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Road construction sector: Turning a corner with favorable policy measures

The infrastructure and construction sector was the major casualty of Covid-19. Road contractors were the major casualties as the activities came to a screeching halt.

The lockdown led to a delay in project completion. Government payments got frozen which increased working capital related issues. And, the inability to realize stuck capital added to the financial crunch.

However, with recovery in the economy, the level of activities have now returned close to normalcy for road contractors. As per an ICICI direct report, the supply chain is being restored to pre-covid levels. And, the projects are also resuming with labourers returning to the work sites.

Future outlook appears stable:

Despite Covid-19 related disruptions, The order inflow remained aggressive for the industry. NHAI awarded 40 projects totaling 1,330 km in H1FY21. It is 1.6x higher than 828 km awarded in H1 FY20. NHAI and MoRTH (Ministry of Road Transport and Highways) is targeting 4,500 km/ 11,000 km of road construction in FY21. It would be a 13.1%/ 7.5% jump, respectively, compared to FY20.

The aggressive new order targets stand to benefit the road construction companies. Their order books are going to see considerable pick up during the rest of FY21 and FY22. It will provide them with strong revenue visibility in the coming years.

Concrete steps to address liquidity crunch:

The government's inability to clear its dues caused a major financial crunch for the sector. However, the government has now started to release the funds. It is also strengthening its payment mechanism to avoid such delays in the future.

The authorities have also announced various measures to resolve payment related issues. It includes

A) Shifting from milestone-based billing to monthly billing

B) Releasing of retention money/performance security in proportion to execution

C) Faster resolution of disputes through reconciliation

These reforms have made the outlook more favorable for the road construction companies.

The government has also revised the model concession agreement (MCA) for Hybrid Annuity Model (HAM) and Build-operate and transfer (BOT) projects.

Under the revised MCA for HAM projects, the ministry has

A) Doubled the number of installments from 5 to 10. It will ensure regular payment at short durations

B) Reduced interest rates. It will improve the average debt service coverage ratio and project IRR

C) Reduced duration for transferring the equity in a project. It will speed up the asset monetization process

Similarly, under the revised MCA for BOT projects,

A) Revenue assessment period is reduced to 5 years from 10 years earlier

B) Project to be awarded only after possession of 90% of the requisite land

These measures are being aimed to improve the financial strength of the sector. And, they will actively increase participation in HAM and BOT projects in the medium to longer term.

Closing comments:

Muted construction activities and delayed government payments were the major issues that the road contractors were facing. However, the industry is now witnessing a few positive developments around it.

NHAI has provided strong guidance on the future bidding pipeline. It will provide strong revenue visibility for the future. The government is also actively looking to clear its dues towards the sector. It has also strengthened the payment mechanism for the future. These measures will go a long way in improving the financial health of the sector.

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