India Infrastructure Near-term momentum in roads; railways to pick up next year �� UBS

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India Infrastructure
Near-term momentum in roads; railways to
p ick up next year
�� We met with various decision makers in the sector over the last week
We had meetings over the last week with: 1) implementing agencies in the
highways and railway sectors—National Highways Authority of India (NHAI) and
Dedicated Freight Corridor Corporation (DFCC); and 2) the central planning body
(Planning Commission)—Public Private Partnership (PPP) and Transport sections.
�� We wanted an update on progress in the various infrastructure sectors
The key objective behind these meetings was to understand the thought process on
private participation in infrastructure, quantum of projects likely to be awarded
over the next 12-18 months, and the status on execution of various projects.
�� NHAI to meet targets this year; DFCC awarding likely in 9 months
Our key findings are: 1) the NHAI is likely to award 7,000km+ p.a. of road
projects in FY12 and FY13 (highest for NHAI in any single year); 2) the DFCC is
likely to award about US$3bn of contracts in Phase-1 in the next nine months and
another US$7bn by March 2013; 3) currently land acquisition in both these sectors
is progressing well; 4) there is strong preference for private participation in the
infrastructure sector given constraints on government finances; and 5) PPP projects
are likely to pick up for state highways and are also likely to be adopted by
railways for some of its other projects.
�� UBS view and action: L&T is our top pick; IRB is the key road play
L&T is our top pick in the infrastructure space given its across-the-segment
presence and ability to execute large projects. IRB is the most levered to the road
sector, in our view.
Meetings with sector participants
Over the past week, we met with various sector participants to get their views
and an update on key developments/project award status.
�� NHAI (implementing agency for the National Highways Development
Project or NHDP)
�� DFCC (implementing agency for the Dedicated Freight Corridor Project or
DFC)—Strategy and Implementation
�� DFCC—Finance section
�� Planning Commission (central planning and coordination body)—PPP
section
�� Planning Commission—Transport section
Key objectives for the meetings
There have been concerns over a slowdown in project awarding activity in the
power generation sector (comprises about 25% of the total infrastructure
spending in the country). Roads and railways are the next two big sectors that
comprise about 20% each. Out of the total spending on roads, about half is on
NHAI projects. The most important project under Indian Railways is the DFC.
We wanted to find out the likely quantum and timelines of project awarding
activity in these two key sectors. We also wanted to understand the extent of
private participation envisaged in these and other infrastructure sectors.
Key takeaways from meetings
The following are the key takeaways from these meetings on various issues:
Roads
(1) BOT preferred mode: Build, Operate and Transfer (BOT) would be the
preferred mode of highway development. Only for non-viable projects
would the Annuity and then the EPC modes be followed—likely for 7,000-
8,000km of highways in NHDP Phase IV. A number of states are likely to
go in for the PPP model for development of state highways (similar to the
one being followed by NHAI).
(2) NHAI to meet targets this year: So far in FY12, 4,500km have already
been Awarded, Bids Opened or Bids Invited. NHAI is on track to meet its
target of awarding 7,300km this year (could award 7,000-8,000km).
(3) 7,000km+ likely to be awarded next year: NHAI is likely to award a
similar number, 7,000-8000km, next year as well. FY12 and FY13 could have
the highest project award activity in any single year since the inception of the
highways programme (last year was about 5,000km).
(4) Land acquisition on track: As most of the projects are brown-field
(expansion of existing lanes), land acquisition is not that big an issue. Land
acquisition is going on well presently, and it has gone up considerably
compared to a few years ago—otherwise it would not have been possible
for the NHAI to award so many projects. Also, construction activity in the

sector is significantly higher now, which also proves that land acquisition
has been good.
(5) NHAI capacity building: The process of selection of a Chairman is on
course; it has taken more time due to broadening of scope—the Minister
wants to include qualified professionals from the private sector as well.
This is, however, not hampering implementation in the near term, although
it has longer-term implications. Capacity building at the NHAI would be
taken up by the new Chairman.
(6) Dispute settlement mechanism in a month: The dispute settlement
mechanism is expected to become operational in about a month’s time
(news reports had earlier suggested that over US$2bn of contractor claims
are stuck in these disputes). Although there are some delays in financial
closures of about one to two months for some BOT projects, these are not
significant (all projects have achieved financial closures).
Dedicated Freight Corridor (DFC)
(1) Phase-1 awarding in next 6-9 months: Civil contracts for over US$3bn in
Phase-1 are likely to be awarded by March-June 2012. This consists of
625km of Rewari-Palanpur on the Western Corridor and 343km of Kanpur-
Khurja on the Eastern Corridor. Pre-qualifications have been invited for the
Eastern Corridor and 27 consortiums have applied. Pre-qualification
invitations for the Western Corridor will be issued soon.
(2) Balance by Mar-13: Total civil contracts for the entire project could be
worth about US$10bn. It could be higher due to inflation/cost escalations.
Entire civil works contracts are expected to be awarded by March 2013.
This tranche would be faster to award as most of the awarding processes
such as bid documents, etc would already be in place.
(3) Type of contracts: The Western Corridor could have large packages of
about 300km worth about US$1bn. The civil contracts are likely to be
fixed-price with an execution period of 36-42 months. There is likely to be
a mobilization advance clause of 5-10% (though interest bearing or not is
yet to be decided).
(4) PPP only on one portion: This DFC is not being executed on a PPP basis.
Only the 534km Sonnagar-Dankuni leg of the Eastern Corridor, worth
about US$2bn, would be on PPP basis. This could have one or two phases,
which is still being decided by the Railways Ministry.
(5) Land—50% acquired: About 50% of the land has already been acquired
and there has been very good progress in the past six to eight months. The
entire land is expected to be acquired by December 2012. Land is being
acquired as per the Railways Amendment Act of 2008 and not as per the
Land Acquisition Act of 1894. Land is being acquired by the Ministry and
not DFCC. Land cost is about 5% of the total project cost and hence, any
increase is unlikely to have a major impact.
(6) Funding: Total project cost is about US$18bn, to be funded at 2:1 Debt-
Equity ratio.


— Debt:
— Western Corridor—The Japan International Cooperation Agency
(JICA) will provide a total loan of ¥677bn (in two tranches) to fund the
entire Western Corridor, of which ¥200bn is in the first tranche. It has a
10-year moratorium, 30-years repayment and an interest rate of 0.2%.
— Eastern Corridor—The World Bank will provide a total loan of
US$2.725bn (in 3 tranches)—first tranche of US$975m (balance
equally divided between the remaining two tranches). It has a 5-year
moratorium, 12-year repayment and an interest rate of Libor+38bps.
The Mugalsarai-Sonnagar section (125kms) on the Eastern Corridor
would be funded by the railways.
— Equity: As it is a prestigious project for the Indian Railways, equity
contribution from them is unlikely to be a constraint. Equity requirement
would be about US$5bn over the next four to five years—this would
amount to about US$1bn p.a. or about 8% of the total railway spending
each year. There is also a provision for market-based borrowing. The
Sonnagar-Dankuni leg of the Eastern Corridor would be on PPP basis.
(7) Key benefits: Almost 90% of the freight traffic on the existing track is
expected to shift. The DFC would connect to the existing railway terminals
at about 100km leads. So for shorter leads, at distances of about 40km,
traffic would have to shift to the existing corridor. The Western Corridor is
expected to be fully electrified and double-stack with 32.5 axle-load.
(8) Key risks: 1) Large volume of work; 2) Project management; 3) Working
near existing tracks (80% of the corridor would be aligned to the existing
railway lines); and 4) Monsoons impacting the pace of execution.
(9) Other Corridors—nascent stage: Technical and financial feasibility
studies are on for the other four corridors (East-South, North-South, East-
West, South-South). Multi-lateral funding agencies might not come
forward for these corridors and some other mechanisms might need to be
explored. The total project cost of these corridors might be US$35bn.
Other sectors
(1) Expressways: A separate Authority is unlikely in the near future and
expressways might be managed by the NHAI itself till such time. The
NHAI is conducting feasibility studies for expressway projects in a few
states.
(2) Metros—PPP is preferable: The Central Government should not be
providing funds, as was the case with the Delhi Metro, as metros are a
commercial enterprise that can levy user charges. Good project structuring
can enable private participation while using real estate (like in the case of
Hyderabad Metro). Monorail should be encouraged only in areas that are
land-constrained.
(3) Railways—PPP is inevitable: Indian Railways will have to get more
private participation to meet targets as government resources are not
sufficient


(4) Airports—Navi Mumbai within a year: The Navi Mumbai airport is
likely to be awarded within a year’s time. The Airports Authority of India
(AAI) is planning expansion in Tier-2/3 cities and is investing in these
projects. However, it might not have funds for such projects and might take
them up on a PPP basis.
(5) Ports—Minor Ports unlikely under TAMP: Minor Ports are unlikely to
be brought under the Tariff Authority of Major Ports (TAMP)—
competition will take care of pricing. Though capacity utilization at major
ports is over 100%, capacity expansion is not viewed as a major concern. It
has not happened in the past due to extraneous reasons such as court cases
etc, but it is likely to gather pace. The bigger issue is hinterland
connectivity as inter-agency coordination is the key hurdle there (while
port capacity expansion is within the purview of one ministry—the
Shipping ministry).
(6) Water—PPP not in the near term: PPP in this sector is doable, but tariffs
in this segment are a sensitive issue, having social and political
implications.
Other relevant issues for infrastructure sector
(1) Private participation necessary: Targets for infrastructure development
cannot be met without private participation due to resource constraints. An
added benefit is that cost, time and financing risks are borne by the private
sector. All infrastructure facilities, where users can be charged, should be
under PPP. In the 12th Five-Year Plan, private participation in infrastructure
is expected to be about 50% (up from about 38% in the 11th Plan).
(2) Real estate as a means of providing viability: It is an acceptable
methodology of providing project viability, as long as it is incidental to the
project (like the Hyderabad and Delhi metros).
(3) Cost of land set to increase: Cost of land is likely to rise across the board.
For example, the roads ministry would have to find a way to provide for the
extra funding (increase in cess is the likely solution). More than 40%
Viability Gap Funding (VGF) for a project is ruled out.
Stock ideas: Top pick L&T, IRB key road play
We maintain our positive view on the infrastructure sector in India. We believe a
peaking of the interest rate cycle and a pick-up in order flows in the second half
of the year are key catalysts. Valuations are quite attractive, in our view, post the
recent correction.
L&T (Buy, SOTP-based PT Rs2100) and IRB (Buy, SOTPbased
PT Rs215)
Our top pick in the sector is L&T given its diversified exposure. We believe IRB
is the most levered to growth in the road sector. In a relatively more uncertain
market environment, our preference would be for companies that have high
revenue visibility, strong execution and robust balance sheets—L&T, Mundra
Port and IRB.


Other UBS-covered companies
We also believe the risk-reward profile is favourable on NCC, IVRCL,
Jaiprakash, GMR and GVK due to attractive valuations. We maintain our Buy
ratings on these stocks. We continue to have a Neutral rating on Adani
Enterprises and a Sell rating on Punj Lloyd.
�� Statement of Risk
The sector faces multiple risks including those of execution, policy, regulatory,
commodity prices and interest rates