Pick up in project awards, early signs of revival of private sector interest

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ICRA

While NHAI awarded 1,572 Km of contracts during 8M FY 15 (Apr-Nov’2014), it had set itself a target of   5,500 Km for FY 15, 35% of which was earmarked for Build-Operate-Transfer (BOT) segment and rest for Engineering Procurement and Construction (EPC) mode. In order to meet its target, NHAI will have to award around 3,900 Km by end of Mar 15, which is an uphill task. Out of around 3,500 Km set aside for the EPC awards during current fiscal, ~1050 Km were awarded till Nov’2014. Around half of targeted EPC awards have received all approvals related to environment and right of way (RoW) and therefore can be awarded quickly as opposed to balance 50%, wherein NHAI is still in the process of securing the RoW and other approvals. Awarding projects after securing all approvals and RoW would significantly reduce the subsequent time overrun as delays in acquisition of RoW and clearances from Ministry of Environment and Forest (MoEF) have been the major reasons for delayed execution in past. Since execution delays result in elongated working capital cycle and reduced profitability due to resource idling, the expected reduction in time overrun is a positive for EPC contractors. ICRA expects a pick up in the award activity given that the central government has doubled the limit up to which Ministry of Road Transport and Highways (MoRTH) can appraise and approve projects on its own to Rs. 10 billion.

According to Mr. Rohit Inamdar, Senior Vice-President, ICRA, “Overall execution rate declined by 17% to 3.41 Km/day during 8M FY 15 from 4.14 Km/day during the same period in the preceding year. Major slippage in execution was during Q1FY 15 when the execution pace slowed to at 3.98 Km/day as against 6.04 Km/day in Q1FY14 owing to the general elections. The execution during Jul-Nov 2014 stood at 3.08 Km/day as against 3.00Km/day. Although the new government has taken several initiatives like delegating the powers for grant of forest clearances to the regional offices leading to possible saving of six to eight months, online filing for clearances to construct rail over bridges and under bridges -both were earlier major bottlenecks, and increasing limits on sand mining, the actual execution is yet to gather momentum. ICRA believes that starting Q1 FY 16, these measures could start yielding positive results, giving a fillip to the pace of execution.”

While in FY 14, the fall in traffic volume was more than compensated by high growth in toll rates owing to high inflation rate, there has been a trend reversal during current year, with low inflation rate and pick up in traffic volumes. Traffic volumes which witnessed de-growth during FY 14, have picked up during current financial year. During H1 FY 15 traffic volume grew by 4% in PCU terms as opposed to over 2% de-growth during H1 FY 14. Though improved traffic volumes could partially compensate for a likely low toll rate hike, low WPI is a cause for concern for the operational toll roads that were bid prior to 2008. The rate revision for such projects is fully linked with WPI as opposed to projects that were bid post 2008, wherein the rate hike calculated as 3% (fixed) + 40% of WPI, is expected to be marginally above 3%. For the last few years, the toll rates were going up by 5-8% annually. However, in the current scenario of low inflation, the road developers could get hit in the short term on account of static/marginally increasing toll rates and no commensurate fall in interest rates. If such an anomaly were to persist over a longer period, it could lead to cash flow mismatches and also affect the profitability of the toll road projects.

Mr Inamdar added, “The final regulations for Infrastructure Investment Trusts (InvITs) notified by SEBI in September, 2014 could pave way for long-term project finance and can support private sector participation. InvITs also have benefits in the form of improved liquidity by virtue of being publicly traded, offer better scalability and improved access to capital markets. The challenge now will be to make InvITs a more attractive option through simple tax structure for the investors to park their funds in operating infrastructure assets. This in turn would increase the ability of developers to undertake more infrastructure development projects.  In the near term, the funding challenges are likely to persist and the industry is likely to witness consolidation given that  many completed BOT projects have been lined up for stake sale by their promoters.”

ICRA’s analysis of 113 BOT road projects, covering almost half of the total population of such projects awarded in the country points to a steady deviation from the earlier Debt/Equity (D/E) norm of 70:30 (2.33x) with around 37% of the projects having higher than 70:30 D/E ratio. Around 10% of the projects, mostly annuity based, have contracted debt to the extent of 90% of the initial project cost.

Mr. Inamdar added, “Shorter tail periods resulting from relatively higher leveraging tend to limit the financial flexibility of a project by lowering its refinancing ability in case of stressed cash flows resulting from lower than anticipated toll collections. Further, absence of tail period could potentially lower developer’s interest in the project. Moreover, progress of several projects in the recent past was adversely affected due to delayed equity infusion or extension of funding support by the promoters, given their tight liquidity.”

ICRA’s analysis reveals that over 80% of the projects witnessed delays in execution. In more than 60% of cases the delay was 6 months or higher and 40% of the projects were delayed by over 1 year.  For fixed price EPC contracts,  for every one year delay in execution, ICRA estimates the project cost to increase by 450-500 bps for projects funded in 70:30 D/E and by 550-600 bps in case of projects funded in 90:10 D/E as a result of increase in interest during construction (IDC) alone. For majority of projects under study, the contingency allowance for cost escalation was inadequate at 2-3% of project cost as opposed to mean cost escalation exceeding 10%. Consequently the total debt component in the overall project funding was higher than estimated. The study shows that for around 40% of the total projects, the debt sanctioned is higher than total project cost (TPC) estimated by NHAI as the project debt is sanctioned based on the developer’s cost estimates which is higher than NHAI TPC by 35% on average. In such cases, the lenders are exposed to a higher risk particularly in the event of termination of the Concession Agreement wherein NHAI guarantees compensation based on its own appraised project cost and not the developer’s estimate.

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