Challenges persist for construction sector and recovery may be delayed due to sharp fall in commodity prices: ICRA

Onus on higher public sector investments is important for revival of capex cycle for these companies, says the ratings agency

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, said ICRA in its report released today. 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. However, on the positive side, with the savings from lower crude oil prices and the government's emphasis on infrastructure projects, public sector investments will increase in medium term," the report said.

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The stalled projects, which had started declining since FY14, have again shown an increase since Q2FY16 owing to unfavourable market conditions, increased funding constraints, and inadequate raw-material linkages.

ICRA's senior vice president Rohit Inamdar said the stalled projects, which had started declining since FY14, have again shown an increase since Q2FY16 owing to unfavourable market conditions, increased funding constraints, and inadequate raw-material linkages. ''

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," Inamdar noted.

Inamdar said 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 nine months of FY16, 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.

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 nine months of FY16, 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.

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.