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India: Construction: Infrastructure
Equity Research
Pick-up in road project awards likely; reiterate Buy on IRB and ILFT
Award activity likely to pick up soon
Post the lull in road contract awards in 2H2010, NHAI has begun to show
increased activity on both awards and incremental requests for qualifications.
After awarding about 4,400 km up to end-Feb in FY11 (13 km/day vs. initial
target of 20 km/day vs. past 3-year average of 4.5 km/day), NHAI is gearing up
to step-up award activity from April onwards with about 11,000 km (worth
US$13.5 bn) of projects targeted for award by April 2012. Simultaneously, we
believe the process of having annual qualification limits (instead of individual
project-wise) is a step in the right direction and could help cut down project
award timelines by up to 3 months.
Valuations are inexpensive and balance risk of aggressive bidding
Post the 16% and 31% fall ytd for IRB and ITNL, respectively, the stocks are
currently trading at 12-m forward P/E of 10X and 9X, 36% discount to
historical median for both, and 32% and 40% discount to MSCI India. We
believe given the relatively modest size of the upcoming 100 projects
(US$135 mn average size), large number of companies may continue to
qualify on the required technical and networth criteria, increasing the risk
of aggressive bidding for some of the projects in the near term. Long
term, we continue to view strong vehicle volume growth and
current low toll rates in India as tailwinds for the sector.
Our picks: IRB and ITNL for their strong track record, robust order
book and limited interest rate risk
IRB (IRBI.BO): (1) 2,300 lane km of under-construction roads provide
visibility on construction revenues; (2) Majority of debt is fixed-cost and the
balance has no immediate interest rate reset; (3) Daily toll collection of
Rs24 mn ensures sufficient cash flows for equity commitments, in our
view. Maintain Buy and our 12-m SOTP-based TP of Rs234.
ITNL(ILFT.BO): (1) Order book of 10,500 km under construction and
development along with 4,300 km of operational roads to drive 56%
revenue CAGR over FY10-FY13E; (2) Similar to IRB, majority of debt is
fixed-cost and balance has no immediate interest rate reset, which in our
view is positive. Maintain Buy and our 12-m SOTP-based TP of Rs277.
Key risks
Aggressive bidding, volatile interest rates, lower spending by government.
Prefer companies with established bidding-execution track record
After a lacklustre 2H2010 for NHAI road contract awards, the past 3 months have seen
some pick up in both award activity (13 km/day during December 2010-February 2011
vs. 3.8 km/day between July-November 2010) and execution (5.6 km/day vs. 3.3 km/day
over the same period).
We expect this momentum to continue as NHAI has targeted 11,000 km (projects worth
Rs610 bn) to be awarded over the next 12 months, a list for which has been displayed
on NHAI’s website.
Credit deployed to the road sector has also increased in the past 2 months, with Rs49
bn additional credit over December 2010-January 2011 vs. Rs88 bn over April-
November 2010 (8-month period).
NHAI has, in 11 months ended February 2011; awarded 4,400 km of new projects vs. its
target of 7,000 km. Execution during the period has been sub-par at 4.6 km/day vs. the
original target of 20 km/day.
Amid this slow movement, we expect the next round of projects awarded to be
competitive as seen from some of the recent bids in which 40-45 bidders have
qualified at the RFP stage.
We prefer experienced and seasoned participants such as IRB Infrastructure and
ITNL due to their strong order books of Rs70 bn and Rs110 bn, respectively, to be
executed over the next 2-3 years. Given this order book coverage, we expect
them to bid conservatively over the next few months.
Further, we believe the annual qualification for road competitors (RFAQs) as compared
with the earlier practice of projects-wise qualification would help speed up the bidding
process—resulting in faster awards of road projects and freeing up bandwidth at NHAI.
Toll rates in India are among the lowest in the world (on PPP adjusted basis) and we
expect them to remain low (specially for commercial traffic) as NHAI has in the past
not been able to push through toll rate increases; however, we expect traffic growth
to reflect the high vehicle volume growth trend over the medium term.
For IRB Infra, earnings expectations have been fairly stable and we believe the recent
underperformance is more a function of a lower market assigned multiple (see Exhibit
32-34). For ITNL, although earnings expectations have come down, the
underperformance has, similar to IRB, primarily been a function of multiple de-rating,
in our view. We think this is an aberration as the fundamental drivers for the sector in
terms of demand for roads and traffic growth have not changed.Prefer companies with established bidding-execution track record
After a lacklustre 2H2010 for NHAI road contract awards, the past 3 months have seen
some pick up in both award activity (13 km/day during December 2010-February 2011
vs. 3.8 km/day between July-November 2010) and execution (5.6 km/day vs. 3.3 km/day
over the same period).
We expect this momentum to continue as NHAI has targeted 11,000 km (projects worth
Rs610 bn) to be awarded over the next 12 months, a list for which has been displayed
on NHAI’s website.
Credit deployed to the road sector has also increased in the past 2 months, with Rs49
bn additional credit over December 2010-January 2011 vs. Rs88 bn over April-
November 2010 (8-month period).
NHAI has, in 11 months ended February 2011; awarded 4,400 km of new projects vs. its
target of 7,000 km. Execution during the period has been sub-par at 4.6 km/day vs. the
original target of 20 km/day.
Amid this slow movement, we expect the next round of projects awarded to be
competitive as seen from some of the recent bids in which 40-45 bidders have
qualified at the RFP stage.
We prefer experienced and seasoned participants such as IRB Infrastructure and
ITNL due to their strong order books of Rs70 bn and Rs110 bn, respectively, to be
executed over the next 2-3 years. Given this order book coverage, we expect
them to bid conservatively over the next few months.
Further, we believe the annual qualification for road competitors (RFAQs) as compared
with the earlier practice of projects-wise qualification would help speed up the bidding
process—resulting in faster awards of road projects and freeing up bandwidth at NHAI.
Toll rates in India are among the lowest in the world (on PPP adjusted basis) and we
expect them to remain low (specially for commercial traffic) as NHAI has in the past
not been able to push through toll rate increases; however, we expect traffic growth
to reflect the high vehicle volume growth trend over the medium term.
For IRB Infra, earnings expectations have been fairly stable and we believe the recent
underperformance is more a function of a lower market assigned multiple (see Exhibit
32-34). For ITNL, although earnings expectations have come down, the
underperformance has, similar to IRB, primarily been a function of multiple de-rating,
in our view. We think this is an aberration as the fundamental drivers for the sector in
terms of demand for roads and traffic growth have not changed.
Award activity has improved and could increase further
After a lacklustre 2H2010 for NHAI road contract awards, the past 3 months have seen pick
up in both award activity (13 km/day during December 2010-February 2011 vs. 3.8 km/day
between July-November 2010) and execution (5.6 km/day vs. 3.3 km/day over the same
period).
We expect this momentum to continue as NHAI has targeted 11,000 km (projects worth
Rs610 bn) to be awarded over the next 12 months. This would be in the form of 100
projects spread across various NHDP phases with:
Majority (approx. 65%) of the work to be done under Phase IV–2 laning and 11% to
be done under Phase III–4 laning in km terms
Almost 82% of the projects to cost below Rs10 bn
As a result, we could see intense competition to continue in the road space over the next
few quarters–we have seen recent bids with as many as 40 bidders qualifying to bid for
some of these road projects.
Adoption of annual qualification process a positive
The NHAI has started the process of compiling annual qualifications (RFAQ) for projects
from March 20, 2011, thereby enabling companies to get shortlisted for a particular price
bracket of projects once in a year. As per the new norms, those shortlisted in the annual
technical qualifications need not provide elaborate details at the time of project-specific
bidding.
Annual qualification will be valid for projects involving two-laning, four-laning as well as
six-laning of highways (refer to our commentary Key takeaways from FT summit on Indian
Highways, dated Feb 8, 2011).
We believe this is positive for the sector as it would help reduce project award
timelines.
We believe more companies would now be able to meet the networth criteria of NHAI and
be able to bid for projects under Rs30 bn as:
(1) Projects worth up to Rs20 bn require a networth criteria of 25% of total project cost
(TPC) – we expect significant competition here.
(2) Projects worth between Rs20 bn and Rs30 bn require a total net worth criteria of Rs5 bn
plus 50% of the cost above Rs20 bn–we expect significant competition here.
(3) For projects with a TPC of above Rs30 bn, the concessionaire should have a networth of
Rs10 bn, plus 100% of the cost above Rs30 bn–we expect moderate competition here.
We analyze below 22 construction companies and how their networth has changed over
time to bid for bigger projects.
Policy decisions on toll rates critical over the long term; continued
increase in vehicle penetration also a long-term tailwind
Toll rates in India are low currently—a long-term tailwind for the sector as
quality of roads improves
Toll rates in India are among the lowest in the world both for passenger and truck
traffic. Even on a PPP adjusted basis, India has among the lowest toll rates in the
world (see Exhibit 15).
Despite that, we do not expect any significant increase in toll rates in the
immediate future as we have observed that the government’s track record to
implement increase in toll rates (especially for commercial traffic) has been mixed.
In December 2010, the MoRTH agreed to introduce a new category, namely 3-axle
commercial vehicle, in the toll fee slab to reduce the toll applicable to such
category of traffic in order to call off a nationwide strike by the truck association.
Over the long-term, decisions on hiking base toll rates could be critical for future
highway development, in our view, especially for expressways and higher quality
highways (higher carrying load, faster speeds)—globally, growth in traffic
generally has low price elasticity, i.e., 10% change in toll leads to approx. 3%
change in traffic; hence we see this as a likely possibility and a catalyst for
development in the segment.
Since increase in toll rate annually is currently based on the increase in WPI
(Wholesale Price Index), it is positive for the sector as it naturally hedges their cost
increases with revenues.
We think, that implementation of differential tolling policy by project would help
improve profitability of the road projects with complex structures such as bridges,
tunnels etc. This could also reduce the burden on NHAI’s balance sheet through lower
VGF (Viability Gap Funding) requirements in the longer term, in our view.
Both passenger and freight traffic continue to grow at a fast pace—low
penetration provides a long-term tailwind
Passenger car penetration in India has almost doubled in the past 10 years; from 5
per thousand people in 1999 to 10 by 2009; however, India is still among the
lowest penetrated car markets in the world.
As highlighted by an expert of toll roads at World Bank during a conference call
(refer to Conference Call with World Bank: Where are China’s toll fees heading?,
dated March 16, 2011 by our China infrastructure analyst Ronald Keung) it takes at
least 1-2 years for traffic to stabilize at a typical toll road; however, it depends on
factors such as cities connected, existence of a parallel road etc.
We observe that most of the Indian highways are relatively new concessions and
hence traffic has not stabilized yet. Even some of the existing large toll roads show
occasional high traffic growth (see Exhibit 24) in line with the above factors such
as high vehicle volume growth. Hence, we view 5%-6% medium-term growth in
traffic as reasonable for most concessions (see Exhibit 25 and 26).
Traffic growth on Indian toll roads is also likely to be strong as the roads under
NHAI concession do not permit the construction of a parallel competitive road
unlike other countries in the world where there are parallel highways. As a result
of this, we also do not see any major impact on traffic even if toll rates are
increased over time.
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
India: Construction: Infrastructure
Equity Research
Pick-up in road project awards likely; reiterate Buy on IRB and ILFT
Award activity likely to pick up soon
Post the lull in road contract awards in 2H2010, NHAI has begun to show
increased activity on both awards and incremental requests for qualifications.
After awarding about 4,400 km up to end-Feb in FY11 (13 km/day vs. initial
target of 20 km/day vs. past 3-year average of 4.5 km/day), NHAI is gearing up
to step-up award activity from April onwards with about 11,000 km (worth
US$13.5 bn) of projects targeted for award by April 2012. Simultaneously, we
believe the process of having annual qualification limits (instead of individual
project-wise) is a step in the right direction and could help cut down project
award timelines by up to 3 months.
Valuations are inexpensive and balance risk of aggressive bidding
Post the 16% and 31% fall ytd for IRB and ITNL, respectively, the stocks are
currently trading at 12-m forward P/E of 10X and 9X, 36% discount to
historical median for both, and 32% and 40% discount to MSCI India. We
believe given the relatively modest size of the upcoming 100 projects
(US$135 mn average size), large number of companies may continue to
qualify on the required technical and networth criteria, increasing the risk
of aggressive bidding for some of the projects in the near term. Long
term, we continue to view strong vehicle volume growth and
current low toll rates in India as tailwinds for the sector.
Our picks: IRB and ITNL for their strong track record, robust order
book and limited interest rate risk
IRB (IRBI.BO): (1) 2,300 lane km of under-construction roads provide
visibility on construction revenues; (2) Majority of debt is fixed-cost and the
balance has no immediate interest rate reset; (3) Daily toll collection of
Rs24 mn ensures sufficient cash flows for equity commitments, in our
view. Maintain Buy and our 12-m SOTP-based TP of Rs234.
ITNL(ILFT.BO): (1) Order book of 10,500 km under construction and
development along with 4,300 km of operational roads to drive 56%
revenue CAGR over FY10-FY13E; (2) Similar to IRB, majority of debt is
fixed-cost and balance has no immediate interest rate reset, which in our
view is positive. Maintain Buy and our 12-m SOTP-based TP of Rs277.
Key risks
Aggressive bidding, volatile interest rates, lower spending by government.
Prefer companies with established bidding-execution track record
After a lacklustre 2H2010 for NHAI road contract awards, the past 3 months have seen
some pick up in both award activity (13 km/day during December 2010-February 2011
vs. 3.8 km/day between July-November 2010) and execution (5.6 km/day vs. 3.3 km/day
over the same period).
We expect this momentum to continue as NHAI has targeted 11,000 km (projects worth
Rs610 bn) to be awarded over the next 12 months, a list for which has been displayed
on NHAI’s website.
Credit deployed to the road sector has also increased in the past 2 months, with Rs49
bn additional credit over December 2010-January 2011 vs. Rs88 bn over April-
November 2010 (8-month period).
NHAI has, in 11 months ended February 2011; awarded 4,400 km of new projects vs. its
target of 7,000 km. Execution during the period has been sub-par at 4.6 km/day vs. the
original target of 20 km/day.
Amid this slow movement, we expect the next round of projects awarded to be
competitive as seen from some of the recent bids in which 40-45 bidders have
qualified at the RFP stage.
We prefer experienced and seasoned participants such as IRB Infrastructure and
ITNL due to their strong order books of Rs70 bn and Rs110 bn, respectively, to be
executed over the next 2-3 years. Given this order book coverage, we expect
them to bid conservatively over the next few months.
Further, we believe the annual qualification for road competitors (RFAQs) as compared
with the earlier practice of projects-wise qualification would help speed up the bidding
process—resulting in faster awards of road projects and freeing up bandwidth at NHAI.
Toll rates in India are among the lowest in the world (on PPP adjusted basis) and we
expect them to remain low (specially for commercial traffic) as NHAI has in the past
not been able to push through toll rate increases; however, we expect traffic growth
to reflect the high vehicle volume growth trend over the medium term.
For IRB Infra, earnings expectations have been fairly stable and we believe the recent
underperformance is more a function of a lower market assigned multiple (see Exhibit
32-34). For ITNL, although earnings expectations have come down, the
underperformance has, similar to IRB, primarily been a function of multiple de-rating,
in our view. We think this is an aberration as the fundamental drivers for the sector in
terms of demand for roads and traffic growth have not changed.Prefer companies with established bidding-execution track record
After a lacklustre 2H2010 for NHAI road contract awards, the past 3 months have seen
some pick up in both award activity (13 km/day during December 2010-February 2011
vs. 3.8 km/day between July-November 2010) and execution (5.6 km/day vs. 3.3 km/day
over the same period).
We expect this momentum to continue as NHAI has targeted 11,000 km (projects worth
Rs610 bn) to be awarded over the next 12 months, a list for which has been displayed
on NHAI’s website.
Credit deployed to the road sector has also increased in the past 2 months, with Rs49
bn additional credit over December 2010-January 2011 vs. Rs88 bn over April-
November 2010 (8-month period).
NHAI has, in 11 months ended February 2011; awarded 4,400 km of new projects vs. its
target of 7,000 km. Execution during the period has been sub-par at 4.6 km/day vs. the
original target of 20 km/day.
Amid this slow movement, we expect the next round of projects awarded to be
competitive as seen from some of the recent bids in which 40-45 bidders have
qualified at the RFP stage.
We prefer experienced and seasoned participants such as IRB Infrastructure and
ITNL due to their strong order books of Rs70 bn and Rs110 bn, respectively, to be
executed over the next 2-3 years. Given this order book coverage, we expect
them to bid conservatively over the next few months.
Further, we believe the annual qualification for road competitors (RFAQs) as compared
with the earlier practice of projects-wise qualification would help speed up the bidding
process—resulting in faster awards of road projects and freeing up bandwidth at NHAI.
Toll rates in India are among the lowest in the world (on PPP adjusted basis) and we
expect them to remain low (specially for commercial traffic) as NHAI has in the past
not been able to push through toll rate increases; however, we expect traffic growth
to reflect the high vehicle volume growth trend over the medium term.
For IRB Infra, earnings expectations have been fairly stable and we believe the recent
underperformance is more a function of a lower market assigned multiple (see Exhibit
32-34). For ITNL, although earnings expectations have come down, the
underperformance has, similar to IRB, primarily been a function of multiple de-rating,
in our view. We think this is an aberration as the fundamental drivers for the sector in
terms of demand for roads and traffic growth have not changed.
Award activity has improved and could increase further
After a lacklustre 2H2010 for NHAI road contract awards, the past 3 months have seen pick
up in both award activity (13 km/day during December 2010-February 2011 vs. 3.8 km/day
between July-November 2010) and execution (5.6 km/day vs. 3.3 km/day over the same
period).
We expect this momentum to continue as NHAI has targeted 11,000 km (projects worth
Rs610 bn) to be awarded over the next 12 months. This would be in the form of 100
projects spread across various NHDP phases with:
Majority (approx. 65%) of the work to be done under Phase IV–2 laning and 11% to
be done under Phase III–4 laning in km terms
Almost 82% of the projects to cost below Rs10 bn
As a result, we could see intense competition to continue in the road space over the next
few quarters–we have seen recent bids with as many as 40 bidders qualifying to bid for
some of these road projects.
Adoption of annual qualification process a positive
The NHAI has started the process of compiling annual qualifications (RFAQ) for projects
from March 20, 2011, thereby enabling companies to get shortlisted for a particular price
bracket of projects once in a year. As per the new norms, those shortlisted in the annual
technical qualifications need not provide elaborate details at the time of project-specific
bidding.
Annual qualification will be valid for projects involving two-laning, four-laning as well as
six-laning of highways (refer to our commentary Key takeaways from FT summit on Indian
Highways, dated Feb 8, 2011).
We believe this is positive for the sector as it would help reduce project award
timelines.
We believe more companies would now be able to meet the networth criteria of NHAI and
be able to bid for projects under Rs30 bn as:
(1) Projects worth up to Rs20 bn require a networth criteria of 25% of total project cost
(TPC) – we expect significant competition here.
(2) Projects worth between Rs20 bn and Rs30 bn require a total net worth criteria of Rs5 bn
plus 50% of the cost above Rs20 bn–we expect significant competition here.
(3) For projects with a TPC of above Rs30 bn, the concessionaire should have a networth of
Rs10 bn, plus 100% of the cost above Rs30 bn–we expect moderate competition here.
We analyze below 22 construction companies and how their networth has changed over
time to bid for bigger projects.
Policy decisions on toll rates critical over the long term; continued
increase in vehicle penetration also a long-term tailwind
Toll rates in India are low currently—a long-term tailwind for the sector as
quality of roads improves
Toll rates in India are among the lowest in the world both for passenger and truck
traffic. Even on a PPP adjusted basis, India has among the lowest toll rates in the
world (see Exhibit 15).
Despite that, we do not expect any significant increase in toll rates in the
immediate future as we have observed that the government’s track record to
implement increase in toll rates (especially for commercial traffic) has been mixed.
In December 2010, the MoRTH agreed to introduce a new category, namely 3-axle
commercial vehicle, in the toll fee slab to reduce the toll applicable to such
category of traffic in order to call off a nationwide strike by the truck association.
Over the long-term, decisions on hiking base toll rates could be critical for future
highway development, in our view, especially for expressways and higher quality
highways (higher carrying load, faster speeds)—globally, growth in traffic
generally has low price elasticity, i.e., 10% change in toll leads to approx. 3%
change in traffic; hence we see this as a likely possibility and a catalyst for
development in the segment.
Since increase in toll rate annually is currently based on the increase in WPI
(Wholesale Price Index), it is positive for the sector as it naturally hedges their cost
increases with revenues.
We think, that implementation of differential tolling policy by project would help
improve profitability of the road projects with complex structures such as bridges,
tunnels etc. This could also reduce the burden on NHAI’s balance sheet through lower
VGF (Viability Gap Funding) requirements in the longer term, in our view.
Both passenger and freight traffic continue to grow at a fast pace—low
penetration provides a long-term tailwind
Passenger car penetration in India has almost doubled in the past 10 years; from 5
per thousand people in 1999 to 10 by 2009; however, India is still among the
lowest penetrated car markets in the world.
As highlighted by an expert of toll roads at World Bank during a conference call
(refer to Conference Call with World Bank: Where are China’s toll fees heading?,
dated March 16, 2011 by our China infrastructure analyst Ronald Keung) it takes at
least 1-2 years for traffic to stabilize at a typical toll road; however, it depends on
factors such as cities connected, existence of a parallel road etc.
We observe that most of the Indian highways are relatively new concessions and
hence traffic has not stabilized yet. Even some of the existing large toll roads show
occasional high traffic growth (see Exhibit 24) in line with the above factors such
as high vehicle volume growth. Hence, we view 5%-6% medium-term growth in
traffic as reasonable for most concessions (see Exhibit 25 and 26).
Traffic growth on Indian toll roads is also likely to be strong as the roads under
NHAI concession do not permit the construction of a parallel competitive road
unlike other countries in the world where there are parallel highways. As a result
of this, we also do not see any major impact on traffic even if toll rates are
increased over time.
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