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Momentum On The Highways

The awarding of road projects is expected to gather pace & boost developers' earnings in FY12…

Indian construction companies that are active in the road sector have underperformed the broad markets in recent times because of a slowdown in award of projects by the National Highway Authority of India (NHAI) since July 2010. Delays in land acquisition and change of management within NHAI are some of the reasons why award of projects slowed had down between July and November last year. But since December 2010 award of projects has picked up again. This trend is likely to gather further momentum in FY12. With more orders coming their way, road developers’ earnings are likely to improve.

Positives
Availability of detailed project reports: Last year, NHAI did not have sufficient number of detailed project reports (DPR), so it could not put more projects up for bidding. Now it has about 6,000 km of approved DPRs in place. According to HSBC Global Research, NHAI expects to receive DPRs for another 2,000-3,000 km in the next few months and will hence be able to accelerate the award of projects.
Land acquisition completed: One reason why award of projects had slowed down was due to delays in land acquisition. Over the past 12 months, several states have signed State Support Agreements (SSAs) with NHAI. This is expected to expedite land acquisition.
The hiatus in award of projects between July and November 2010 also allowed NHAI to complete land acquisition for many projects. According to HSBC Global Research’s findings, more than 60 per cent of the land for about 60 per cent of the projects to be awarded in FY12-13 has been acquired by NHAI. Improvement in land acquisition status is visible especially in two- and four-lane highways (a large portion of the land required for six-lane highways had already been acquired).
Pickup in award of projects: A lot of projects were awarded in Q1FY11, but after that there was a lull from July to November. NHAI restarted the process of inviting bids from December 2010.

Bids for 11,000 km to be awarded
Stretch   No. of projects   Length
Phase V- 6 laning  27 2,561
Phase III- 4 laning  15 1,274
Phase IV- 2 laning  57 7,316
SARDP-NE -2 laning  1 81
Total 100 11,232
Source: National Highways Authority of India, HSBC Research
Approximately 5,000 km of road projects were awarded in FY11. This is much below the target of 9,000 km. However, it is the highest in the history of National Highway Development Project (NHDP) in any given year. This amounts to award of 14 km per day against the initial target of 20 km per day (but is much higher than the 10-year average of 5 km per day).
Higher target for FY12: NHAI has listed 100 projects on its website, which amount to 11,000 km of road development for which bids will be invited during FY12-13. Of this NHAI plans to award at least 7,000 km in FY12, and about 2,000 km in Q1FY12 itself.
Policy changes for the better: Analysts at Sharekhan believe that the award of 7,000 km in FY12 is an achievable target due to the various policy changes that have been brought about over the last 15-18 months. For instance, NHAI will now go in for annual pre-qualification of developers. This means that developers will now have to submit bulky pre-qualification documents only once a year. If they qualify, they will be able to bid for all the projects that come up for bidding during the year.
This is an improvement over the earlier system where bidders had to go through a tedious pre-qualification process for each project. This is expected to reduce the time taken in the bidding process and speed up the award of projects.
NHAI also plans to award some of its projects through electronic auctioning. This is again expected to enhance transparency and speed up the bidding process.
States renewing their thrust on roads: States’ budgets for FY12 reflect higher allocation to the road sector. The cumulative allocation of 13 states amounts to Rs34,500 crore, a year-on-year (y-o-y) increase of 26 per cent.

Negatives
Slowdown in execution in FY11: Execution of projects also took a hit in FY11: it fell from 7 km per day in FY10 to 5 km per day in FY11. However, it has been improving sequentially: from 2 km per day in Q2FY11 to 5 km per day in Q3FY11 and 6 km per day between January and February 2011. The softening of stance by the Ministry of Environment and Forests on environmental issues has enabled the pace of execution to pick up.
Intense competition: With order inflows in other infrastructure sectors also slowing down, several players with little experience in road construction have now entered the fray. When bidding resumed in Q4FY11 as many as 40-50 players bid for each project. In the near future bidding is likely to remain aggressive. This could result in margins, especially of smaller players who bid for smaller projects, getting depressed. Only after a few projects have been awarded will bidders bid more rationally.

Choosing the best stocks
Avoid highly competitive segments: Of the 100 projects for which NHAI plans to invite bids, 65 per cent are small projects that involve two-laning of highways. About 50 per cent of the projects will cost less than Rs10,000 crore, while another 30 per cent will cost between Rs10,000-15,000 crore. Thus, 80 per cent of the projects that are smaller sized will see intense bidding.
According to HSBC Global Research, only 8-10 developers have sufficient balance sheet strength to handle big projects. It is these larger-sized projects that will witness lower competitive intensity and higher returns.
Go for experienced players with large order books: Award of projects is expected to be strong in FY12 after the recent lull. Bids are likely to be aggressive, especially by newer players, and this could depress margins. It would be preferable to invest in experienced players that already have large order books as they are not likely to be as aggressive in their bids.
According to analysts at Sharekhan, IRB and ITNL are two experienced players that already have large order books and are not expected to bid aggressively. HSBC Global Research expects large developers with liquid balance sheets like L&T, IRB Infra, GMR and Reliance Infra to be the major beneficiaries of more projects being awarded in FY12-13. HSBC too recommends IRB Infrastructure which is a segment leader. It is 100 per cent focused on roads and has a strong balance sheet. HSBC analysts expect the company to win projects worth $ 1 billion (Rs4,450 crore) during FY11-13, thereby increasing its market share from the current 5 per cent to 6.5 per cent.

Valuations
Many of the stocks of road developers, such as L&T, Nagarjuna Construction, Hindustan Construction Company, IVRCL and Simplex Infrastructures are trading at price-to-book value (P/BV) ratios that are lower than their five-year median P/BV.