Macro slowdown: Road, highway developers heading for a rough ride

A comparison of the financials of road companies over two time periods – fiscals 2010 to 2015 and 2015 to 2019 – by CRISIL indicates as much.

The two periods are distinct in that fiscal 2010-2015 was the reign of build-operate-transfer (BOT) companies, while fiscal 2015-2019 has been dominated by engineering, procurement and construction (EPC) players.

The two sets of companies analysed are also largely unique. For the sake of convenience, let us call these two sets of players ‘old’ and ‘new’, respectively.

Of the old set, the top seven by revenue as of fiscal 2010 had less than 100 percent of net worth as investments in their project special purpose vehicles (SPVs). This indicates the proportion of capital locked in those SPVs.

And their leverage, as measured by total outside liabilities to tangible net worth (TOL/TNW), was less than two times for most of these.

Among the new crop too, seven of the 10 companies studied had less than 100 percent of net worth as investments in their project SPVs as of fiscal 2015. And TOL/TNW for most of these was less than 1.5 times, indicating low leverage and a healthy capital structure. This indicates that the starting points for both sets were not very different.

With significant awarding in BOT mode after fiscal 2010, the old players competed aggressively to grab opportunities to scale up, winning orders for execution. But this also required them to put in higher equity, which they did by leveraging.

The new players, on their part, were primarily EPC companies with smaller scale and limited exposure to BOT risks. They had smaller, healthier balance sheets and had stayed away from BOT bidding in the past. With an increase in awarding and the National Highway Authority of India (NHAI)’s focus on EPC and hybrid annuity models (HAM) since 2016, these players were able to win projects based on their strong execution skills.

By fiscal 2015, equity investment in the project SPVs of the old lot had shot up to 200-300 percent of their net worth and TOL/TNW had deteriorated beyond four times for most, while revenue remained stagnant.

Land acquisition and clearance issues made matters worse. Players struggled to complete projects, resulting in time and cost overruns, without sufficient accruals to keep leverage in check. Many found themselves financially in the dock, severely constraining their ability to bid for new projects. In fact, this is what paved the way for the emergence of the new set of players.

As for the new set of players, by fiscal 2019, most had tripled their scale without significantly leveraging their balance sheets. Nine of the 10 companies analysed are estimated to have had comfortable leverage, with investments less than 100 percent of their net worth in the SPVs, and TOL/TNW of less than 1.5 times – the same as when they started out – despite significant ramp-up in size.

Being ‘lean and clean’ has helped the new players stay in the game, while the aggressive, asset-heavy, over-leveraged models pursued by the earlier ones got them into trouble.

To be sure, the NHAI’s change in focus from BOT awards to largely EPC and HAM projects supported the growth of the EPC players. Given that the capital requirement in EPC and HAM is lower than that for BOT, these companies were able to sustain their healthy balance sheets and keep a check on debt levels while pursuing growth.

Further, steps by the NHAI such as addressing bottlenecks in land acquisition and clearances, and notifying the appointed date for HAM projects only once 80 percent of the land is made available, have been enablers.

The sector has also seen increased private equity interest following asset monetisation moves.

The new road companies should continue to benefit from the shift in the NHAI’s awarding strategy from BOT to EPC and HAM – which has ensured their financials are less strained, given lower equity commitment and lower debt requirements – as long as the focus remains.

The authority’s attempts to address land-related issues will also ensure projects are not stalled on this count. Continued interest from global funds will also provide a fillip.

However, given the headwinds to growth, the new breed of road companies will do well to remain cautious on bidding, maintain healthy balance sheets, contain leverage at 1.5-2 times (compared with 5-7 times for players in the BOT era), and continue to be asset-light. Else the road would turn skiddy fast.