Analysts cautious on road construction stocks despite govt's infra push

High earnings visibility, manageable debt-equity levels factors to consider

Construction of roads across the country has yet again assumed importance, with the latest Reserve Bank of India’s (RBI) annual report for 2017–18 expecting the economy to look up further, aided partly by infrastructure expenditure. 

“During 2018–19, the infrastructure mission is set to accelerate. In the road sector, the key targets are awarding works for around 20,000 km of national highways; construction of 45 km per day vis-à-vis 27 km per day last year; and developing ring roads around 28 major cities under the Bharatmala project,” the RBI report noted.

The Centre’s focus over the past few years, according to A K Prabhakar, head of research at IDBI Capital, has been on infrastructure, especially roads and rail. Companies, he said, have also benefitted from the new contract awarding system — the hybrid annuity model (HAM) — which ensures the capital is not stuck for a long duration in a particular project.

“That apart, there are incentives for companies to complete projects early. I like NBCC and Dilip Buildcon in the road construction segment,” Prabhakar added.

Analysts at Phillip Capital agree and believe that with 40 per cent contribution coming from the National Highway Authority of India (NHAI) under the HAM model, project execution has been significantly de-risked.
 

“With the resolution of land acquisition problems, a new chairman, and the new pipeline (Bharatmala Paryojna) announced in late 2017, the order award activity in FY19 and beyond is likely to remain robust,” said Deepika Bhandari, analyst in the institutional research division at Phillip Capital. She recommends stocks such as NCC, Ahluwalia Contracts, J Kumar Infra, Ashoka Buildcon, PNC Infra and Sadbhav Engineering in the road construction segment.

During FY18, the NHAI awarded contracts for 7,400 km, totalling Rs 1 trillion — up 70 per cent year-on-year (y-o-y), reports suggest. Along with those awarded by the Ministry of Road Transport and Highways (MoRTH), the total road contract awards for FY18 stood at 17,055 km — 7 per cent higher than FY17. 

A look at the stocks from the sector, however, paints a different picture, with a number of them underperforming the market in calendar year 2018. On a year-to-date basis, counters like NBCC, Hindustan Construction, Sadbhav Engineering, PNC Infratech, Ashoka Buildcon, Dilip Buildcon and Simplex Infra have slipped in the range of 13-64 per cent. While analysts attribute the fall to a sharp correction in mid-and small-cap indices, there were some concerns on financial closures (bank financing) for HAM projects after strong order flows in FY18, thus leading to uncertainty on the execution front. The concerns, however, have receded as execution has picked up. 

With improved lending, outlook on financial closures has improved as well. Execution during the first five months of FY19 has improved by 10-12 per cent according to rating agency Icra, which is impressive given the ongoing monsoon season, which is typically lean.

“Despite the fall, these stocks are trading above the levels two–three years ago. That said, investors should remain selective while putting money into these stocks. Earnings visibility, manageable debt-equity levels, and transparent management are factors to consider,” said G Chokkalingam, founder and managing director of Equinomics Research.

Macquarie, too, had suggested investors to be selective and select firms with a proven long-term execution track record, lower dependency on NHAI order awards, superior balance sheet strength, and exposure towards BOT (build-operate-toll) business aiding cash flows. Their picks included IRB Infrastructure, Ashoka Buildcon and Sadbhav Engineering.