Risks Emerging in Roads; Delays in Financial Tie-Ups Key Monitorable
India Ratings and Research (Ind-Ra) has maintained a stable outlook for the construction sector for FY20, in view of continued revenue growth, albeit at a slower pace than that in last two years, and a stable EBITDA margin. The revenue growth of sector participants in FY20 would be driven by a strong order inflow in sub-sectors such as road, irrigation, electrical engineering, procurement and construction (EPC) and urban infra, while spending on industrials would remain muted. Therefore, Ind-Ra expects limited rating changes in its portfolio of construction companies in FY20. Given the sector is working capital-intensive, the improvement in credit profile depends on prudent working capital management through mobilisation advances, which are secured through the submission of non-fund-based facilities and a high creditor cycle.
About 80% of the debt of EPC firms has been taken to meet working capital requirements. Ind-Ra expects the deleveraging of the balance sheets of construction companies to be gradual, as the benefit of increased scale and higher EBITDA will be offset by higher working capital requirements. Road EPC players may see an increase in debt to meet equity commitments. Meanwhile, their revenue and EBITDA may be deferred due to delays in financial closures or the receipt of appointed date owing to challenges such as land acquisition, leading to high leverage levels. Ind-Ra expects the funds flow from operations of EPC firms to remain healthy in FY20 in view increasing scale and stable margins.
Prudent working capital management will be a key differentiator among peers with similar business profiles. Ind-Ra expects the net working capital cycles of ‘A’ category and above entities to remain short and stable relative to lower rated issuers. Ind-Ra expects the liquidity of higher-rated entities to remain manageable in FY20, supported by the receipt of advances and cash flows from order book execution. However, the agency believes that the majority of higher-rated entities will have to tie up additional limits to achieve a higher scale, as utilisation levels of fund- and non-fund limits peak. The sector is heavily dependent on bank credit flow, which remains constrained. Lower rated entities may face difficulty in tying up additional limits due to their limited balance sheet strength; the difficulty could affect their ability to execute contracts in a timely manner and bid for new orders.
Construction companies focused on road EPC would continue to have a higher leverage than that of the industry, as they have an elongated working capital cycle. Their capex requirements will be partially funded by incremental debt. A higher capex requirement is mainly driven by the continued deployment of new technology machinery for cemented road projects. Although the EBITDA margins of these particular companies will remain muted, such firms are likely to record higher revenue growth than the industry average, given they have a healthy order book. The majority of road EPC companies will be unable to meet equity commitment from internal cash generations and would, thus, be dependent on stake dilution in asset-holding special purpose vehicles. Higher rated companies are better placed to achieve financial closure for their projects on account of their balance sheet strength and/or group backing.
Ind-Ra believes that higher rated companies will continue to exercise bidding discipline and not take up unprofitable orders or overload order book sans financial resources. The margins of EPC firms focused on roads, bridges and electrical EPC works would remain muted despite their high scale due to intense competition. However, players operating in the metro and urban infrastructure sub-sectors would continue to have better margins on account of low competition and complexity of projects undertaken.