Why Indian infrastructure companies do not enjoy good valuation?
ECONOMY & POLICY

Why Indian infrastructure companies do not enjoy good valuation?

Indian infrastructure sector has been a key driver for the Indian economy. The sector is highly responsible for propelling India’s overall development and enjoys consistent focus from the Government as well. Rather it is one sector with highest capital gearing. This in simple terms means a Rupee one Invested in infrastructure generates opportunities worth Rs 10. It is a known fact that despite witnessing a good growth on the GDP front, India has been an infrastructure deficit country. Indian Government has always tried its best to provide its support to the sector with different sops and incentives. However despite all such factors, the performance of infrastructure companies on the bourses depicts a different story.

Indian infrastructure sector has been a key driver for the Indian economy. The sector is highly responsible for propelling India’s overall development and enjoys consistent focus from the Government as well. Rather it is one sector with highest capital gearing. This in simple terms means a Rupee one Invested in infrastructure generates opportunities worth Rs 10. It is a known fact that despite witnessing a good growth on the GDP front, India has been an infrastructure deficit country. Indian Government has always tried its best to provide its support to the sector with different sops and incentives. However despite all such factors, the performance of infrastructure companies on the bourses depicts a different story. If we take a long term view, while the Indian benchmark indices have touched a new peak after witnessing a meltdown in 2008, the infrastructure companies have not been able to cross the historical highs they had posted during the bull phase they witnessed during 2004-2008. While the other sectors like steel, cement and even the other building material companies have managed to cross their respective historical high levels. However the infrastructure sector – that basically drives the demand for the above sectors has not been Able to witness a revival. There were a few tranches where the infrastructure companies witnessed some marginal up move, however the performance over the past decade has been below par. While a few of the companies are still providing negative returns in the past one decade, few of the infrastructure also got delisted. Forget about the smaller companies that have actually eroded the wealth of the investors, the biggies like L&T have also provided just 6 per cent CAGR for the past one decade, marginally higher than the risk free returns. If such are returns for the posted boy of the Indian infrastructure sector – one can just imagine what kind of returns other smaller companies have provided. As stated earlier the infrastructure sector has been constantly getting support from the Government – initiatives like AMRUT, Smart Cities Mission and even acts like consistently increasing road development per day. Further adding to that the best of the minister with the help of the road transport minister at the helm, there has been great support from the ministry as well. However despite all efforts, the Indian infrastructure companies have underperformed. The issue is, a lot of retail investors have got an exposure to the sector with most of them stuck at the highest of the levels. As stated earlier, while a few of companies are either delisted a few are still suspended from trading. As such not providing an exit option. What is the reason behind such a poor performance of infrastructure companies on the bourses? Let’s take a detailed look at the same going ahead. However before that let’s have a look at the price charts of the leading infrastructure players. Also read: Why investors are wary of investing in Real Estate companies?  Let’s start from the largest player L&T. While the stock is providing a positive sort of return over a decade, the CAGR Returns are just marginally higher than the risk free returns. And the basic premise suggests, if risk is higher than the reward – it is meaning less to invest in such an opportunity. As seen in the chart the decline in the stock at the start of the Pandemic was much steeper as compared to the benchmark indices. First and the foremost factor why Indian infrastructure companies do not enjoy good valuations is poor performance in the past one decade. The following charts depict the story. While L&T has at least provided positive returns – the likes of GMR infrastructure, GVK Power & Infrastructure and Lanco Infratech have not only eroded wealth but are either delisted or suspended from the bourses. The story is no different for the other players like Hindustan Construction Company (HCC), Punj Lloyd and IVRCL Infrastructure. Following are the charts showing performance of the mentioned companies. HCC GMR Infra While the above two charts are providing detailed analysis about the poor price movement, the losses are at least minor. The charts like Punj Lloyd and Jai Prakash Associate clearly indicate how the investors gave a cold shoulder to the infrastructure companies. The charts of Punj Lloyd indicate how the wrong acquisitions and aggressive bidding for projects resulted in poor financial performance and eventually poor performance on the bourses as well. There are gullible investors invested in the company considering it to be the next L&T of the Indian infrastructure play. However it only performed poorly. Punj Lloyd Similar has been the story of Gammon Infrastructure. The company started with a bang but eventually the spark faded. Poor financial performance and even few cases of poor construction quality (resulting in structure collapse) Gammon Infra is another story of company eroding investors wealth. Gammon Infra While looking at the charts one may feel it is only a private lot that has performed poorly. But the story is no different for the public Sector undertakings as well. The likes of Engineers India (EIL) and even the NBCC have witnessed pressure during the past one decade. The following chart shows. EIL Following are few of the other companies that have eroded wealth of the investors. Sadbhav Infra Sadbhav Ltd While the above provided are the examples of companies providing negative returns, there are few companies that provided marginally positive returns. The road developers like Dilip Buildcon and even the Ashoka Buildcon have provided marginally positive returns. However the returns are lower than the street expectations especially the way equity markets provide over a long term. Dilip Buildcon Ashoka Buildcon While we have shown how the infrastructure players have failed to create wealth for the investors, there must be some reason behind why Indian Infrastructure players hardly enjoy valuation premium. Also read: Govt wants to allow firms to invest in EL projects Factors impacting the Indian infrastructure sector valuation premium While we have always spoken about the positive factors providing impetus to the infrastructure sector, there are few of the factors affecting the sector negatively. Or we can say there are factors that have affected the infrastructure sector over the years and are likely to impact going ahead as well. Just to list down the same, we believe the top major constraints in infrastructure development over the next few years are corruption, political and regulatory risk, access to financing and macroeconomic instability. The constant pressure backed by the above factors results in many of the infrastructure companies losing valuation premium. Let’s have a look at the above parameters in detail. While we have mentioned all Government and policy support to the infrastructure sector, the political and regulatory risk has other many facets. Just to put it in a simple manner, such factors include community opposition on an investment, changes to asset-specific regulations and breach of contract terms. We have seen how a few of the projects got delayed due to delay happening in land acquisition (Local unrest and demands). Apart from that in the case of India, denial of payments from the government that go against contractual agreements seem to be perceived as highly likely to influence future investment decisions. Delays add to the cost and eventually impact the margins. Rather many of the projects eventually became financially unviable due to such delays. As regards the financing issues, we have seen how the poor access to financial support led to problems for infrastructure companies. To put it in a simple manner, the financing issue touches upon the core feature of infrastructure. Long-term payback period of the infrastructure projects makes it vulnerable to many uncertainties. Rather, it affects financiers and investors who are looking for long-term and steady returns. After the global financial crisis though, long-term lending is not easy to get, India not being an exception. We still remember how the infrastructure companies had to raise funds at a higher rate (almost 1.5x of the prevailing rates). Rather the debt burden was so much that a Few eventually could not even generate cash flows to generate interest payments as well. One article suggested that, stated that the government doesn’t want to take on more risk in privately financed infrastructure projects, leaving the private sector exposed. Other factors constraining infrastructure development are the delayed approvals that put a strain on the long-lasting and sometimes opaque tendering processes. Large road and energy projects can take several months to be awarded and if processes are not clear and impartial enough, investors hardly mobilize resources to bid. All such events lead to slower growth and project completion and eventually slower margin growth. Apart from this, no one would openly accept but a monster called corruption is always affecting the Indian infrastructure players. Though it is not a major factor to worry, there are certain actions that can be taken to put the sector back on track amid all the corruption impact. Experts suggest key measures that include stronger cooperation and communication between the private and public sectors, the enforcing of a unified legal framework and creation of better dispute-resolution mechanisms for infrastructure investments. In addition to this, clear deadlines and independent, highly qualified and business-savvy regulators were also proposed. Then there is the insistence on transparency and the enforcement of anti-corruption standards. The above key challenges have long been raised by international and domestic investors. The government has set up a Project Monitoring Group (PMG) to track frozen projects and remove bottlenecks. Any project in infrastructure can be referred to the group for resolution. The PMG has already been successful in resolving more than 200 of the projects referred to it, worth nearly 30 percent of the value of all projects, according to the World Bank. Also read: Fastest growing construction companies in India 2020: CW Survey  Other issues – order book does not necessarily mean good bottom-line If we take a look at the reasons behind the poor performance of Indian infrastructure sector, it is the consequence of a multiple whammy of sorts for the sector. The adversities include fuel supply shortages, an uncertain regulatory environment, high interest rates and delays in clearances of projects. When we take a detailed look, even the execution slowdown is leading to revenue slowdown. Higher debt, rising cost of funds and lower profitability has meant a slowdown in the investment capital expenditure. All in all there are issues even after the allotment of the project and hence the order book does not necessarily result in a good topline and bottomline. Developers say that road project delays had affected most of the leading infrastructure companies in the past. Though the pace of development has increased and even the mode of contracts has changed – (from BOT to Hybrid and new modes) the cash flow generation is still not that great. Major business with handful players One factor that makes the infrastructure play a Very difficult one for the investors is too much concentration of business with few companies. Just to put the numbers in perspective, the top 7 companies got 40 percent of Rs 50,000 crore worth of the fresh contract, awarded by the National Highway Authority of India (NHAI) in March 2021. Earlier there were more companies bidding for fewer contracts. The margins were under pressure then and even disruption occurred in the sector. However the current scenario will lead to a situation where the larger concentration of business would happen and eventually this will pose increasing equity funding risk. Many companies have seen significant increase in the order books but the execution still holds the key. And any failure to execute at the right time and right cost would mean hefty losses to the finances as well. Add to that the pressure of scarcity of financing options like working capital and project financing needs of large companies, the issue would make the valuations of infrastructure companies get affected. Currently most of the infrastructure financing is done and largely met by state-run banks that are already reeling under mounting bad loans pressure. Overall that pressure has reduced the appetite of banks towards giving out loans to the infra sector and rising interest rates are also impacting the outlook of these companies, thus increasing the risk involved in investing with them. It is true that markets are on historical high levels, however the infra companies are yet to cross historical high. And most importantly further equity dilutions won’t be a great idea for the companies as not many would go for equity dilution. Historical Evidence – there was frenzy about getting into infra space, then fizzled As we stated earlier there was a period when every company was trying to get into the infrastructure space. The following list shows how the companies had changed the names to showcase themselves as infrastructure companies. BSE Code Old Name New Name Date 531194 Mewar Leasing Ltd. Brahmaputra Infraproject 16-Apr-99 531261 Tanu Leafin & Investment Ltd. Concurrent (India) Infrastructure 10-Jun-99 531261 Tanu Leafin & Investment Ltd. Concurrent (India) Infrastructure 10-Jun-99 530773 IVR Constructions Ltd. IVRCL Infrastructures & Projects 01-Oct-00 531959 Kumaon Pharmacaps & Chemicals Newtime Infrastructure 15-Mar-02 512048 Hindustan Stockland Ltd. Splash Media & Infra 07-Oct-02 532123 BSEL Information Systems Ltd. BSEL Infrastructure Realty 16-Oct-03 500390 BSES Ltd. Reliance Infrastructure 27-Feb-04 530343 Genus Overseas Electronics Limited Genus Power Infrastructures 13-Sep-07 530323 Era Constructions (India) Limited Era Infra Engineering 11-Feb-08 513648 Marg Holdings and Financial Services Marg Projects and Infrastructure 19-Dec-08 531194 Mewar Industries Ltd. Brahmaputra Infraprojects 17-Jul-09 531261 KUSHAGRA SOFTWARE LTD. Concurrent (India) Infrastructure 16-Nov-09 500402 SUBHASH PROJECTS SPML Infra 14-May-10 530215 Victory Aqua Farm Limited Kings Infra Ventures 17-May-10 508860 DIAMANT INVESTMENT & FINANCE. Diamant Infrastructure 08-Jun-10 531959 INTRA INFOTECH LTD. Newtime Infrastructure 15-Nov-10 506016 JALGAON RE-ROLLING INDUSTRIES JRI Industries & Infrastructure 22-Mar-11 531537 BOSS SECURITIES LTD. Jyothi Infraventures 04-Jul-11 501945 HINGIR-RAMPUR COAL CO DHENU BUILDCON INFRA 17-Sep-12 512121 HARI OM TRADERS & AGENCIES Delma Infrastructure 19-Jul-13 519477 Umred Agro Complex ltd. CIAN Agro Industries & Infra 27-Apr-16 We still remember, many companies even changed or altered names of companies. Forget about the smaller construction companies changing names by adding word infrastructure – even few realty companies had started using suffix – Infrastructure. All in all, the increased number of projects, buzzing order inflows, consistently improving margins and most importantly ample liquidity – it was just like a dream run for Indian infrastructure players. However the bull phase that started in 2003 ended in 2008 at least for the infrastructure companies. In this phase a lot of small contractors formed Joint Ventures and entered the Indian infrastructure segment. With executions of smaller contracts first eventually the companies entered the larger execution game as well. Naturally the competition increased in the field and even the margins came under pressure as more companies bidded for fewer contracts. This resulted in competition and disruption of the market. While the smaller players enjoyed the volumes and lower margins initially, the disruption in markets eventually affected all players. We believe, though the number of players have reduced over the years, the space has not remained so vibrant. Further as stated earlier, mere order books won’t result in cash flow and an improved bottom line. Further the smaller players have not only destroyed the overall market but also the trust of investors. With smaller players already getting wiped out there are only a few players left in the field. With larger ones already getting enough FII inflow the smaller ones are not getting any investment. Hence there is no more liquidity chasing the infrastructure players, the valuations are getting affected. Ambitious government targets – fundamental issue (likely to be a reason of fear) With a successful stint of government at 10th Five year plan in Terms of Public Private Partnership (PPP) (at least in terms of attracting private capital), No wonder the next five year plan was further more ambitious. To put the figures in perspective, the target for the 11th plan for Infrastructure was USD 500 billion with private participation seen at 30 percent. And the high ambitions did not stop here, and the 12th plan was estimated at USD 1 trillion with private participation at 50 percent. With Indian economy running full steam then, it looked very obvious. And why not – with Indian economy growing at near to double digit figure, ample (rather more than required) liquidity, consistently improving foreign fund flows and last but not the least –rising domestic demand, almost everyone on the street expected the target to get achieved. No wonder the positivity was visible on bourses as well as indices touched all time high levels by end of 2007. While everything looked very good till the end of 2007, something happened on a global platform that took everyone by surprise - Global meltdown of 2008 occurred. Financial crisis of 2008 is considered the worst economic disaster since the Great Depression of 1929. Just to list out the few of the factors in 2008 financial crisis, it occurred despite Federal Reserve and Treasury Department efforts to prevent it. It led to the Great Recession, where housing prices fell even more than the price plunge during the great depression. It happened in the US however the impact was visible all over the globe. And as expected it resulted in liquidity flowing back from emerging markets to developed economies. Even India that had witnessed consistent FII inflow for more than a decade, witnessed significant out flow. In 2008 FIIs turned net Sellers to the tune of Rs 53000 crore. While each and every sector witnesses negative impact-capital intensive, rate sensitive and debt laden companies were hit the most. Especially the realty, infrastructure and capital goods were the one severely impacted. The impact was so severe that even today the confidence of institutional investors has not been back into the infrastructure companies. There was a specific reason behind the same – looking at the growth rates witnessed during FY04 to FY07 –not only the large companies but also the smaller infrastructure companies had gone ahead to expansion plans. As stated earlier with many joint ventures and complex organisational structure – balance sheets looked large but were heavily debt laden. It was a period where expecting better growth prospects infrastructure companies had raised funds from every possible way. Debt constituents were significantly higher and worst was everyone even justified those high debt ratios. Every financial institution had lent funds to infrastructure companies. And here is the root cause of all the problems faced by not only the infrastructure companies but also the NPA issues (even making its impact felt now) faced by the financial institutions. Wrong acquisitions & strategies – even an issue today Wrong acquisition strategies by the companies had been one issue with infrastructure companies. Take the example of Punj Lloyd. It was supposed to become a new poster boy of Indian infrastructure space. But in a bid to be on a faster route towards growth it opted for an organic route. It acquired Sembawang Corp. Sembawang was a design-to-build engineering and construction service firm with core capabilities in process and plant engineering, heavy civil engineering and building. It resulted in a good amount of increase in the order book of Punj Lloyd, but all the margins were very low and in just a few quarters it resulted in pressure further mounting on Punj Lloyd margins. What made matters worse was legacy contracts were already making an impact on bottomline and few geo-political issues in its export orders resulted in severe impact on revenues as well. As a result investors were quick to give the cold shoulder to Punj Lloyd. Scenario was no different for the likes of other big players like Reliance Infrastructure, JaiPrakash Associates and IVRCL Infrastructure. This clearly indicates it was not only economic and Government related issues that affected the companies from the Infrastructure sector. Companies with wrong acquisitions, aggressive bidding. Unnecessarily diversification and an over leveraged balance sheet were bound to collapse. As we stated earlier cash flow generation was hardly visible and with all sources of fund raising going dry – companies had no choice but to sell non-core assets. During this difficult period Indian infrastructure sector witnessed many deals where many non-core assets were sold by the companies –lower than (Deep discounts) the fair value of those assets. Worst of all, assets were purchased at very high valuations and sold at deep discounts. So the assets that were supposed to generate cash flow actually resulted in further losses. Over all it was a scenario where Infrastructure projects were stalled, Infrastructure companies were bleeding and its impact was also visible on financers of those projects. We had stated earlier that, while infrastructure lending was a specialised field in earlier days – looking at initial performance and returns even Banks had lent aggressively to infra. Even with lower domain knowledge in infrastructure - banks were lending aggressively, but as the cash generation cycle got stuck – it led to NPA issues for banks. Even today mergers and acquisitions are happening and we feel those are happening at higher valuations that are unsustainable. Huge sum stuck in stalled projects in arbitration – still pending cases We had discussed the complete cycle of how many infrastructure projects got stalled and affected. And as a result a huge chunk was under litigation and arbitration process. To put the figures in perspective, in December 2020 only around Rs 80,000 crore worth amount was stuck in arbitration. In August 2016 it was decided that Government agencies would pay 75 per cent of the arbitration amount where the projects got stuck due to land acquisition delays, contractual delays or regulatory delays. Unless such a process is kept on Fast track the infrastructure worries won’t disappear. Macroeconomic issue - lower spending as a percentage of GDP on infrastructure There is a thumb rule, a country must spend at least 8 percent of GDP on infrastructure. Even China has been doing so since the late past two decades and the results are in front of everyone. This has helped China to post even double digit growth in the past. If we take a look at Indian figures, till 2006 infrastructure spending (Construction, Utilities and Other infra) as a percentage of GDP was less than 5 percent. It was eventually increased after 2008 and has remained above the 7 percent mark. If we only consider the Construction and infra the figures are still less than 5 percent). However, there is a need to increase spending further. Simply put, the target of USD 5 trillion will only remain an aspiration if infrastructure spending is not increased. To put the figures in perspective, India has only been able to put USD 100 to 110 billion annually into infrastructure development. This huge investment gap of about USD 90 billion, needs funding through different and most importantly innovative approaches. Underlining the strong relations between the economy and infrastructure data suggests that the correlation of investments in inland, road, rail and airport infrastructure to GDP are higher than 0.90. Given the fiscal constraints that leave less room for expanding public investment at the scale required, there is an urgent need to accelerate the flow of private capital into infrastructure. India needs to spend 7-8 percent of its GDP on infrastructure annually, which translates into annual infrastructure investment of USD 200 billion currently. However, India has been able to spend only about USD 100-110 billion annually on infrastructure, leaving a deficit of around USD 90 billion per annum. For China they have kept the Infrastructure spending as a percentage of GDP continuously in the higher single digit and above since 1996-97. Though the national infrastructure pipeline (NIP) has been scheduled and is being undertaken, the financing for the same needs to be taken care of first. Especially in a scenario where the Covid -19 pandemic has affected the budget estimates. Unless the infrastructure spending increases the golden days won’t be back soon. Conclusion Indian infrastructure space has been ignored by the investor’s fraternity. One can gauge the same from the fact that the infrastructure funds haven’t provided returns as compared to benchmark indices. There are historical issues pertaining to the sector in the form of debt burden, execution capabilities and even the management bandwidth of smaller companies. Though the infrastructure has started to witness some momentum and the response to GR Infrastructure had been good, there are certain pockets where improvement is required. Factors impacting the sector 1) Poor performance of infrastructure companies for more than one decade (Either erosion of wealth or hardly in returns as compared to other sectors) 2) Inability to raise capital at right (prudent) cost or rates. Raising funds had been an issue with the Infrastructure companies as financial institutions have to go for Higher Risk Weightage. 3) Smaller players had entered space and bided at very competitive margins. This resulted in stiff competition that led to longer term impact on the Cash Flows of the companies as well. 4) Legacy order book – Impact on larger players was visible 5) High cost acquisitions – companies are still paying the price for acquiring assets at higher cost 6) PPP in the first phase yielded good results. However, when the Government had set a higher target for private participation, it eventually faded. 7) Longer time taken for arbitration in many cases. Still delaying the completion of many infrastructure projects 8) No synchronisation between State and Centre. We have recently seen how the State and Centre had locked horns over NHAI projects 9) Ambitious Government Targets – A Fundamental Issue 10) Rising raw material prices and fuel prices – expected to be major factor 11) Macroeconomic Factor – Lower Spending on infrastructure as a percent of GDP Solutions Expected to Provide Solace 1) Increase spending on Infrastructure from current levels to bridge the infrastructure gap 2) National Infrastructure Pipeline – Good initiative but still Execution holds the key 3) National Monetisation Pipeline – good policy move. However, it needs to be executed without glitches and hiccups. 4) NMP is being planned – However, further overhauling is needed in Infrastructure financing (or Credit System) 5) Focus is required on selecting the right project and not just wasting energy on making any project financially viable. 6) Adoption of Latest Technology – Must look at developed nations or Even China for Example 7) Setting up Priorities –Projects that require earlier and quicker execution 8) Essential to introduce pan- India policies in the sector for standardiSation. Image courtesy

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