 104 HAM projects awarded till date have achieved financial closure, banks or developers' limited ability to absorb incremental HAM projects means EPC may be the preferred mode of project awards in FY19. NHAI is targeting FY19 spend of Rs 1 trillion, up 32 per cent. Factors such as upcoming elections and limited appetite for HAM projects are likely to limit FY19 project awards. Developers with strong financial health such as Sadbhav Engineering, KNR Constructions and Ashoka Buildcon, among others, remain well-placed to capitalise on the growth ahead.
According to Satish Parakh, Managing Director, Ashoka Buildcon, the company is taking on more work and will continue to bid for projects under the HAM route. 'We are expanding our geographic presence given the huge ordering expected under the Bharatmala Pariyojana,' he said. Parakh added, the major policy changes over the last four years have turned things around for the roads sector.
In addition, innovative models like the Toll, Operate and Transfer (TOT) and HAM have shown the government that it has been proactive in dealing with the challenges. While the sector is arguably in a sweet spot, land acquisition is unquestionably the biggest hurdle afflicting roads development under the new road development programme. The compliance to the Right to Fair Compensation and Transparency in Land Acquisition, Rehabilitation and Resettlement Act, 2013 (RFCTLARR) is a major challenge, not least of all due to the exponentially higher compensation.
'The success of the programme critically hinges on the pace of land acquisition,' said Rajeshwar Burla, AVP and Associate Head, ratings agency ICRA.
In fact, land acquisition costs have tripled from Rs 8 million per hectare to Rs 23.8 million per hectare and with the new hybrid model in place, the National Highways Authority of India (NHAI) also needs to disburse more cash upfront compared with earlier when payments were made in annuities over 15-20 years for projects awarded under the Build-Operate-Transfer (BOT) model. Industry observers believe that after the 70 per cent increase in the number of kilometre awarded by NHAI in FY18, this is not likely to increase by much this year, given NHAI's own funding requirements as well as the higher cost of land acquisition. In fact, according to Macquarie Research, NHAI may award just 5,000 km this year.
Nevertheless, the new programme has taken a corridor-based approach compared to the project-based approach in the past, that led to inconsistent infrastructure development across corridors. Whether the 83,677 km of national highway development by FY22 is an achievable target, remains to be seen. To put things in perspective, the National Highway Development Programme which started under the former late PM Atal Behari Vajpayee and the largest highways project ever undertaken in the country till date, had achieved a progress of 26,255 km in 17 years.