Bumpy ride ahead for road companies with order likely to enter slow lane

Higher interest rates and stiff competition could further weigh on their share prices

The dynamics of road-building in 2022-23 may be affected by fund-raising constraints placed on National Highways Authority of India (NHAI). NHAI will avoid borrowing in 2022-23 and will therefore depend on cess funds for 75 per cent of its capex.

This implies that the roads sector will absorb a very large share of the entire fuel cess raised and there could be a cash crunch unless tolls (which currently funds around 10 per cent of NHAI’s capex) grow substantially. In effect, there is likely to be a funding gap, which could be met to some extent by asset monetisation.

The 2022-23 capex is estimated to be in the range of Rs 1.34 trillion. Around 60 per cent of NHAI capex is currently met through borrowings and if this ceases, about 15-20 per cent of capex will have to be met by asset monetisation, assuming toll collections contribute 10 per cent or so.

Fuel Cess could contribute a total of Rs 1.4 trillion in the next fiscal and is also earmarked for other infra sectors including ports, shipyards, etc. The current component of cess on petrol and diesel is already high at Rs 13 per litre (petrol) and Rs 18 (diesel) and it is politically difficult to hike these levies, unless crude prices fall considerably from the current high levels.

There are many listed road construction companies. Some of the larger ones are GR Infra, Ashoka Buildcon, Dilip Buildcon, PNC Infra, HG Infra, and KNR Constructions. Revenue growth was double-digit for most of these companies in the Q3, 2021-22, with Dilip suffering contraction due to extended monsoons affecting work on Southern projects. Margins contracted across the sector as costs of raw materials escalated. High competition in the roads segment makes it difficult to maintain margins.

The order book is reasonable but there’s been a slowdown in awards by the NHAI and the MORTH in the last nine months. Also easier pre-qualification norms have led to stiffer competition, which means bidding wars. Some stakeholders expect norms to be tightened from next fiscal and this could lead to a moderation of competition and hence, better margins.

Next year will be tricky for all these players. The cash crunch at the top and the likelihood of hardening interest rates across the economy could lead to higher interest costs for corporates in a sector, which has a fairly high debt component and high working capital needs for long-gestation projects. Margins could get a little better if inflation eases off, but competition is likely to remain extremely stiff, which means a ceiling on margins. Asset monetisation and efficient execution of ongoing projects will both be crucial to managing this environment. State government projects could help add to the topline.

The market response to the sector has not been positive for a while and investors should be braced for a tough time in the next fiscal. The share prices of different road companies have seen widely varying trends.

In the last month, GR Infra is down 24 per cent, while PNC is down 12.7 per cent. Ashoka Buildcon and Dilip Buildcon have negative returns of 5.1 per cent and 2.6 per cent respectively. But KNR is marginally positive, while HG Infra is up 1 per cent. The broad NSE 500 is down 3.8 per cent in the same period.