The construction sector is besieged with hurdles that are hampering growth.

October 3, 2011

India’s construction story has great relevance at a time when most metros have lesser space for development and a large number of people from tier-II and tier-III cities are flocking to the cities, which has put enormous strain on the infrastructure in metros. However, for companies in the construction sector, this has resulted in stiff competition, thus bringing down the Internal Rate of Returns of most of their projects.

The construction sector has been in the news of late. Firstly, increasing interest rates has ensured that it is a topic of discussion among the general public and secondly, delays in rolling I out of projects by the government has been a cause of concern for construction companies in the last few months. These have resulted in the downgrading of a number companies in the sector.

So what exactly are the problems that are posing hurdles for the sector’s growth? At a time when interest rates are rising and companies are in the cost-cutting phase, would construction companies be able to find a firm footing in the coming quarters? We give you a lowdown on the opportunities in the construction sector and the problems that are making it difficult for construction companies to turn these opportunities into visible earnings.

THE INDUSTRY

The construction industry is directly related to the infrastructure of the government and corporations in different sectors. It is estimated that under the 11th Five-Year Plan (FY08-12) around Rs.11 trillion has been spent on infrastructure.

Of the total estimated amount of Rs.20 trillion, Rs.9 trillion is to be spent in FY12. Apart from this, the 12th Five-Year Plan is expected to entail an investment of Rs.41 trillion in infrastructure projects, which means the investment allocated to this sector is over 200% in comparison with the previous Five-Year Plan.

In addition to this, other sectors such as power, road, irrigation, port, airports and water infrastructure depend heavily on construction companies as enablers of growth. In the coming two fiscal years, these sectors are likely to present enough order book and earnings visibility for the construction companies.

a) Power Sector

Experts believe that if the government follows the investment pattern of the Eleventh Plan, a substantial amount of investment would be channelized into power generation, transmission and distribution segments of the power sector in the Twelfth Plan. After providing for investment in these sectors, the remaining investment would find its way into roads, irrigation as well as water supply and sanitation.

In addition to this, India’s power capacity is expected to treble in the Eleventh Five-Year Plan. In comparison to the Tenth Five-Year Plan of adding capacity of 12 GW of thermal power, it is expected that the Eleventh Five-Year Plan would add a capacity of 50 GW.

Additionally, private players in the sector too would play a crucial role in it and is estimated to account for 56% of 27 GW supposed to be added in FY12. Hence, there is enough opportunity for construction companies that would be building power plants to meet the power demand in the country. The estimated opportunity for the construction companies would be worth $56 billion or Rs.254 crore, approximately. The Power Grid Corporation of India, which is the central nodal agency for maintaining national and regional transmission grids, has a capital expenditure of Rs.550 billion, which it would spend in the span of four years ending 2012.

b) Roads

Roads form an integral part of the order book of construction companies. Being a developing country, infrastructurally speaking, roads in the country are in a bad state and suffer from under capacity.

The government has come up with programmes such as the National Highway Development Project (NHDP) and the Pradhan Mantri Gram Sadak Yojna (PMGSY) to upgrade the national highway network and the rural road infrastructure, respectively. Projects have also been undertaken at the state level to upgrade state highways. Multi-lateral agencies like the World Bank and the Asian Development Bank have been involved in funding a number of projects at every level.

Under NHDP, the government has planned to develop 49,987 km of national highways. Projects like the Golden Quadrilateral and the North-South/East-West corridors are almost complete. However, projects whose cumulative length adds up to more than half of the total length to be developed under the NHDP, are yet to be awarded. Estimated projects worth $55 billion are yet to be awarded and may be issued in FY11-14 if NHDP is to be completed by its deadline.

c) Water Infrastructure

Water infrastructure is in dire need of investments. There is a scarcity of fresh water in India. Nearly 85% of water in the country is used for irrigation. Every year some regions of the country face drought, while others face floods. Scanty rainfall received last year and the spate of farmer suicides in recent years have brought the government’s attention to the development of water resources and channelize the supply to every corner of the country.

The government has set aside nearly Rs.415 billion for water projects. This forms about 71% of the total allocation under the Jawaharlal Nehru National Urban Renewal Mission (JNNURM). The projects under JNNURM are meant to establish and upgrade infrastructure in cities with water supply, sewerage and drainage being the top priority. Providing clean drinking water and treating and disposing sewage are the main objectives of the programme. Hence, these projects provide enough opportunities for the construction companies to cash on.

ISSUES

However, there are several roadblocks obstructing the growth of construction companies. The construction companies are finding it difficult to secure consistent orders. There have been delays due to lack of clarity on land acquisition, fuel linkages, and financing. Also, projects are getting unviable due to outdated costs and insufficient manpower. Another important reason for delays is regulatory norms on the part of the government, which is probing a host of scams. These obstacles have stalled swift issuance of projects and, hence, increased interest cost of companies.

Construction companies are also facing a problem of increase in working capital cycle. A working capital cycle is defined as the number of days taken by a company to procure revenues for its projects. The working capital cycle of construction companies has widened in the past few years due to issues such as credit crunch in FY09, delay in payments, slippages in execution of projects and change in mix of projects.

The working capital cycle for companies has increased from 85 days to 145 days. This deterioration in the last two quarters is mainly due to delays in payments and increasing loans and advances.

This has resulted in higher borrowing, thus impacting profitability. Most companies’ loans and advances shot up because of increasing loans to their subsidiaries for investments in BOT projects, which will be returned once the projects become operational.

As a result of increasing working capital cycle of construction companies, the debts on their books have been rising. Most construction companies still maintain a debt to equity ratio of less than 1. However, with high working capital these companies have to stretch their balance sheet to fund future growth. More so with rising interest rates, the resultant increase in cost of funds would hurt profitability of companies. Also, execution of projects in the last two quarters has slowed down. Much of the negative impact of these factors can be seen in the lackluster performance of most construction companies in the sector in the June ’11 quarter.

Going forward, it is important that the government clears projects promptly and urgently. Traditionally, the third and fourth quarters of a fiscal are considered to be better than the first and the second quarter.

Experts believe that it would take few more quarters for the sector to enjoy the desired momentum in project execution considering inflationary and interest rate concerns. However, most big-sized companies are likely to see revenues coming in the next three to four years.

Source: stockmarketsreview.com