Ind-Ra: Highway Sector Shifting Gears to Regain Momentum

India Ratings and Research (Ind-Ra) believes that policy initiatives in the recent past will act as stepping stones to the revival of the highway sector. Rescheduling of premiums and the 5:25 refinancing schemes have provided some respite to SPVs with a forlorn hope of restoring their financial health. The introduction of the hybrid annuity model and infrastructure debt funds further highlights the government's focus on addressing the rising need for devising an efficient and flexible financing path.

The budgetary allocation to the road sector for FY16 has also been increased by a staggering 125%; however, channelising these funds in the right direction at the right time coupled with the timely implementation of reforms will be key to the revival of the sector.

Inflation-linked toll rate hikes have been a saving grace for most toll road projects for past two to three years, disguising, to some extent, the declining traffic. Notwithstanding the higher leverage observed, this has helped in propelling toll income, enabling SPVs to post EBITDA margins of around 80% on an average. Though challenges do remain in terms of timely clearances and timely award of encumbrance free right of way, the performance levels of various projects, in pockets, have improved.

That being said, the growth in the sector has been rather slow. The total national highway length grew at a meager 3.9% CAGR between FY05-FY15, way slower than proliferation of freight & passenger traffic at 8.8% and 7.8%, respectively, during the same period. Furthermore, the pace of execution of road projects by National Highway Authority of India ('IND AAA'/Stable) has been at a sluggish 5.6km/day during the past five years and was sub-par in FY15, with daily road construction dwindling to 4.1km/day from an all-time high of 7.4km/day in FY13. According to Ind-Ra, it could take a decade to complete the pending projects planned under National Highways Development Project (NHDP) at the historical average rate of construction.

The project award rate has also been volatile with a high of 17.8km/day and a low of 3.1km/day in FY12 and FY13, respectively. Ind-Ra believes that the execution rate will have to treble from the current level, if the pending projects planned under the NHDP programme have to be completed in the next five years. Ind-Ra observes a pick-up in award of road projects in 1QFY16. While only five (734km) out of 35 projects were taken up under the build, operate and transfer (BOT) mode in FY15, three projects with a length of 343.8km (nearly half of the length awarded in FY15) have already been awarded on the BOT basis in 1QFY16. A total of five projects were awarded in 1QFY16 on engineering, procurement and construction model.

Ind-Ra's analysis shows that an outlay of INR2.21trn (at current costs) needs to be pumped into the highway sector to complete the pending projects planned under NHDP. The estimated capital requirement is over and above the timely infusion of funds in case of a shortfall in cash flow for debt service obligations and any potential cost overrun, a phenomenon not so uncommon for road projects. This would further pose a challenge since nearly 35% of sponsor companies in Ind-Ra's portfolio have a sub-investment grade rating.

According to Ind-Ra's analysis, projects stalled during the construction stage could incur an increase in costs of nearly INR1m/km-INR1.5m/km on a monthly basis. In addition, in a majority of toll road projects in Ind-Ra's portfolio, the traffic has underperformed by an average of 33% from the traffic projections in the first year of operations. This could translate into a notional loss of INR500bn in the decade ahead if bidding continues to be at such aggressive projections.

While the recovery of the highway sector is certainly on the cards, the pace of recovery is contingent upon the timely execution of policy measures and an economic milieu conducive to meet the immediate funding requirements of the sector.

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