Challenges Persist for Construction Sector

The recovery in the Construction sector is likely to get delayed further with the sharp fall in prices of commodities, which will in turn, defer the private sector investments in segments such as oil & gas, steel, and mining, according to ICRA Ltd.
This delay is amid corporates and banks both having stressed balance sheets, limiting the funding avenues for newer projects.

The pace of recovery in the construction sector will be slow and linked to the on-ground impact of the policy measures taken as well as the availability of funds. While the lowering of interest rates will help ease the debt servicing burden, this alone will not be sufficient to improve the credit metrics on account of elevated debt levels of the companies in the sector, according to ICRA.

However, on the positive side, with the savings from lower crude oil prices and the governments emphasis on infrastructure projects, public sector investments will increase in medium term, ICRA said.

The stalled projects which had started declining since FY2014 have again shown an increase since Q2FY2016 owing to infavourable market conditions, increased funding constraints, and inadequate raw-material linkages.

According to Mr. Rohit Inamdar, Senior Vice-President, ICRA, The growing number of stalled projects in the last two quarters, which are already high at 8% of GDP is a matter of concern. While many projects were stuck for want of land or clearances, with the changing macro-economic scenario and weak commodity prices, viability and promoters interest to continue with the projects, have also declined. This apart, funding issues have also remained pertinent for infrastructure sector which comprises the largest share of stressed advances for public sector banks the primary lenders for infrastructure projects.

Project Monitoring Group (PMG), which was set up in January 2013 in the Cabinet Secretariat to revive projects both in the public and private sector, had accepted 743 projects with an estimated cumulative investment of Rs. 31 trillion till Feb-2016 (681 projects worth Rs. 28.4 trillion till Sep-2015).

With the help of the Cabinet Committee on Investment (CCI), issues related to 353 of these projects, cumulatively worth Rs. 11.7 trillion, were resolved by Feb-2016 (308 projects worth Rs. 10.4 trillion as of Sep-2015). However, another 390 projects with a cumulative investment of over Rs. 19 trillion are still facing hurdles. Apart from reviving stalled projects, the
implementation of the proposed plug-and-play model, which aims at awarding major projects after acquiring land and the requisite approvals, is expected to significantly reduce execution delays and attract higher private participation in the sector.

Mr. Inamdar added, The recovery in the sector will be gradual as most players are still burdened with leveraged balance sheets even as the volume of stalled or slow moving projects remains sizeable. In addition, aggressive bidding in the past and inability or limited ability to raise equity for build-operate-transfer (BOT) projects have impacted the viability of
infrastructure projects and reduced the risk appetite of developers for new projects. Further,structural constraints like uncertainty in land acquisition, delays in approvals and inadequacy of long-term funding avenues, if not tackled expeditiously, will slow down recovery in the infrastructure sector.

The recovery of the construction sector thus has been a mixed bag with some segments like roads and urban infrastructure registering improvement in the pace of execution and awarding of fresh projects at a time when the overall construction activities have remained tepid at best.

The construction gross value added (GVA) grew at a slower rate of 3.7% in 9mFY2016 compared to 4.8% growth in FY2015. Similarly, new project announcements have also seen a sharp decline despite the push by public sector capex reflecting weak private sector investment sentiments.

Any significant improvement in the liquidity profile and credit metrics of construction companies will take time and will be contingent on an improvement in the working capital cycle and in the pace of execution, besides their ability to deleverage by raising long-term funds through stake sale or equity issuances.

Construction companies that have been aggressive in the BOT space in the past are also struggling with high leverage, thus their ability to improve their liquidity and capital structure through measures like stake sale in subsidiaries, monetization of assets, and dilution of equity will be of critical importance.

Many construction and infrastructure companies have either raised or have plans to raise funds through the equity route [via qualified institutional placements (QIPs), rights issues, warrants, preference shares or sale of stake in the special purpose vehicle (SPV) or holding company] to reduce their overall indebtedness at the group level.

The infrastructure sector has witnessed a sharp increase in stressed advances, which contributed to about 45.7% to the total restructured advances of all Scheduled Commercial Banks (SCBs) as of Sep-2015. The sectors share of the total SCB advances, in contrast, was just 15.5% as on the same date.

The Gross Non-Performing Asset (NPA) ratio for the infrastructure sector increased from 3.0% in Dec-2014 to 4.1% in Sep-2015, which is a pointer to the financial stress that the sector has been passing through. The Reserve Bank of India (RBI) has taken steps like allowing flexible restructuring of loans to ease cash flow pressures in the infrastructure sector. However, until the projects are revived, the situation is not likely to improve materially.
While the order book position of most construction companies has remained sizeable at 3x the revenues, execution has not gained significant traction with the order books of several companies remaining burdened with slow moving or stalled projects. For companies with better balance sheet, execution has witnessed improvement in FY2015 and 9mFY2016 with their ability to mobilise higher resources.

However, many construction companies are facing stretched liquidity and limited resources to expedite execution resulting in weaker revenue growth. In terms of profitability however, there has been a gradual improvement in FY2015 and 9mFY2016, led by a reduction in subcontracting and benign commodity prices. While the sustainability of the improvement in operating
profitability remains to be seen, without scale-up of operations, interest coverage ratios are only marginally better. Sticky receivables and higher work in progress because of stuck or slow moving projects which have been the key reasons for the lengthening of working capital cycles of many players in the sector have not shown any meaningful moderation thus far.