Road contractors expect margins to drop 200 basis points: crisis

Aggressive bidding and high raw material prices will drag operational profitability of EPC (engineering, procurement and construction) highway contractors by 200 to 250 basis points (bps) to a ten-year low this fiscal year, the Department said. rating agency Crisil in a report.

Road EPC players’ credit profiles will remain stable, however, supported by debt-free balance sheets, prudent working capital management and steady cash accumulation, with strong allocations over the past two fiscal years supporting revenue growth, the report Crisisl based on an analysis of 20 EPC actors, which constitute 70% of road sector revenues, said.

The National Highways Authority of India (NHAI) granted 6,300 km last fiscal year, up 30% year-on-year, with 55% under the Hybrid Rent Model (HAM). The relaxation of bidders’ financial and technical capacity criteria led to a peak HAM award of 3,500 km in fiscal year 2022, compared to 2,600 km in the previous fiscal year.

Additionally, to speed up construction by awarding to more players, package sizes have been reduced by 30% in the past two fiscal years compared to order sizes in fiscal years 2016-20. As a result, mid-sized regional players won 40% of HAM awards in fiscal years 2021 and 2022, compared to around 25% in fiscal years 2016-20.

Aniket Dani, Director of Crisil Research, said: “Limited competition in HAM projects had supported healthy profit margins for roadside EPC players between fiscal years 2018 and 2021.

Changes in bid eligibility criteria and smaller package sizes have intensified competition, particularly in the past fiscal year. Average bid premiums fell to 4% last year from 16% earlier. Proposed changes in network eligibility criteria and additional performance security for abnormally low bids may moderate competitive intensity.”

The intensification of competition and the sharp rise in the prices of the main raw materials – steel, bitumen and cement – had reduced the operating margins of road EPC players by 200 basis points last fall. Prices for these key commodities jumped 26%, 60% and 4% respectively in the past fiscal year and are also expected to remain high this fiscal year. The cost of raw materials represents 45-50% of the overall cost of roadside EPC players and therefore margins will remain sensitive to any significant price increase. Although many contracts have built-in escalation clauses, these come into effect with a lag. An expected moderation in input prices could improve margins next year. However, the improvement will be limited to 100 basis points with the execution of aggressive bidding contracts, Crisil said. Anand Kulkarni, Director of Crisil Ratings, said: “Despite declining profitability, road EPC players’ balance sheets will remain healthy. Revenue will grow 13-15% this fiscal year, supported by strong backlogs, as evidenced by the backlog-to-revenue ratio of more than 3x. Sound accrual and limited debt will support comfortable leverage, with the total external liabilities to net worth ratio around 1.1x this fiscal year. Thus, players’ credit profiles should remain stable despite the current headwinds.”

Despite competitive pressures, moderating input prices will remain essential for profitability and accruals. A protracted war between Russia and Ukraine and its impact on commodity prices could affect credit profiles and will be worth watching.

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