SP Group, cash strapped and under-capitalised after betting on infra sector

Did Shapoorji Pallonji (SP) Group overestimate the growth potential in India’s infrastructure sector and underplay the financial risks involved in betting big on this cash-guzzling sector?

“The development momentum has picked up. There is good visibility of opportunities in roads, Railways, mass rapid transit system, ports, and related segments. This creates optimism among Indian construction companies,” reads Afcons Infrastructure’s — one the largest SP Group companies — annual report for 2015-16 (FY16), detailing the growth possibilities ahead.

A civil construction firm, Afcons Infrastructure is 68.2-per cent owned by Shapoorji Pallonji & Company (SPCPL) and accounted for 18 per cent of the group’s consolidated revenue in 2018-19 (FY19).

That optimism did translate into fast-paced growth for Afcons and its parent, SPCPL, in the subsequent years. But the expansion did little to improve the group’s poor profitability and cash flow.

SPCPL’s consolidated revenue nearly doubled between FY16 and FY19 — the latest year for which its finances are available — growing at a compound annual growth rate of 24 per cent. The company’s revenue jumped from Rs 26,285 crore in FY16 to Rs 49,902 crore in FY19.

The rapid expansion in the top line translated into an incredibly fast growth in operating profit and net profit, but most of it was absorbed by working capital and didn’t translate into matching cash flow from operations.

Rating agencies said this made the group vulnerable to refinance risks.

The group is now finding it tough to discharge all liabilities created in the past few years.

Last week, SP Group missed the deadline to repay dues to group listed company, Sterling and Wilson Solar (S&W Solar). The promoters paid just a tenth of their total dues of Rs 1,000 crore owed to their subsidiary. SPCPL owns 50.6-per cent stake in S&W Solar.

SPCPL reported a profit after tax of Rs 333 crore in FY19, translating into a net profit margin of 0.7 per cent, against Larsen & Toubro’s (L&T’s) net profit margin of 5.6 per cent in its construction and infrastructure business in FY19.  

That growth didn’t translate into cash flow either, increasing the group’s reliance on external financing to sustain its operations and pay past dues. SPCPL reported negative cash flow of Rs 287 crore in FY19 from its operations, against positive cash flow of Rs 3,349 crore in 2017-18 (FY18) on a consolidated basis. The company had reported negative cash flow in 2016-17 as well. Negative cash flow means cash flow from operations falling short of all cash expenses.

All SP Group companies, including listed companies, such as Forbes & Company, S&W Solar, and Gokak Textiles, are subsidiaries of SPCPL, and their numbers reflect in its consolidated finances.

At the balance-sheet level, the group expansion in capital-intensive sectors, such as highways, ports, power, and real estate, led to a rapid rise in its asset base, largely financed through debt and non-debt liabilities.

The group’s total assets jumped from Rs 18,000 crore in FY18 to Rs 68,350 crore at the end of March 2019. In the same period, the group’s networth increased from Rs 3,468 crore to Rs 4,712 crore, while long-term borrowings jumped from Rs 2,845 crore to Rs 15,337 crore.  

As a result, the group remains under-capitalised, with one the highest debt-to-equity and debt-to- earnings before interest, tax, depreciation, and amortisation ratio in the industry. The group’s asset-to-equity (or networth) ratio was 14.5x in FY19, while long-term debt-to-equity ratio was 3.3x. The corresponding ratio for L&T’s engineering procurement construction division was 2.6x and 0.08x in FY19, respectively.

Last week, India Ratings & Research (Ind-Ra) downgraded SP Jammu Udhampur Highway’s non-convertible debenture, citing potential erosion of its debt service coverage and deteriorating credit profile of its sponsor, SPCPL.

“Sponsor undertakings are pivotal to the rating and vulnerability emerging from the sponsor group, including a credit-profile weakness that will impact the rating,” said Ind-Ra.

SPCPL through SP Roads owns the entire stake in SPCPL.

In November last year, ICRA had downgraded SPCPL, citing refinancing risks, and delayed its deleveraging plans through equity infusion and asset monetisation.

All this makes SP Group highly dependent on its 18.37-per cent stake in Tata Sons, currently valued at around Rs 1.5 trillion, to raise fresh capital to meet its liabilities and deleverage the balance sheet.