FY26 Construction Outlook - Modest Revenue Growth and Margin Recovery
India Ratings and Research (Ind-Ra) expects the Engineering, Procurement and Construction (EPC) sector to achieve revenue growth of 10%-12% yoy in FY26, following a lower 8%-10% growth rate in FY25 (FY24: 10%-12%). This will also be much weaker than the FY22-FY24 CAGR of around 20%, driven by the modest growth in central budget for FY26, a continued shift of state spending away from capex, and mixed trends on private capital spending. The EPC sector revenue growth is broadly linked to the growth in nominal gross fixed capital formation (GFCF) and construction gross value added (CGVA), which Ind-Ra expects to grow at 11.3% yoy and 12.5% yoy, respectively, for FY26 vs 7.2% yoy and 8.6% yoy for FY25.
“The centre's own capex growth in FY26 has been scaled back to 10%, a marked decline from 30% CAGR over FY20-FY24, with higher allocations to states and Production-Linked Incentive (PLI) scheme to spur state and private sector spending. While Ind-Ra expects states' capital spending to recover 14.5% yoy in FY26 (FY25: 5.1%), aided by increased capital grants by the centre, the increased welfare spending commitments are likely to pose a downside risk. Private sector capex has seen a sector-specific rebound, which is expected to sustain, and central public sector enterprises' (CPSEs) capex is likely to see continued momentum,” says Krishan Binani, Director, Corporate Ratings at India Ratings and Research.
Sub-sectors view for FY26:
Transmission and distribution (T&D)/power: An improving outlook on steady order flows and potential margin improvement
Metro, Buildings, Defence, New Age Sectors: Neutral outlook led by stable demand environment
Water and Allied Infra: Improving outlook; turnaround likely post a sluggish FY25
Roads and Railways: Deteriorating outlook due to flat central allocations. Specific segments in railways may continue to perform well.
Margin growth is likely to remain challenging (like in the past few years), due to heightened competition as companies would diversify in view of a lull in awards in the larger segment of national highways, despite a relatively stable input price environment, and lower drain from legacy contracts. Ind-Ra expects a 30-40bp yoy improvement in FY26 margin, on a weak FY25 margin level. Margins in FY25 are now expected to deteriorate marginally yoy (vs an earlier expectation of 30-50bp improvement).
Credit metrics and liquidity position are likely to improve in FY26, following working capital cycle normalisation post the general elections and modest growth in operating cash flows. The interest coverage ratio could increase to 3.9x in FY26 (FY25: 3.6x, FY24: 3.5x), the net leverage is likely to drop to 1.3x (1.5x, 1.5x) and cash flow from operations (CFO) to interest cover could recover to 2.5x (2.2x, 2.3x).
For the purpose of this report, Ind-Ra has considered its entire portfolio of rated EPC companies, excluding Larsen & Toubro Ltd (debt rated at ‘IND AAA’/Stable) due to its large scale and diversified operations, which would have skewed the analysis.
Ind-Ra believes the liquidity profile of EPC entities will remain adequate in FY26, driven by an improvement in CFO with adequate working capital and capex linked tie-ups. CFO margin is expected to improve to 7.4% in FY26 (FY25: 6.7%), while CFO to EBITDA conversion could improve to 65% (62%), as the working capital cycle stabilises after a busy election year in FY25. Although banks continue to apply caution in their exposure to the EPC sector, there had been an encouraging increase in the non-fund-based working capital exposure in FY24 following the withdrawal of Covid-19 relief measures.
However, there will only be a marginal increase in 1HFY25, reflecting normalisation amid rangebound order inflows, and rising adoption of surety bonds. Although EPC companies' leverage profiles may structurally increase as they increasingly undertake public-private-partnership projects, driven by government push, the comfort is drawn from the monetisation vehicles developed by most major companies, either in-house or in partnership with infrastructure trusts.
