Order rebound could lead to uptick for road infrastructure players

There may be an ongoing slowdown in the roads sector. Road construction companies working in the engineering procurement and construction (EPC) mode had weak execution in the second quarter of the 2022-23 financial year (Q2FY23), being affected by lower backlogs and heavy monsoons.

Diversified players like L&T, KEC and NCC did better. On the whole, debt and net working capital levels improved for the segment but there were exceptions. The Q2 order inflows were low or nil for road developers. The National Highways Authority of India (NHAI) award of road contracts was weak in the first half (H1) of FY23.

During H1, NHAI awarded only 35 projects with length 1,024 kilometres (km) worth Rs 19,100 crore (this includes 386 km of maintenance contracts). This is only a small share of NHAI’s FY23 target of roughly 8,000 km of awards. L&T and KEC were the only exceptions with stronger inflows – these two companies, along with NCC, posted better revenues as they accelerated execution.

In most cases, operating profit margins were flat or slightly improved. However, KEC’s margins were hit by losses in its acquisition of SAE Towers (Rs 100 crore operating profit loss) and Ashoka Buildcon posted lower margins due to execution of competitively bid projects with low margins and higher cost pressures.

The trends in net debt and net working capital were mixed. NCC and Ashoka saw a rise in net debt levels while HG Infra and PNC Infratech saw net debt reduction. Among pure road contractors, there is some impact of cost inflation. Some managements guided that margins pressure is expected to continue, given intense competition. Among general contractors, NCC’s margins remained subdued.

The outlook for the sector is hard to judge. Road contractors are hoping for a sharp acceleration in NHAI awards but this is expected only in Q4FY23 and the target of 8,000-km-award may not be met. However, given lower Q2 execution, most companies have a reasonable order book that implies visibility for revenues in H2 and in FY24. Competition for bids is said to be easing.

On average, road companies have order books of around 3 times book to sales. In one sense, NHAI has front loaded awards because there was a large number of awards in April 2022. In FY22, NHAI awards amounted to over 6,600 kms.

If Q3 is weak (October and Nov have been), then Q4 will have to see a big expansion of awards. Given pass-through and price escalation clauses in contracts, the higher raw material costs will not impact margins negatively.