ITNL scare shows road sector risks; IRB Infra, Ashoka Buildcon stocks fall

Execution hiccups, funding costs and delays in financial closure are hurting the sector

Among the sectors most affected by the fallout of downgrades for IL&FS Transportation Networks (ITNL) is road infrastructure. Listed players in this space have lost up to half their value from the highs seen a few months ago. While IRB Infrastructure, Ashoka Buildcon, Sadbhav Engineering, KNR Constructions hit their 52-week lows on Friday, there was little demand for the stocks of Dilip Buildcon and PNC Infratech.

These players were in the spotlight a few months ago after the government announced the fast-tracking of projects in the road segment. Strong order flows from the National Highway Authority of India (NHAI) in the March quarter had led to record order books for these companies, and this kept the Street optimistic and stock prices high. However,  the rally fizzled out.

Post peaking of the NHAI project awards, the Street is focusing on execution. This includes land acquisition and funding requirements for these projects. The concerns on the financial closure of the awarded contracts are becoming more important given the financing constraints, especially from public sector banks which are saddled with  bad loans. Further, the reversal of the interest rate cycle is bound to increase project as well as working capital costs. Despite a strong order book, ITNL’s debt paper was downgraded.
 

Sandeep Upadhyay, MD & CEO, Centrum Infrastructure Advisory, says that the overall sentiment is subdued for funding greenfield projects. Except for renewables, the appetite for financing is limited. Besides the financial stress within IL&FS, which is a major player in the infrastructure sector, the correction in some engineering procurement and construction companies (EPC) can be attributed to them being historically overvalued. "Expect the market to keep a close watch on the IL&FS Group developments and debt resolution process which may have a bearing on other stakeholders in the sector," he adds. 

The Street concerns on the near-term uncertainty have also been highlighted by India Ratings, which has analysed Rs 1.18 trillion worth of hybrid annuity model (HAM) projects awarded until July 2018. The rating agency said that HAM projects worth only around Rs 580 billion achieved financial closure due to lack of appetite and lending freeze at many public sector banks. The agency believes around 18 per cent of Rs 600 billion worth of projects could face difficulties in financial closure.  

Thus, while pessimism prevails, the government’s efforts are on to bring financial closures to projects. Industry checks, according to analysts at Kotak Securities, indicate a likelihood that SBI starts lending to road projects, though at stiffer terms (higher upfront equity). 

Any uptick in the pace of financial closures could address the key overhang for Dilip Buildcon, which has a large (about 50 per cent) share of its reported road segment backlog pending financial closures, say analysts. The company received additional cash from the Shrem group in August 2018 to which it had sold about 24 road assets. It is expected to receive a total sum of Rs 10 billion from the group by March 2019 to improve its balance sheet and ability to execute and bid for projects.

Meanwhile, Edelweiss Securities feels that as full clarity on the financial closure of HAM projects and the trajectory of future HAM awards may take time to emerge, investors will cheer greater EPC awards (due to less uncertainty regarding financing) in FY19. 

Nevertheless, there are also concerns about the quantum of fresh orders that will take place in FY19, given the general elections next year. Amid uncertainties, analysts see an opportunity for investors looking at cheap valuations. While analysts suggest remaining selective, Macquarie recommends companies with proven long-term execution record, lower dependency on NHAI awards, superior balance sheet and exposure towards BOT business. Analysts' picks include IRB Infrastructure, Sadbhav Engineering and Ashoka Buildcon. Edelweiss is betting on Sadbhav Engineering and Ashoka Buildcon and it also likes KNR Constructions. It says that investors with a medium-term outlook should take advantage of the prevailing attractive valuations.