Construction industry: Sluggishness to continue in on-ground execution  

October 14, 2011

Slow decision-making in the government and stretched payment cycles in the construction industry expected to pull down earnings

Moneylife Digital Team

Construction industry players have indicated that sluggishness in on-ground execution will continue, according to a recent IDFC Securities report. The key bottlenecks include slow decision-making in the government and stretched payment cycles.

Working-capital levels have been stubbornly high, leading to a continued rise in debt levels in Q2FY12. There has been a visible slowdown in order flows from the power sector even as ongoing projects face the risk of an execution slowdown. A rise in debt levels and borrowing rates would drive interest provisioning higher than earlier estimates. Lowered earnings of L&T by about 4% each for FY12 and FY13 have been indicated in the report. The earnings estimate for HCC will factor in incremental concerns on execution, and the company may suffer a net loss of Rs15.80 crore for the quarter (from break-even earlier).

A likely peaking of interest rates and fund-raising through divestment of infrastructure assets are the key potential triggers for stocks in the near term. The outperformers in the industry include L&T, IVRCL, HCC and NCC, and Simplex is expected to be above average due to its relatively rich valuations.

Order inflows have been muted across construction companies, due to slower order intake from the industrial & power segments. Orders from Central/state government authorities in areas like urban infrastructure, water, etc, have been hit by slow decision-making in the government. Also, power-sector orders have decelerated due to uncertainty over availability/pricing of fuel and higher borrowing costs. Orders from the building (mainly government & institutional) and road segments have been relatively robust.

Overall, announced orders flows for EPC players (including BTG) have grown by 7% y-o-y (year-on-year) in H1FY12. Excluding orders flows from NTPC’s bulk tenders (9x800MW), order flows have declined by 12% y-o-y to Rs86,800 crore.

Uncertainty on availability/pricing of fuel has already led to a visible slowdown in power sector orders. Orders from the power sector (generation + T&D, or transmission & distribution) declined by 31% y-o-y to Rs331 billion YTD (year-to-date), but were up 9% y-o-y to Rs5,250 crore, including NTPC bulk tenders. With these uncertainties likely to persist in the near term, execution of under-construction projects (especially projects in early stages) may get stretched due to deferrals by clients, says the report. Further, difficulty in raising equity-funding for under-construction projects may also decelerate the execution of these projects.

Working capital levels remain stubbornly high. There has been no tangible improvement in the previous quarter. The payment cycle of government and PSU (Public Sector Unit) contracts remains stretched due to slow decision-making.

Borrowings rates for sub-contractors and suppliers have increased to about 15% due to the continued rise in interest rates, rendering market borrowings unviable. Construction companies have also had to increase support to their sub-contractors and suppliers to ensure continuity of execution. As a result, there has been a further rise in debt levels of most construction companies. Borrowing rates have risen further and are now at 11.5%-12% for most players in the segment.