Exciting road ahead for road construction companies…
With the political canvas finally looking clear and all set for growth to kick in, one of our veteran clients asked me recently, “Which sectors and stocks do you expect to do well in Modi 2.0?”
Over the next few days, on my expedition to find companies that look promising, a number of stocks caught my attention. Coincidently, 6-8 of these were prominent players from the road sector. They had posted average revenue growth of 30% in Q4 FY19 and with 31% full-year PAT growth, they looked really mouth-watering.
Ever since the commencement of Modi Sarkar’s second innings, there’s been a buzz around its ambitious plans to build new India. According to the BJP’s manifesto, Modi 2.0 is expected to pump Rs 100 trillion into infrastructure development by 2024.
But I usually don’t follow stories that aren’t backed by on-ground action. As they say, in the long run, markets are weighing machines…
So, I dug a little deeper into the industry developments and made a list of companies that had impressed me. Here’s what I found…
Under Modi 1.0, India became the world’s fastest developer of highways. In the last five years, India constructed approximately 39,000 kilometres of highways—a jump of nearly 60% from the UPA-2 tally.
Improving mix of road contracts…
Similarly, Modi 1.0 awarded more contracts as compared to UPA-2. According to NHAI data, UPA-2 awarded contracts for building 17,461 kilometres of the road while Modi 1.0 awarded contracts for building 21,448 kilometres of roads.
Road construction: Gathering pace…
Modi 2.0 aims to build 60,000 km of national highways in the next 5 years. According to data published by NHAI, the total length of India’s national highways was 1,32,500 kilometres as on March 31, 2019. Such massive additions bode well for the sector. As mentioned in the BJP’s manifesto, Modi 2.0 is expected to bring in new technologies in road construction and maintenance activities.
Another reason for the government to support the road construction sector is that it creates mass employment opportunities. Employment generation has been one of the key challenges the government has faced.
The government expects its Bharatmala scheme to create 100-million man-days of employment during the construction phase. Moreover, improved economic activity (due to the addition of infrastructure) will create another 22 million jobs.
Since Engineering, Procurement, Construction (EPC) and Hybrid Annuity Models (HAM) are likely to be preferred options of the government to facilitate road building going forward, companies with a presence in both these segments would gain traction.
Contrary to a popular belief that banks are reluctant to fund HAM projects, a Crisil report suggests that 90% of awarded HAM projects worth Rs 1 lakh crore have already secured debt funding. This would boost the confidence of private players.
I believe this robust macro picture warrants us to consider individual companies catering to road construction.
Road construction companies: report card…
The timing of the revenue growth of road construction companies couldn’t be better. As Modi 2.0 is committed to clearing all the roadblocks to construct a robust network of national highways, the revenue growth of these companies might keep the pace, going forward.
PNC Infratech, Ashoka Buildcon, HG Infra Engineering Ltd and KNR construction have outshone others.
Besides growing at a blistering pace, they enjoy high revenue visibility, thanks to their order books which are over 2 times their FY19 revenue, except in the case of Ashoka Buildcon.
PNC Infratech has reported its best-ever quarterly performance in Q4 FY19. The company’s revenue and PAT for the full year stood at the highest level as well. PNC Infratech’s order book has grown at a whopping 67% in FY19. The company reported a better RoE in FY19 as compared to its 3-year average. It is available at 2.3X its price to book and enjoys a decent credit rating of “AA-”.
HG Infra Engineering Ltd. is another company that’s emerging as a strong player in the road construction segment. Over the last 5 years, the company has constantly reduced its dependence on sub-contracting work. In FY14, sub-contracting accounted for nearly 55% of the company’s revenues; this has dropped to 24% in FY19. The company has been diversifying geographically. In FY14, it had a presence in just two states. In FY19, the company has a presence in 7 states. HG Infra has been improving its presence in hybrid Annuity Models (HAM).
KNR Construction Ltd, on the other hand, has been a steady performer. Its healthy return and valuation ratios are encouraging. At 19.1% in FY19, KNR Construction’s ROE is better than the 3-year average ROE of 17.4%.
With improving prospects for the sector, some companies have managed to up their game. Take, for instance, Ashoka Buildcon; it had an overhang of the poor performance of the last two years. Nonetheless, there are clear signs of a turnaround. In FY19, it has shown remarkable improvement in the operating performance with improvement in the order book and rising cash profit from road assets. Independent credit rating agencies have assigned a credit rating of “AA-” to its long term facility.
That said, risks pertaining to land acquisition and policy shifts remain the key challenges for road construction players. As you might be aware, the newly elected Andhra Pradesh government has annulled contracts awarded by the previous government. This has been a mighty blow for NCC Ltd.
When such flip flops happen, companies engaged in road construction stand to lose.
NCC Ltd. has denied having received any written communication from the state government in this regard, but it’s set to lose orders worth Rs 6,100 crore if it receives an official letter. It might qualify for fresh bidding but uncertainty has shaved off 17%-20% from its stock price already.
If interest rates remain stable or drop further and the government adheres to its guidance of building 40 km of roads every day, the road construction space will keep buzzing in the coming quarters.
In such a scenario, companies with strong execution records, a multi-state presence and low gearing would be the biggest beneficiaries.
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