Adequate order book position, a strong pipeline of projects and Government measures to boost construction companies' performance in FY2022

Good times await the construction sector in FY2022 as it is on a recovery path post the disruption caused due to the Covid-19 pandemic. The execution was severely impacted in H1FY2021 due to the nation-wide lockdown, reverse migration of labour and supply chain constraints. However, in the last few months, the Government has announced a slew of relief measures to support the players including the relaxation on EMD & performance security, relaxation of bidding eligibility criterion and increased frequency of payments for Government tenders. While the pandemic-related uncertainties continue to remain, execution has recovered sharply in the last few months. ICRA expects the pace of execution to improve over the medium term, supported by adequate orders in hand as well as the recent measures taken by the Government. Further, companies which have a healthy balance sheet and order book are expected to witness an improved performance in FY2022.

The order book position of most of the construction players is currently adequate, which provides medium-term revenue visibility. With a huge pipeline of projects to be awarded in the infrastructure sector (as per the National Infrastructure Pipeline - NIP), ICRA expects the new order inflows for construction companies to remain healthy in FY2022. However, delays in land acquisition, funding issues, and state government priorities remain key risks to the new order inflows. The order inflows from non-infrastructure segments like industrial and real estate (excluding affordable housing segment) is expected to remain muted, with weak private sector capex growth.

According to Shubham Jain, Senior VP and Group Head, Corporate Ratings, ICRA Ltd, “The infrastructure sector is the key contributor to construction sector’s order book. With a sharp increase in infrastructure investment planned under the NIP, the construction sector is likely to see significant opportunities in the medium term. A major part of the NIP is towards transportation (roads, railway, etc), energy/power, and urban infrastructure. The players which are focused on these segments and have a healthy balance sheet are well placed to capitalise on these opportunities. On the execution front, ICRA expects the healthy order book to support growth in operating income of construction companies in FY2022. However, companies which have leveraged balance sheet, and stalled or slow-moving projects, would continue to face challenges.”

Operating profitability is expected to remain stable with the benefits of improved execution scale; though this would also be dependent on any steep variation in key raw material and labour cost and increased competitive intensity. The working capital cycle for the larger construction players has remained at higher level in the past, owing to slow realization of receivables, and slow-moving legacy projects. This has been met partly by higher creditors, thus percolating to sub-contractors working capital cycle as well. Some of the recent measures taken by the Central Government are helping companies involved in such projects by way of faster bill realisation and lower Bank Guarantee (BG) requirements. Lower BG requirements will help release the margin money blocked and enhance companies’ ability to scale-up. On the other hand, companies which are working on state government contracts are likely to see elongation of their receivable cycle in the near term. Due to these factors, overall, the working capital position in FY2022 is expected to remain range-bound and at similar levels as in the past.

With the increased scale of operations in the next fiscal, the debt of construction companies is expected to increase, albeit marginally, except in the case of increase in working capital intensity or investment in asset-owning models like the Hybrid Annuity Model (HAM) based projects where the increase in borrowing could be higher. Low-interest rates and reduced BG requirement will help in keeping the overall finance expenses under control. With this, the credit metrics of construction companies are expected to improve in FY2022. However, some players in the sector remain highly leveraged and their liquidity pressure is likely to persist as the lenders remain cautious towards the infrastructure/construction sectors. Their ability to raise funds via stake sale in its subsidiaries, monetisation of assets, or dilution of equity will be key factors in improving liquidity and the capital structure.

Abhishek Gupta, Assistant VP, ICRA Ltd., reiterates: “For entities with high exposure to PPP projects, regular monetisation is crucial for churning of capital. While earlier, bilateral sale of assets was the primary mode of asset monetisation, over the last few years the Infrastructure Investment Trust (InvIT) has emerged an attractive vehicle for asset monetisation which can pool capital from long-term investors. Increased capital availability with developers can help improve private players’ interest in PPP projects, thereby speeding up the infrastructure investment cycle and opportunities for construction players.”

Due to these factors, ICRA’s FY2022 outlook on the construction sector is Stable. The ratings agency expects the credit profile of construction companies to recover in the coming fiscal after weakening in FY2021. However, companies which are highly leveraged or have high exposure to state government projects could witness a weakening credit profile. As Government bodies are key clients for most construction companies, supportive measures as undertaken in the past can help strengthen the sector.