ICRA: Increase in competition in road sector; lack of bidding discipline to result in profit margin erosion for contractors

The Ministry of Road Transport and Highways (MoRTH) has provided relaxations in the eligibility criteria of bidders for HAM/EPC projects this has in turn resulted in increased competitive intensity over the past few months. There has been an entry of new players in the road sector from other sectors (stadium, hospitals, hotel, smart city, warehouses/silos, oil and gas) as well as an increase in bidding eligibility for existing players. Lower state capex, muted private sector opportunities and higher opportunities in road sector has pushed more entities towards road sector.

Rajeshwar Burla, Co-Group Head & VP, Corporate Ratings, ICRA, said, "competition in road sector is expected to remain at an elevated level with more contractors fulfilling the relaxed eligibility criteria. The EPC mode continues to remain extremely competitive with many bidders quoting at a discount of as high as 30-35% to the NHAI's base price. The BOT (HAM) has also witnessed heightened competition resulting in average premium to NHAI cost reducing to around 15% from 25-30% earlier and even negative O&M bid in some cases. The number of bidders has surpassed 40 participants (of which qualified were 30) for some of the EPC projects and 10-15 participants (around 5-10 earlier) for HAM projects."

ICRA expects the central government spend on infrastructure building to be maintained given its positive multiplier effect on the overall economy, notwithstanding the adverse impact of Covid-19 induced slowdown on economic activities. The budgetary allocations for MoRTH increased at a CAGR of 21% from to Rs. 1,08,230 crore in FY2022 BE from Rs. 41,193 crore in FY2017, and is expected to remain robust considering the large Bharatmala Program. This apart, NHAI has been actively trying to monetise assets through TOT and InvIT modes.

Burla added, "Discounted bids to NHAI's base price are coinciding with the period of high commodity prices (steel, cement etc.). Consequently, the impact on the profitability of the contracting companies could be substantial. While price escalation is covered in EPC contracts, the fact that NHAI's base price itself is based on dated DPRs implies that the escalation clauses may not mitigate the impact of rise in input prices to a large extent. Bidding discipline, therefore, remains a key for road contractors to maintain adequate profitability and avoid build-up of stress on working capital cycle."

The aggressive bidding for the projects may also lead to projects getting delayed or stuck or under dispute as lower profitability in the projects would constrain the contactor's ability to absorb time and cost overruns in the project. The time and cost overruns could be due to various reasons, including steep increase in commodity prices, change in scope, delays in land acquisition and approvals; and force majeure events among others.