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Amar
Amar Ambani
Head - Research, IIFL,
India Infoline Group
Heavy toll, High bends
Posted on: 14:41 November 18, 2011
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Heavy toll, High bends
Players with strong balance sheets are likely to break free of the current gloom but the diversion off the dismal still seems distant.
 
The highway projects commissioned until April 2010 tell a story of gloom rooted in over estimation of traffic prospects on one hand and an under-estimation of time and cost overruns on the other. The result has been obvious - with equity IRRs much lower than the cost of equity for most players. The scene is even worse for some of the recent awardees.
 
As many as 27 NHAI projects show a dismal return and almost 80 per cent of the projects are unlikely to even cover the cost of equity.
 
Few patterns are evident from the observations:
 
  • The performance of toll road assets has left much to be desired. What began as an experiment in Public-Private-Partnership (PPP) projects on the Build-Operate-Transfer (BOT) model gained momentum only in 2005. But until July 2011, only 55 projects were operational vis-à-vis the 187 awarded.
  • Of the five factors determining the equity IRR of a toll road asset, viz, project cost, completion time, base traffic, traffic growth and interest rate, the first four are sunk costs and considerations in the case of operational projects. Hence, IRR volatility is driven by revenue growth and interest rate assumptions. The analyzed set of companies show an incompatibility between consistently higher revenue growth and lower debt cost.
  • A sizeable number of projects would need equity infusion to meet interest obligations. While positive Ebitda will be sucked by debt obligations, even little cash build-ups post debt repayment will be consumed by the yearly maintenance burden. 
  • Although large projects seem attractive in the wake of lower competition, big is not necessarily beautiful for these projects as our analysis reveals.
  • The biggest culprit for low IRRs has been the over estimation of traffic. Many a management estimates have proved far-fetched, especially with respect to the volumes and value of non-toll diversions, toll exempt vehicles, resilience to economic slowdown and of course, revenue growth assumptions. FY09 was the worst-hit year for traffic prospects. The need of the hour is clearly a conservative estimate that does not throw negative surprises.
  • Land acquisitions and clearances still eat up sizeable time leading to overruns and implementation delays. Political conflicts and multiple touch points of interaction add to the mess. Although the NHAI is fighting to resolve this grey area, the benefits still seem distant.
  • Rise in commodity prices make a mockery of fixed price contracts as developers are forced to account for price volatility from time to time. The rising bitumen price is a classic case in point.
  • Hyper-competition will result in aggressive bidding for some time to come. Marginal costing, netting off construction margin to calculate return hurdles and debt restructuring will be imminent for many players. Consolidation is a logical offspring of this chaos but the shift does not seem immediate. 
To summarize, the road to recovery still seems far away and it would need a player with the right wherewithal to see through the rough patch before things begin to look up. Companies with good track records, disciplined bidding, strong balance sheets and the acumen to chase fast-track opportunities will fare well in the ultimate analysis. However, these are early days yet. Things may well get worse before they get better.
 

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