India’s infrastructure sector has gained some, and lost some. While, overall, its performance has been positive, some main sectors are yet to reach full potential. But, compared to the previous years, what has changed drastically is execution support and monitoring, with the old wound of land acquisition rearing its head repeatedly. EPC&I takes a look.



Infrastructure sector has been a key driver of the Indian economy. The sector is highly responsible for propelling India’s overall development. According to the Department of Industrial Policy and Promotion, Foreign Direct Investment received in Construction Development sector (townships, housing, built up infrastructure and construction development projects) from April 2000 to March 2017 stood at US$24.3-billion.

And, now, as we cross the half-yearly period, a look back at the past six months would be a good indicator to what is to come ahead. According to India Ratings and Research (Ind-Ra), the rating for the infrastructure sector is negative for FY18, with varied outlooks on the individual sectors. The agency says that the negative outlook on the three heavyweight sub-sectors – toll roads, thermal and wind – continues to pull the overall sector outlook down.
While it has maintained a stable outlook on solar and seaports due to the reasonably established payment profile of state utilities (barring a few) and growth-led cargo throughput volumes, the agency has revised the outlook for airports to positive for FY18 from stable in FY17. This, writes Siva Subramanian, Associate Director – Infrastructure, Ind-Ra, is based on the solid fundamentals of air passenger volumes (pax), underpinned by moderate fuel prices (although higher than 2016 levels) and favourable policy actions.
Commenting on Rewables, Ind-Ra believes that with the current rate of capacity additions, a minimum 2.0 percent dip in plant load factor (PLF) in FY18 can be expected. Overall, capacity additions have consistently outpaced demand growth since FY13, leading to surplus power.
State utilities could invite medium- to long-term bids; however, the closure of bids will be protracted and utilities will procure economical spot market power to avert paying capacity charges.
Fixed-price power purchase agreements (PPAs) insulate many thermal power projects from low spot rates and cash flow volatility. Nevertheless, irregular power scheduling – like in 2016 – compounded by infirm renewable power generation, could force plants to operate below the normative load factor in FY18. Although there are no project-specific operational challenges and fuel availability issues, the upside potential is limited, writes Subramanian.
The credit quality of wind power projects, the agency reports, will further worsen if the wind resource risk manifests, given the significant exposure of wind capacities to fragile state utilities. Also, utilities’ aversion to sign PPAs under feed-in-tariffs (FiT), albeit project commissioning, has impaired the sector sentiments. The uncertain source supply and grid non-availability, despite its ‘must run’ status, are slowly shaking the fledgling renewable energy sector.
On the contrary, the stable solar sector outlook reflects the presence of fixed-price contracts with dependable central government owned utilities or better rated state utilities. Several solar projects carry investment-grade ratings, with sufficient financial cushion demonstrated even during unusually low solar resources.
Ind-Ra believes that a combination of an evolving payment security mechanism (such as the creation of a payment security fund and state government guarantee) and a fall in panel prices (November 2017 YoY about 28 percent) will not only reduce funding costs but also drive low solar tariffs.
While Ind-Ra has projected a mixed-bag for infrastructure sector, industry observers are of the opinion that the government infra spends backed by multi-laterally funded projects (in urban infra, railways, T&D) and state enterprise (PSU) spending should keep contrators’ order inflow growth steady and possibly earnings growth in mid-teens over the next 2-3 years. They believe that execution support and monitoring is improving materially with land acquisition as the main impediment currently. The key differences between the current outlook than that of 2007, they say, are:
a)  Superior order book quality due to limited exposure to leveraged private sector projects, and
b)  Higher quantum of smaller programme-led orders vs historically large, single turnkey projects in power, metals or cement.
Over the last two years, order book growth for contractors has mainly been driven by government driven infrastructure spends in roads, metros and power T&D. However, with private sector investments – and no material uptick in state-owned enterprise capex either – hopes of a cyclical capex recovery were premature. This was especially true given the excess available capacities in traditionally high-capex industries of power generation, metals, cement and hydrocarbons. Continued investments by the government and strong focus on execution and monitoring coupled with funding from multi-lateral agencies and PSUs could result in further order book growth.
So, what has changed the outlook, and what hasn’t? For starters, the project mix is different, with transportation and urbanisation dominating, unlike in the previous cycle. The investments then were largely centred around power generation and metals, whereas investments now are likely to be more urbanization and transportation oriented. Urbanization will largely involve transportation, housing, roads and water and waste-water management.
Today, unlike before, the focus is more on execution and, more importantly, monitoring. Infrastructure companies and industry analysts alike will tell you that there is a material improvement in terms of implementation support and monitoring by the government. Execution support comes from single window clearances and higher accountability on the bureaucracy. Moreover, the government has increased its project monitoring through continuous reporting sessions – by no less than the PM’s office – and online reporting of the progress.
Also, unlike five years ago, the order book and pipeline largely consists of projects awarded to government bodies that are unlikely to face similar balance sheet issues. Banks continue to be hesitant to lend and are doing so selectively and levered balance sheets, which means that private investments are unlikely to make a big comeback in the next couple of years.
Unlike in the private sector that is highly levered, state-owned asset owners, contractors and consultants are unlevered. The government has shown that it is willing to let PSUs increase balance sheet leverage, as indicated by the increase in extra-budgetary resources in the capex plans for roads and railways. Similarly, industry observers and analysts believe that state-run companies will participate in more BOT projects over the next few years.
Analysts say that government companies have enough headroom to invest to take on more BOT projects. Moreover, the government also plans to monetize these assets and has increasingly pared its stakes in these companies. Awarding projects to these companies to execute, therefore, resolves the government’s need to ensure timely execution – with less vigilance issues – and boost its valuations of these companies.
So, what does it mean for the contractors?
-  Government companies, especially consultants and contractors, may be prime beneficiaries of large capex programmes driven by the need to reduce vigilance overhand and increase valuations of these players.
-  Since government-owned entities will be sub-contracting these projects, counter-party risk for contractors may be minimal.
-  Private sector companies in areas where PSUs still have ample capacities may struggle to compete.
-  In civil construction, government entities may increasingly rely on outsourcing to contractors – especially in design – that could positively impact the margins.
-  Customer advances may not be as easily available for the contractors as in the previous cycle due to more EPC/sub-contracted works.

Roads and Highways – the outperformer
Tendering activity in the roads sector was strong in FY17 though growth of 29 percent YoY was lower than 54 percent in FY16. The Central Government has allotted `1.2-tn in FY18 for the sector vs `1.1-tn in FY17.
While the year started with very strong targets of awarding and construction, the actual awarding and construction posed a strong show despite missing the ambitious targets. According to data from the Ministry of Road Transport and Highways, last quarter of FY17 saw a massive pickup with awarding growing at 60 percent YoY and construction at 35 percent.
While this is well below initial targets, it is still at all-time high levels in road awarding as well as construction. The introduction of Hybrid Annuity model has played a key role in improving awarding of projects.
However, the sector continues to be impacted by multiple factors including land acquisition, environment and other clearances. The governmental effort to remove these bottlenecks may further improve the pace of awarding and construction in coming years.

Hybrid Annuity Model Find Takers, but Lenders Hesitate
Ind-Ra’s analysis reveals that ‘aggressive bidding’ – a common phenomenon witnessed in toll roads – has resurfaced under HAM as well. Additionally, termination payments in HAM are lower than those under toll or annuity, leading to a higher risk borne by the lender in the event of termination.
The difference in the bid price and bid project cost between the project winner and second highest quote was about 8.6 percent and 11.6 percent, respectively. Similarly, the difference between the O&M cost quoted between the L1 and L2 was wide. Also, a very low equity contribution (9-10 percent against 20 percent in toll and annuity projects) from inexperienced developers restrains lenders from approving loans.
Of the 37 projects the government aimed to award by FY17 end, 94.6 percent of projects have been modelled on the EPC and HAM bases. Of these, 60 percent are for expansion to four lanes and 35 percent are for six lanes.
The number of projects awarded under HAM has doubled since FY16. HAM model has gathered pace in FY17 and is likely to be one of the preferred modes of awarding PPP contracts in the near term.

Annuity Road Projects – Stable Outlook
Ind-Ra has maintained a stable outlook on annuity-based road projects for FY18. This stems from assured semi-annual revenue from the National Highways Authority of India, which has been demonstrated this ability across numerous projects over the years. The near timely receipt of full annuities from some state governments provides comfort, as does the ability of entities to operate and maintain their assets within estimated budgets. Aspects such as tapping capital markets after initial annuity receipts, short tail periods and thin coverage metrics continue to be the trademarks of annuity road projects.
Although state annuity projects have been part of the infrastructure growth story for some time now, the number of state governments expanding their road networks through the annuity route remains sparse. Some of the state concession annuity-road projects could also access capital markets, though counterparty risk could manifest and give rise to credit risk. With InvITs gaining momentum recently, some developers are also exploring to hive off their annuity assets (including state-concession projects) into InVITs.

Advanced Model of Infrastructure Refinancing – InVITs – Gain Ground
Debt-laden sponsors have gradually embraced the investment trust model, launched a few years ago, by cherry picking projects with reasonable operational performance to refinance and trim the debt loads. Sponsors with sizeable operating projects in roads and power are the likely beneficiaries of this model.
InVITs not only free up the locked equity capital (with some premium) for sponsors but also embellish the project sustainability. However, given the possibility of addition of 10 percent under construction assets to the InVIT portfolio and the acquisition window always active, yields jeopardising additions could elevate leverage. This exposes the cash flows of better performing assets to the perils of new weak entities.

Tendering leads growth
According to some analyst reports, tendering for infrastructure projects increased by 19 percent in FY17 vs 64 percent inFY16. Growth decelerated due to a high base. Given a sharp uptick in allocation for roads and railways by the Central Government over the last two years, analyst reports suggest that a similar outcome over the next two years can be expected.
Growth in tendering was led by both Central and State Governments, though the former was a larger contributor. Tendering by the Central Government was up 27 percent YoY in FY17 vs 13 percent YoY for the State Governments.

Railways, Water disappoint
Key trends from the tendering activity are:
a)  Roads segment remains at the forefront of both scale and growth of tendering (up 29 percent in FY17 – 40 percent of overall tender value.
b)  Power T&D posted a big uptick – up 120 percent YoY – driven by IPDS/DDUGJY.
c)  Government-led real estate acvitity is increasing – up 71 percent YoY.
Water continues to disappoint, despite an ambitious project like the Clean Ganga. Road companies and power distribution contractors and manufacturers are likely to be the biggest winners of the surge in tendering.

Transmission
The outlook, as reported by Ind-Ra, reflects the achievement of normative availability and regular revenue receipts for transmission assets. The regulatory regime for interstate transmission system (ISTS) projects in the form of point of connection and revenue sharing mechanisms continues to lend strength to the credit profile of ISTS assets.
Availability in operating projects remains above the normative level of 98 percent. Receivable days for interstate assets remain similar to that of Power Grid Corporation of India Limited (PGCIL), the largest owner of ISTS assets.
Although PGCIL’s trade receivables indicate a mild increase since FY14, a further surge beyond 100 days (30 days of credit period allowed under regulations) could be a concern for the sector. Revenue realisation of PGCIL was 97.34 percent of billing in FY16 (FY15: 97 percent; FY14: 98.87 percent).
Privately-owned intrastate projects are distributed among Maharashtra, Madhya Pradesh, Haryana, UP and Rajasthan. Most of the intrastate projects receive payments in a regular cycle. However, given the widely disparate receivable cycle observed among coal-based power, renewable and transmission companies, limited comfort is derived from the continuity of timely revenue receipts for intrastate transmission assets.

Impact of Demonetisation and GST on state revenues, capex
While the initial FY17 capex forecast was budgeted significantly higher over FY16, subsequent revisions have been quite dramatic for most states. As reports show, the FY17 first half spending (pre-demonetisation) was lower than targeted - ~33 percent of the full year’s budget! And, demonetisation has further impacted spending capacity.
Thanks to the consequent economic slowdown, states would likely miss on revenue targets. Over and above, the UDAY scheme spending and impact of pay commission would further impair the states’ spending ability, say industry analysts.
States may find another formidable challenge towards achieving desired revenues, in the form of GST implementation, at least in the short-term. Taking these factors into account, states have now reduced their FY17 revenues and capex budget, and now foresee a modest growth in FY18. But, with the government’s focus on infrastructure development, the capital outlay during the coming years is likely to be strong.

Refinancing to Invigorate Credit Quality
Ind-Ra expects refinancing to be a main stay for road projects in FY18. Recent trend foretells new sponsors’ intention to improve the financial viability of a project through either debt reduction or introduction of a new class of debt (subordinate). The combined effect of reduced leverage, alignment of repayment structure with projected cash flows and entry of a stronger sponsor augurs well for projects.
The debt cut can be as high as 12 percent, before finalising the acquisition transaction. This is a clear departure from the conventional models where developers resort to ‘top-ups’. At the same time, existing sponsors have refinanced debt, by capitalising on the tail period and lower interest rate to bolster the credit quality.

Conclusion
It has been a mixed bag for infrastructure development in the country. While Roads and Highways hogged the limelight, some sectors were plagued by recovery woes. However, with the government pushing ahead with its agenda of investing in infrastructure development, the biggest beneficiaries are the state enterprise (PSU), whose spending should keep contrators’ order inflow growth steady and possibly earnings growth in mid-teens over the next 2-3 years.


Over the last two years, order book growth for contractors has mainly been driven by government driven infrastructure spends in roads, metros and power T&D. However, with private sector investments – and no material uptick in state-owned enterprise capex either – hopes of a cyclical capex recovery were premature.

Today, unlike before, the focus is more on execution and, more importantly, monitoring. Infrastructure companies and industry analysts alike will tell you that there is a material improvement in terms of implementation support and monitoring by the government.

Of the 37 projects the government aimed to award by FY17 end, 94.6 percent of projects have been modelled on the EPC and HAM bases. Of these, 60 percent are for expansion to four lanes and 35 percent are for six lanes. The number of projects awarded under HAM has doubled since FY16.

Growth in tendering was led by both Central and State Governments, though the former was a larger contributor. Tendering by the Central Government was up 27 percent YoY in FY17 vs 13 percent YoY for the State Governments.