Macro developments suggest positive trends in the road sector with pickup in execution. Recent bids under the Hybrid Annuity Model (HAM) in May-June have seen participation increasing from two-four players to seven-eight players as the risk-reward equation is favourable.
According to a report by Jefferies, the road ministry´s focus and activity levels are positive for the sector. The month of May 2016 witnessed a strong execution at a 22-km-per-day completion run-rate and will be closely watched in the coming months.
Commentary from industry players also suggests strong execution and that can be very well gauged from the following numbers.
Ashok Leyland said that tipper sales have grown at about 65-70 per cent and FY17 is expected to be a very good year, as both road construction and mining are opening up. Importantly, considering the results of the private and public banks, non-performing assets in the construction equipment segment have drastically dipped, suggesting borrower cash flows are improving.
Meanwhile, equipment major JCB suggests that construction gear growth was exponential from January to June of this year due to public spending in road sector and improvement in National Highways Authority of India (NHAI) payment cycle. This is a clear sign of relief for the contractors.
On overall targets, completion of 15,000 km in FY17 (as per the road ministry´s target) would need funding of close to Rs.1,500 billion, of which only Rs.550 billion was allocated in the budget, with an additional provision of Rs.150 billion to be raised through bonds. Media reports suggest that the ministry is planning to raise the balance amount from Life Insurance Corporation of India (LIC) and Employees´ Provident Fund Organisation (EPFO), along with monetisation of some assets.
HAM TO THE RESCUE
It seems HAM, which witnessed tepid response at the beginning of implementation, is gaining momentum now. In fact, there is a continuous increase in competition for HAM projects and a few major contractors fear that HAM may meet the same fate as public-private partnership projects.
In the May-June 2016 period, around seven-eight bidders participated in most of the projects awarded by NHAI under HAM in contrast to the two-four player market in the initial bids during March-April. Consequently, bids have become slightly aggressive as competition is becoming cognisant of the favourable risk-reward scenario in HAM vs EPC vs BOT model.
Sources in the sector suggest that given the large pie of projects and some large players still sitting out, HAM is still very attractive with 20 per cent equity internal rate of return (IRR). What is interesting is scepticism of road-focused players like Ashoka and IRB, amidst newer players winning a lot of HAM projects. Ashoka Buildcon has been bidding for quite a few projects but has failed to win even one and its bids are not even close to the L-1 bidder. Jefferies views the HAM model as deferred EPC and expects competition to intensify in the future, as traditional EPC players with reasonable balance sheets will jump into HAM.
A total of six projects extending up to 209 km and worth Rs.41 billion were awarded by NHAI in May 2016. Of this, five have been on HAM and only one on EPC mode. This is in line with the ministry´s commentary on awarding close to 85-90 per cent of the projects on HAM and EPC mode.
Gujarat has been most active, awarding five out of six projects. Among winners, Sadbhav has picked up two HAM projects and MEP, which was traditionally into Operate-Maintain-Transfer (OMT) and toll collection models, continues to pick up projects. NHAI has published a list of 6,600 km that it intends to award this year, but this is much below the run-rate required to achieve the FY17 NHAI target of 15,000 km.
Media reports suggest that the ministry is working on a complete list of projects which it intends to award to achieve the 25,000 km overall FY17 target.
Though this new hybrid model lowers the responsibility of a contractor to 60 per cent of project cost to raise the money, the question of sufficient promoter participation by contractors with 25 to 30 per cent equity component (within 60 per cent project cost) will be raised by banks. This would mean arranging of 15 to 18 per cent participation of overall project cost by promoters before the balance amount of 40 to 45 per cent is granted by public sector banks or financial institutions (private banks have mostly kept away from infrastructure loans).
It is well known that the balance sheets of most leading infrastructure groups are stressed and over leveraged. They may not have the spare capacity to bring in equity participation in new projects, nor will the banks grant further project funding unless the balance sheets of these groups are deleveraged by the existing projects.
The other concern expressed by financial experts is about pricing of these projects under HAM. Since contractors taking up such projects will have to line up promoter´s equity and loan component of the project, keeping in mind project execution and long-term O&M risks, apart from making profit on the promoter´s equity, these projects may be priced up at least 25 to 30 per cent more than the price obtainable under a full EPC model.
This will result in higher annuity payouts and matching higher values of toll, which the government will have to charge to recover high annuity payouts, which is committed to the promoters. These expectations of high toll collection may not be easy to match for any democratically elected government. Recently, the government of Maharashtra has had to close down many small- and medium-size toll collection plazas due to popular political pressure and it is now struggling to compensate the private concessionaires, to honour the contractual commitment made to the Special Purpose Vehicles (SPVs) created by private contractors.