We see significant growth in India’s addressable roads sector market over FY16-FY18 led by increased government infrastructure spending, easing regulatory hurdles, and the introduction of innovative financing models to spur private sector investment. Overall, we believe companies that can efficiently manage their working capital and cash flows would be able to scale up profitably over the medium to long term. Picks: IRB, MBL, NCC, JKIL and SPII.
Æ Addressable market to grow: To kick-start India’s investment cycle through infrastructure spending, the government, amid weak private sector investments, has meaningfully increased the budgetary allocation (Rs 400bn; +59% YoY) to the Ministry of Roads and Surface Transport. Also, NHAI funding is set to almost double from FY15 levels to Rs 450bn in FY16. Thus, an increase in the addressable market from 3,068km in FY15 to 5,400km in FY16 (NHAI expected awards) is likely to aid growth, for both asset developers and EPC contractors.
Æ Regulatory issues addressed to stimulate investment: Unlike for projects awarded in FY11-FY12 that faced several regulatory hurdles, norms have now been eased and land acquisition is 90% complete for projects to be awarded in FY16. Moreover, to address private sector funding constraints, GoI has come up with innovative financing models which minimise developer risk and make debt servicing more manageable. Thus, minor as well structural changes in regulations should incentivise investments in the sector.
Æ EPC segment – Working capital, cash flow management the key: The EPC contracting business is marked by low entry barriers and lower scalability compared to an integrated (BOT+EPC) model. However, companies that can manage working capital and hence cash flows are likely to emerge most profitable in the sector. Growth in the addressable market would ensure profitable scalability for EPC contractors – a challenge in the recent past.
Æ BOT segment – Macro tailwinds favourable: Asset developers/owners or the BOT business is sensitive to (1) cost of capital and access to capital and (2) traffic growth estimates. We expect the cost of capital to trend lower over the next 12-18 months and traffic growth to pick up due to an industrial recovery, making BOT business models attractive for long-term investors.
Æ Top picks: Our top EPC picks are Nagarjuna Construction Company (large scale, deleveraging focus), MBL Infrastructures (strong order inflow growth) and J Kumar Infraprojects (superior execution and cash flow metrics). In the integrated BOT space, we like IRB Infrastructure (strong traffic growth) and Supreme Infrastructure (attractive play with improving metrics).