Ind-Ra Maintains Neutral Outlook for Construction Sector for FY25

India Ratings and Research (Ind-Ra) has reaffirmed a neutral outlook on the construction sector for FY25, while highlighting a deteriorating sub-sector outlook for roads engineering, procurement, and construction (EPC). According to Ind-Ra, EPC players are anticipated to exhibit a healthy performance in FY25, albeit with a moderation in revenue growth rates. The agency foresees a modest uptick in operating margins, coupled with adequate liquidity buffers. Krishan Binani, Director, Corporate Ratings, Ind-Ra, states, "The neutral sector outlook is supported by an expected 10%-12% year-on-year revenue growth in FY25. Anticipated increases in order inflows during the second half of FY25, driven by government budgets and private sector capex acceleration, are expected. Margins are projected to experience a modest uptick, further improving credit metrics."

Despite the continued focus on capex by the central government and likely rebound in state and private spending, Ind-Ra expects the EPC sector’s pace of order execution to moderate in FY25, given the elections in 1QFY25. After the 30% CAGR growth over FY20-FY24, the centre’s own capex is projected to grow at 17% in FY25, following the trend of lower spends in an election year. Acceleration in sector-specific private sector capex and continued growth in state spending are likely to partially offset the lower central spend. That being said, the revenue growth in the past two years has exceeded Ind-Ra’s expectations, with the FY24 revenue growth likely to have been 17%-18% as against Ind-Ra’s 14%-16% estimate (FY23: 16%-17% yoy vs 12%-15% estimate). For the purpose of this report, Ind-Ra has considered its entire portfolio of rated EPC companies, excluding Larsen & Toubro Ltd (‘IND AAA’/Stable) due to its large scale and diversified operations, which would have skewed the analysis.

The sub-sectors of civil construction, power (especially transmission & distribution), water and metro are likely to lead the revenue growth in FY25, while the growth in the roads and railways sector could be sluggish. After witnessing two consecutive years of depressed margins in FY22 and FY23, there could have been a modest, lower-than-expected margin recovery in FY24. Ind-Ra expects a further margin expansion of 30-50bp yoy in FY25, if the raw material prices remain range bound; however, the margins would still be 30bp lower than that pre-covid level. Moreover, the credit metrics are likely to recover on account of the increased profitability amid a stable working capital cycle, with the interest coverage ratio increasing to 3.9x in FY25 (FY24: 3.5x, FY23: 3.1x) and the net leverage declining to 1.3x (1.6x, 2.0x). A longer-than-expected higher interest rate cycle and global slowdown are key risks.

Ind-Ra expects new order inflows to start from late 2QFY25, once the elections are over. A strong uptick was visible in the tenders awarded (FY24: 17% yoy) in the past two years, keeping the order book visibility stable despite the sharp revenue growth. Tenders announced, which remained muted in 9MFY24 (down 1% yoy), picked up pace in 4Q and grew 25% yoy in FY24. With the general elections to be held during 1QFY25, the tendering activity could slow down. Tender announcements and awards could see upward momentum from June 2024 and in line with historical announcements, would start from 2QFY25.

Ind-Ra believes the liquidity profile of EPC sector entities in FY25 will remain adequate, based on a cash flow from operations improvement, coupled with the debt likely to be tied-up for the proposed capex. There could be an increase in the working capital requirements due to the withdrawal of exemption such as monthly billing and bank guarantee exemptions provided to EPC contractors under Atmanirbhar Bharat. Banks have been continuing to apply caution in the form of tightened sanctioning terms with increased collateral requirements while enhancing or extending bank lines to EPC players on account of volatility in the sector and the risks arising from borrowers failing to deliver on contractual obligations. Ind-Ra saw some improvement in the liquidity profile in 9MFY24 with a rise in the recoveries and an increase in overall system-wide non-fund-based limits after staying flat in the last two fiscal years.