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The Construction sector has borne the brunt of the growth slowdown
in the investment cycle. The sector has witnessed steady erosion in
ROEs, from 15-20% in FY04-05 to 7-8% currently, mainly on
account of margin compression and increasing capital intensity due
to increasing working capital and foray in infrastructure ownership
business. Clarification on non-applicability of Section 80-IA benefits
(tax exemption on profits) for contracting in FY07 budget further
impaired reported ROEs, as companies steadily aligned tax
provisions to marginal rates. The sector’s ROE erosion was
accentuated by massive losses at Punj Lloyd, as the company’s
overseas acquisitions misfired badly.
Contractors’ EBITDA margins were expanding in the first half of the
analysis period (FY04-08), as strong growth in order books blunted
competitive intensity and private clients were willing to pay higher
costs for expeditious completion. A scramble to win projects started
to show up as lower margins, as the cycle turned for the worse in
FY08. High commodity prices have come in as an additional drag.
The slowdown in the capex cycle not only dragged margins lower but
also made the terms of trade adverse for contractors as clients
started delaying payments. Asset turns have gradually declined as
working capital intensity worsened. Players in the sector did not help
matters by chasing asset ownership dreams.
The decline in ROEs in the initial phase of the asset-heavy business
with long gestation periods is understandable. We would not have
been worried if we were sanguine on the long-term IRRs on the
assets created. However, the evidence from the first flush of projects
getting operational is mixed—there are more misses than hits.
Accounting losses in the first few years of an infrastructure asset are
a fact of life, but cash losses in projects with concession lives of 15-
20 years means that sacrifices in upfront ROEs are not going to be
rewarded by high ROEs in the medium to long term.
The balance-sheet ballooning for contractors could not have come at
a worse time. With equity dilution at rich valuations no longer
possible and interest rates hardening, a larger proportion of EBITDA
is being eaten away by interest costs. With RoA lower than cost of
incremental debt, increasing leverage will only worsen ROEs.
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
The Construction sector has borne the brunt of the growth slowdown
in the investment cycle. The sector has witnessed steady erosion in
ROEs, from 15-20% in FY04-05 to 7-8% currently, mainly on
account of margin compression and increasing capital intensity due
to increasing working capital and foray in infrastructure ownership
business. Clarification on non-applicability of Section 80-IA benefits
(tax exemption on profits) for contracting in FY07 budget further
impaired reported ROEs, as companies steadily aligned tax
provisions to marginal rates. The sector’s ROE erosion was
accentuated by massive losses at Punj Lloyd, as the company’s
overseas acquisitions misfired badly.
Contractors’ EBITDA margins were expanding in the first half of the
analysis period (FY04-08), as strong growth in order books blunted
competitive intensity and private clients were willing to pay higher
costs for expeditious completion. A scramble to win projects started
to show up as lower margins, as the cycle turned for the worse in
FY08. High commodity prices have come in as an additional drag.
The slowdown in the capex cycle not only dragged margins lower but
also made the terms of trade adverse for contractors as clients
started delaying payments. Asset turns have gradually declined as
working capital intensity worsened. Players in the sector did not help
matters by chasing asset ownership dreams.
The decline in ROEs in the initial phase of the asset-heavy business
with long gestation periods is understandable. We would not have
been worried if we were sanguine on the long-term IRRs on the
assets created. However, the evidence from the first flush of projects
getting operational is mixed—there are more misses than hits.
Accounting losses in the first few years of an infrastructure asset are
a fact of life, but cash losses in projects with concession lives of 15-
20 years means that sacrifices in upfront ROEs are not going to be
rewarded by high ROEs in the medium to long term.
The balance-sheet ballooning for contractors could not have come at
a worse time. With equity dilution at rich valuations no longer
possible and interest rates hardening, a larger proportion of EBITDA
is being eaten away by interest costs. With RoA lower than cost of
incremental debt, increasing leverage will only worsen ROEs.
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