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Industry update| Infrastructure| 7th July 2010
Indian urban infrastructureWashing and housing half a bn peopleRapid urbanisation means that India needs heavy investment in urbanwater, transportation and (affordable) housing infrastructure. Public
reports suggest that in next 20 years Indias investment in urban
infrastructure will be 20X its investment in the past decade. We
believe unless funding, governance and policy challenges are
addressed, investments could be lower than the required US$1.2 tn.
Construction companies and technology providers (in
water/transportation) will be the key beneficiaries.
Urbanisation amplifies infrastructure deficit
Whilst the degree of urbanization in India is one of the lowest in the world
(~30%), Indias urban population is growing at a rapid pace340 mn in 2008
(290 mn in 2001) expected to grow to 536-590 mn by 2026-30 (source:
National Institute of Urban Affairs and World Bank). This pace of urbanisation
has not only exposed Indias urban infrastructure deficit but also highlighted that
the deficit backlog is increasing at a rapid pace. Government (GoI) sponsored
and UN studies highlight that the severe supply deficits in basic urban services
(water, sanitation, transportation and affordable housing) will rise 2-4X if
investments continue at the current pace.
What does this mean for infrastructure companies?
GoIs commitment to urban infra will increase materially. GoI embarked on an
urban renewal mission (JNNURM) in 2005 and raised investment plans for
urban water supply, sanitation (WSS), transportation and housing by 20X to
Rs6.2 tn (US$133 bn) in XIth plan from the Xth plan. Whilst the plan appears
large, actual investment has been dismally low at US$17 per capita/ annum in
comparison to Chinas US$116. McKinseys report, Indias Urban Awakening,highlights that India needs to invest US$1.2 tn (US$130/capita/annum) in its
cities over 2010-30, 20X the amount spent over the last decade.
Investment will be the highest in urban transportation and affordable
housing. As per the GoI and McKinsey studies, 82% of the capital spend on
urban infrastructure will be on urban roads (17%), mass transit (33%) and
affordable housing (33%). Whilst JNNURM presently gives WSS and slum
development high importance, urban investment plans under the XIth plan,
actually allocate 58% of funds to housing and 21% each to WSS and
transportation. Affordable housing will continue to be a key focus area given
that every 7th person in urban India is a slum dweller.
Urban PPPs not a worthy bet, opportunity largest for construction and
technology providers. PPP opportunities in urban mass transit/transportationhave unattractive risk-reward balance given the limitations of charging for
public good services. However, PPP in smaller WSS schemes may be
profitable for developers as citizens accept to pay for the improving quality of
civic amenities. Hence, he main business opportunity from urban investments
will be for construction companies (US$14 bn annually for next five years) and
technology providers building WSS/transportation projects.
Challengesthe usual evils: funding, governance, planning and policies.
We continue to prefer builders over diversified developersWe reiterate our preference for construction and ancillary companies over
diversified developers given that the former have better visibility on earnings
(vis-a-vis developers who are bidding for projects with risks outside their
control). Our top picks amongst construction are CCCL (20% upside), IVRCL(16% upside) and HCC (38% upside). As the higher backlogs get translated to
revenues and return ratios improve for these companies, we expect construction
business to trade in the range of 12-15X one-year forward earnings. Potential
equity placements/raisings by these companies at the asset level could also act
as positive stock price catalysts for the parent.
Infrastructure companies under coverage
Company name PUNJ.IN
Recommendation SELL, 11% downside
Current price (Rs) 136
Valuation (Rs) 121
Market Cap (Rs bn) 45.3
Company name IVRC.IN
Recommendation BUY, 16% upside
Current price (Rs) 185
Valuation (Rs) 215
Market Cap (Rs bn) 49.5
Company name NJCC.IN
Recommendation BUY, 3% upside
Current price (Rs) 185
Valuation (Rs) 190
Market Cap (Rs bn) 47.4
Company name HCC.IN
Recommendation BUY, 38% upside
Current price (Rs) 117
Valuation (Rs) 162
Market Cap (Rs bn) 35.5
Company name SINF.IN
Recommendation BUY,4% upside
Current price (Rs) 460
Valuation (Rs) 479
Market Cap (Rs bn) 22.8
Company name CCCL.IN
Recommendation BUY,20% upside
Current price (Rs) 90
Valuation (Rs) 108
Market Cap (Rs bn) 16.7
Company name GVKP.IN
Recommendation SELL,11% downside
Current price (Rs) 44
Valuation (Rs) 39
Market Cap (Rs bn) 69.5
Source: Bloomberg, , Execution Noble research
AnalystNitin Bhasin+91 22 4211 0909
Binoy [email protected]
SalesPramod Gubbi, CFA
+91 22 4211 0902pramod.gubbi@ execution-noble.com
Sarojini Ramachandran
+44 (0) 20 3364 6736sarojini@ execution-noble.com
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Unprecedented scale of urbanisation
Whilst the degree of urbanization in India is one of the lowest in the world (~30%),
Indias urban population is growing at a rapid pace340 mn in 2008 from ~300 mn in
2001. During the last fifty years, whist Indias population has grown 2.5x but Indias
urban population has grown by 5x. Studies (sources: GoI, Mckinsey, World Bank)
highlight that the rate of urbanisation in India will further increase to 40% by 2030 the
urban population reaching nearly 575-590 mn (2X the current population of the US).The scale and speed of urbanisation that India may go through has not happened
anywhere before except in China. This scale of urbanisation will mean that by 2030
India will have 68 cities with population of a mn plus compared to 42 cities today
(Europe today has 35 cities).
Figure 1 The addition to the urban population over the next
two decades to be equal to the present urban population
Figure 2 Population split across different tiers of cities13
tier 1 and 55 tier 2 cities to account for 44% of urban population
Source: Ministry of Urban Affairs, McKinsey Global Institute Source: McKinsey Global Institute
is exposing Indias urban infrastructure deficit
Whist India is beginning to catch up on its existing deficit in infrastructure, the
backlog is increasing at a rapid pace. Across all major civic amenities, Indias cities fall
well behind in delivering even the basic. These gaps can further increase as the urban
population and incomes increase leading to rising demand for every key infrastructure
service. Government (GoI) sponsored and UN studies highlight that the severe gaps
between present supply and the basic demand in urban services (for water, sanitation,
transportation and affordable housing) will rise 2-4X over next 20 years if investments
continue at the current pace.
Table 1 The urban services deficit is high across segments
Table 2 On current trends, supply-demand gaps in urban
services will increase sharply
units Current Basic services
standard
Best in
class
Water supply ltrs/capita/day 105 150 220
Share of publictransportation
%, total trips 30 50 82
Parks & open space sq mtrs/capita 2.7 9 16
Sewage treated %, sewagegenerated
30 100 100
Solid waste collected %, total wastecollected
72 100 100
Slum population %, totalpopulation in
cities
24 0 0
Piped water coverage % population 74 100 100
(units)
2007 2030
Supply Basicservicedemand
Supply Basicservicedemand
Water supply bn ltrs/day 56 83 95 189
Sewage bn ltrs/day 13 66 42 151
Solid waste mn tonsp.a
51 71 295 377
Privatetransportation
000 lanekms
430 640 540 980
Rail based masstransit
Directionalroute kms,
kms
990 3,000 1,990 8,400
Affordablehousing
mn units 5 30 12 50
Source: UN, Planning Commission, McKinsey Global Institute Source: UN, Ministry of Urban Development, McKinsey Global Institute , NCAER
0
5
10
15
20
25
30
35
40
45
0
100
200
300
400
500
600
700
1961 1971 1981 1991 2001 2008 2030
Urban population (mn)
(LHS)
Percentage of Urban to total
population (RHS)
195
331
52
104
93
155
2008 2030
Tier 1 cities: Population > 4 mn
Tier 2 cities: Population 1 - 4 mn
Tier 3 & 4 cities: Population
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India is waking up to the need for urban infrastructure
investment
Considering the gaps in urban infrastructure services, the GoI embarked on an urban
renewal mission (including Jawaharlal Nehru National Urban Renewal Mission
(JNNURM)) in 2005 and raised investment plans for urban water supply, sanitation
(WSS), transportation and housing 20X to Rs6.2 tn (US$133 bn) in the XIth five year
plan from Rs 297 bn tn in the Xth five year plan. The importance of investment in urbaninfrastructure can also be assessed by its high 29% share of the XI th plan as compared
to 3.3% in the Xth plan. Senior Government officials, in recent discussions, highlight
that the investments in urban infrastructure will be materially higher in the decade to
come as demand from the higher level of urbanisation further increases. Whilst the XIth
plan clearly details the investments in WSS and urban transportation, it also highlights
the deficiency in affordable housingduring the XIth plan, the total housing
requirement, including the backlog, is estimated at 26.5 mn units. As per the XIth plan,
the total investment requirement for meeting the housing requirement would be of
the order of Rs3.6 tn (US$77 bn) consisting of Rs 1.5 tn required for mitigating housing
shortages at the beginning of the XIth plan and Rs2.1 tn for new additions to be made
during the XIth plan.
Table 3 Planned investments on urban infrastructure increase 20X in XIth
plan from Xth
plan
Xth plan
(Rs bn)
XIth plan
(Rs bn)
increase Investment as a %ageof total investment inurban infrastructure
XIth plan
Investment as a %ageof total investment in
XIth plan
Investment needs for urban water supply andsanitation, sewerage, drainage, and solid wastemanagement sectors
20 1,292 6,360% 21% 6%
Financial requirement to cater to the growingdemand for Urban Transport
27 1,326 4,811% 21% 6%
Total investment requirement for meeting thehousing requirement
250 3,613 1,345% 58% 17%
Total investment planned in urban infrastructure 297 6,231 1,998% 29%
Total investment planned for the plan period 8,932 21,566 141%
Source: Planning Commission
JNNURM vehicle for the national urban renewal and reforms
Whilst the five-year plans carry the detailed plans for investments across various
segments, the GoI embarked on a national urban renewal missionJawaharlal Nehru
National Urban Renewal Mission (JNNURM)in December 2005 to give focused
attention to the integrated development of urban infrastructure and services in 65
select cities benefiting 60% of the total population. JNNURM lasts for a period of 7
years, coinciding with the end of the XI th plan in 2012. The total investment initially
envisaged in urban areas during the seven year mission period is over Rs1.2 tn (US$25
bn), of which the Central Governments contribution is about Rs610 bn, while the rest
is being contributed by states, cities and other sources such as PPP.
Table 4 Urban sector investment requirement as per the original JNNURM plan Table 5 JNNURM sub-missions
Category No of cities Investment over2005-12 (Rs bn)
Annual fundrequirements
Cities with over 4 mn population 7 571 82
Cities with 1-4 mn population 28 571 82
Selected cities with < 1 mn population 28 63 9
Total 63 1,205 173
Sub-mission 1
(Responsibility ofMinistry of UrbanDevelopment)
Urban Infrastructure andGovernance (UIG)
Urban InfrastructureDevelopment Scheme forSmall and Medium Towns(UIDSSMT)
Sub-mission 2
(Responsibility ofMinistry of Housingand Urban povertyAlleviation)
Basic Services to the UrbanPoor
Main thrust will be onintegrated development ofslums
Source: JNNURM website Source: JNNURM website
20x increase in the Governments
spending plans for urban infra
Total investment envisaged in urban
areas during the seven year mission
period is over Rs1.2 tn (US$25 bn)
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Under JNNURM, water supply and sanitation (WSS) have been accorded highest
priority in sub-mission 140% of total spend. Based on the approved project costs of
Rs1 tn, nearly 36% of the sanctions have been for sub-mission 2 with a focus on
creating affordable housing.
JNNURM progress reports highlighting investment and service levelshortfalls
Whilst the JNNURM approval and sanctions data highlight significant progress,
looking at the cumulative Additional Central Assistance (ACA), it seems that the
mission may fall short of its planned investments by 2012. Our discussions with the
senior Government officials indicate that the shortfall could be in the range of 25-30%
on account of limited manpower and financial capacities in state and urban local
bodies, delays in releasing funds, shortage of contractors and due to lack of proper
project packaging and tendering. Moreover, service levels in most JNNURM cities
continue to be poor. In the case of WSS, coverage is still significantly below 100% and
in the case of sewerage coverage is still only 61%. In the case of solid waste
management (SWM), household coverage is 48% and only in one of the 28 cities
waste is disposed off in a scientific manner.
Table 6 Progress report of JNNURM shows that there will be
shortfalls in investments
Table 7 Urban Infrastructure and Governance (UIG) sanction
patterns shows that water supply and sewerage will account for
a larger share of spend in the near-term
Sub-mission 1 Sub-
mission 2Total
UIG UIDSSMT
Projects approved (no.) 524 753 1,422 2,699
Total approved project cost(Rs bn)
583 128 361 1,071
Additional Central Assistance(ACA) committed (Rs bn)
272 103 199 575
% of ACA committed 46.7% 80.9% 55.2% 54%
Cumulative ACA released (Rsbn) 111 61 84 257
Progress as visible from ACAreleased as a proportion toACA committed
41% 59% 42% 45%
Sanctioned
(Rs bn)% Disbursed
(Rs bn)%
Water Supply 196 34% 44 40%
Sewerage 135 23% 24 22%
Drainage/Storm water Drainage 85 15% 15 14%
Solid Waste mgmt 22 4% 4 4%
Roads/ Flyovers 76 13% 9 8%
Public Transport System 48 8% 11 10%
Other Urban Transport 8 1% 2 2%
Urban renewal 5 1% 1 1%
Dev of heritage areas 2 0% 1 1%
Preservation of Water Bodies 1 0% 0 0%
Parking 6 1% 0 0%
Total 583 111Source: JNNURM website, Ministry of Housing and Urban Poverty Alleviation Source: JNNURM website
The GoIs commitment to urban infra will have to increase
materially
India has been investing ~5% of its GDP in infrastructure for the last 7-8 years with
investments in urban infrastructure being not more than 0.5% of GDP. India will have
to materially increase this level of infrastructure spending to meet the challenge of
urbanisation.
Whilst the GoI plans indicate a 20X increase in urban investments in the XIth plan over
the Xth plan, a recently released McKinseys study, Indias Urban Awakening,
highlights that India significantly under invests not only in capital spend but also in
ongoing operational spend in its cities. Furthermore, India spends only US$17 per
capita per annum on urban capital investment as compared to US$116 for China and
US$127 for South Africa. Also, Indias current urban spending varies dramatically
according to the size of the city: a tier 1 city spends US$59/capita/annum as
compared to US$1/capita in the case of tier 3 and 4 cities. McKinseys study highlights
that India needs to invest US$1.2 tn in its cities over next two decades, 20X the
amount spent over the last decade. Over and above this capital spend, the country will
have to spend an equal amount of money on operational expenses in the next twodecades. We expect this to take the total spend on urban infrastructure to 2% of GDP.
In 2007, India made urban capital
investments of only US$17 per capita
compared to US$116 spent by China
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Table 8 Indias per capita spend on urban infra is dismally
low in comparison to other developing countries (2007), US$
per capita per annum
Figure 3 Urban transportation and affordable housing will
account for nearly 82% of the expected capex in urban infra
India China South
AfricaUK
Opex 33 246 381 1381
Capex 17 116 127 391
Total 50 362 508 1,772
Per capita spend in tier 3&4 cities in India is significantly lower than tier 1
Tier 1 Tier 2 Tier 3 & 4
Opex 72 24 11
Capex 58 14 1
Total 130 38 12
Per capita spending in India will have to rise substantially (US$)
Current Required Increase
Capital expenditure 17 134 7.9X
Operational expenditure 33 116 3.5X
Total 50 250 5X
Source: Factiva, Finance Commission, GoI budgets, McKinsey Global Institute Source: McKinsey Global Institute
Largest investment segments: Urban transportation and
affordable housingWhilst JNNURM presently gives WSS and slum development high importance (see
table 5), urban investment plans under the XIth plan, actually allocate 58% of the funds
to housing and 21% each to WSS and transportation (see table 3 on page 3).
Affordable housing has been a focus area given that every 7th person in urban India is
a slum dweller and the increasing urbanisation is leading to more migration to a few
cities. Whilst we expect that investments in WSS will remain high in the near-term,
gradually urban transportation will become the largest investment segment as the GoI
takes steps to reduce strain on urban roads and increase the share of public
transportation. We In order to do so, GoI will have to set up rail-based mass-transit
and bus rapid transit systems (BRTS) in tier 1 cities and tier 2 cities.
GoI and McKinsey studies show that 82% of the capital spend on urban infrastructure
will be on urban roads (17%), mass transit (33%) and affordable housing (33%) (see
figure 3 on page 5). Further, the McKinsey study highlights that such a high
investment in urban transportation and affordable housing is on account of a high
backlog in urban roads and affordable housing (due to insufficient investments in the
past) and due to high growth capex required in mass transit systems.
Significantly high investment in affordable housing will be required to make Indian
cities slum free. As per the Mckinsey study, demand for affordable housing could rise
from 25 mn households today to more than 38 mn households in 2030. The XI th plan
also highlights that total housing requirement up to 2012, including the backlog, is
estimated at 26.5 mn.
Table 9 High backlog and growth expenditure will keep
share of urban transportation and affordable housing high
Table 10 McKinseys funding requirements for these segments are
linked to target service levels
(US$ bn) Backlog capex Growthcapex
Total capexover 2010-30
Urban roads 151 48 199
Mass transit 98 294 392
Affordable housing 243 152 395
Criteria Units Currentdelivery
Basic servicestandard
Road transportation Vehicularcongestion
Peakvehicles/lane km
170 112
Mass transit Share of publictransportation
30 50
Cities with rail-basedmass-transit system
Nos 4 35
Affordable housing Slum
population
% total
population
24 0
Source: McKinsey Global Institute Source: UN, Ministry of Urban Development, McKinsey Global Institute , NCAER
96 5315
32
199
392
395
1,182
Water
Sewage
Solidwaste
Storm
water
drains
Urban
roads
Mass
transit
Affordable
housing
Totalcapex
Segment-wise capex over 2010-30 (US$ bn)
82% of the capital spend on urban
infrastructure will be on urban roads
(17%), mass transit (33%) and
affordable housing (33%)
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So, how can the infrastructure companies participate?
Whilst most of the opportunity for the infrastructure companies in the urban
infrastructure will arise from the construction component, there will be a demand for
technology and equipment in some segments, as it has done elsewhere, apart from
pure construction and equipment supply contracts, the GoI is also planning to bring
private investment into urban infrastructure through the PPP mode.
The construction opportunity from urban infrastructure
Whilst construction services will be the key demand segment in urban infrastructure
creation, there will also be requirement of technology in water and sewage treatment
plants, automated parking systems and mass rapid transportation systems. Whilst
most of the urban infra segments are civil work intensive, water treatment and mass
rapid transport require technology/equipment and this will be the other key
opportunity segment for Indian and international companies.
Table 11 Urban infrastructure opportunity segments: work scope and characteristics
Segment Scope of work Equipment
intensity
Technology
intensity
Civil
intensity
Water supply Water supply, preservation of water bodies, replacement of old & worn outpipes with new & higher capacity ones
Moderate Low High
Water treatment Water treatment including desalination, purification, High High Moderate
Sewage transportation Renewal of old sewage disposal system, setting up new sewage transportationsystem
Moderate Low High
Sewage/waste watertreatment
Constructing and operating sewage water treatment plants Moderate High Moderate
Solid wastemanagement
Constructing and operating solid waste management systems, renewal of oldsolid waste disposal system
Low Moderate Moderate
Storm water drains Construction and improvement of drains and storm water drains Moderate Moderate High
Urban roads Construction and improvement of roads, bridges, flyover, expressways, etc. Low Low High
Rail-based Mass transitsystems
Development and improvement of metro rail (public transport systems) High High High
Bus rapid transit
systems
Development and improvement of bus network, (public transport systems) High Low Low
Affordable housing Integrated development of slums creating new housing Low Low High
Others Street lighting, civic amenities like community halls, child care centres,constructing parking lots on a PPP basis, development of heritage centres, etc
Moderate Low Moderate
Source: JNNURM projects, Execution Noble research
Note: Equipment intensity signifies the equipment absorption potential of a segment such as wagons for metros and buses for bus rapid transport system
Crisil reports suggest that urban infrastructure segment will create an Rs1.2 tn
construction opportunity for the Indian construction companies over 2008-13,
translating into a Rs245 bn (US$5.3 bn) annual opportunity from WSS and urban
transport segments. Whilst, this opportunity is large, we highlight that this does not
include the opportunity from the affordable housing segment, which has high civil
intensity. For FY11, Crisil highlights that construction opportunity from urban
infrastructure (WSS and transport) will be about Rs247 bn (US$5.4 bn).
Source:
Urban infrastructure PPP unattractive risks versus rewards
The conventional path that cities have trodden to date has been to attempt all
infrastructure jobs in the traditional manner of awarding contracts from year to year,
ie. just like traditional construction contracts. Even with the help of government
grants cities cannot use the traditional budgetary method to fund their entire
infrastructure, hence the need for PPP.
Crisil reports suggest that urban
infrastructure segment will create a
US$5.3 bn annual construction
opportunity
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Table 12 Scope of PPP opportunities in urban infrastructure
Sectors Scope of work PPP mode Opportunitypotential
Returnpotential
Water Projects Construction, Operation and Maintenance ofWater treatment plant, Management ofExisting Water Distribution System, Expansionof Water distribution network
Performance based mgmt & service contracts
Lease contract
BOT/Concession
High Moderate
Solid WasteManagement
Segregation, Collection; Transportation andDisposal
Service Contracts; Management contracts Community Participation for Collection and
Segregation of Waste
PPP formats for solid waste management
High Moderate
Sewerage/ StormWater drainageSystem
Renovation in Old City Areas and new Systemin unserved areas
Annuity Contracts
Performance based contracts for constrn & O&M
Other PPP models such as Design, BuildFinance, Transfer (DBFT)
High Low tomoderate
Traffic &Transportation
Constructing Bus Terminals, New Ring Roads/Bypass/ Bridge, Laying/Improvement/Widening, Parking Lots, Warehouse, TruckParking, Fuel Station, Service Center, Officecomplex
PPP (BOT/BOLT/DBFO)
BOT model with tolls/shadow tolls and O&Mcontracts
EPC + O&M contracts
BOT (Lease/ DBFO)
High Low tomoderate
Urban Renewal Shifting of non-conforming commercial/industrial uses, renovation of water/sewerage/SWM system
BOT models for commercial projects
Service/Management contracts for upgradingexisting system
Moderate Moderate
Social Infrastructure Community Halls, Public Spaces, Slaughter
Houses, etc
Management/Service contracts
Annuity ModelsLow High
Street Lighting Self explanatory Performance based Contract for Supply,installation, O&M for 2/5 years period
Low Moderate
Source: JNNURM projects, Execution Noble research
JNNURM over the last 4 years has been able to award 66 PPP projects with a total
project cost of Rs77 bn. This headway in PPP in urban infrastructure is due to the
availability of Viability Gap Funding (VGF) under JNNURM and financial and
administrative reforms at the Urban Local Body (ULB) level. JNNURM under its
schemes allows for 70-90% of the project cost as grant (VGF) for water projects so
as to make PPP viable and to restrict the incidence of major tariff revisions for users.
We find that PPP opportunities in urban infrastructure not only suffer from the usual
challenges of design, structuring, planning but also from the user charge issue
wherein due to the public good component, it is not easy to recover costs as user
charges in services like WSS and urban transportation.
Moreover, tariffs continue to be governed by political considerations instead of the
cost of service provision. In a recent meeting with an MD of a water supply board of a
south eastern city, we were informed that price of water is undervalued for all
segments of users and metering is below 50% and service providers do not even
recover 2/3rd of their operation and maintenance expenditure.
Whilst there are examples of successful PPP water supply projects, these projects
show that success is dependent upon micro-level planning, well structured projects
and the support of state governments as a key facilitator. In particular a strong
regulatory framework, a good information base about the existing system and a sound
tariff policy, can make PPPs successful in WSS segments. Whilst urban transportation
has had the highest number of PPP projects, we find bus rapid transit system (BRTS)
and, to some extent, roads to be the better opportunities as compared to highly
capital intensive rail-based mass-transit systems currently being rolled out in large
cities such Delhi, Bangalore, Gurgaon, Hyderabad, Chennai and Mumbai.
Table 13 PPP projects under JNNURM
Sector No. Projectcost
(Rs bn)
Water Supply 5 7.3
Sewerage 2 0.7
Solid Waste Management 40 21.4
Mass rapid transport system/roads/flyovers/bridges
19 47.7
Total 66 77.1Source: JNNURM projects, Execution Noble research
PPP opportunities in urban
infrastructure suffer from the user
charge issue
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Mapping the infrastructure opportunity across the infrastructure cos
Table 14 Company mapping in urban infrastructure
Company Name Market Cap
(Rs bn)
Revenues(Rs bn)
Water/Sewage
treatment& Supply
Solid WasteManagement
Transport AffordableHousing
Expertise
Urban roads Mass transit EPC PPP TechnologyProvider
L & T 1,083 435
Reliance Infra 293 145
GMR Infra 234 46
Thermax 89 33
GVK Power 69 18
Voltas Limited 67 48
IVRCL 49 58
Nagarjuna 48 58
Punj Lloyd 44 104
Sintex Industries 43 33
Blue Star 39 25
Era Infra 37 34
HCC 36 40
Patel Engineering 29 31
Gammon India 28 52
Simplex Infra 23 46
Gammon Infra 20 3
CCCL 17 20
ARSS Infra 17 10
Sadbhav 17 13
Man Infra 15 5
Maytas Infra 12 11
Shriram EPC 12 14 Madhucon 11 13
HDO 9 9
Unity Infra 8 15
Subhash Projects 7 16
Pratibha 7 10
J. Kumar 6 7
Ion Exchange 2 5
Source: Company data, Execution Noble research
Challenges for the urban infrastructure investment plans
Whilst project implementation is gathering pace albeit at a lower than expectedspeed, urban infrastructure plans face challenges from the usual evils: funding,governance, planning and policies. Amongst these, we find funding and thegovernance issues to be the key ones.
A. Funding Whilst the 74th constitutional amendment calls for the transfer of
financing powers and assets to local governments in line with their functions, the
fact remains that Indias performance on utilising urban funding sources remains
poor. Barring property taxes/user charges, Indian cities have been unable to fund
urban investments through land monetisation, use of debt, PPP and through
creation of city development funds (municipal development funds, SPVs).
Hitherto the funding streams have been the municipal budget, government grants
and loans. Cities must also figure out what the financial instruments, other than
the traditional resource base, can provide a sound revenue stream. This essentiallymeans shifting infrastructures from being funded by taxes to funding them
through user charges, different varieties of fees and land instruments.
Furthermore, lack of deep and robust bond markets also keep the fund raising low
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through municipal bonds which have been used by countries such as USA to
develop urban infrastructure.
B. Governance: The lack of a single point authority in Indian cities and disjointed
relationship between the metropolitan authorities and the local municipalities are
the key reasons for the poor state of governance in Indian cities. Despite the fact
that the 74th amendment to Indias constitution devolved power and
responsibility from state governments to cities on key functions, state policymakers have been mostly silent on the implementation of these functions. Whilst
JNNURM has set forth a specific set of governance and accountability
mechanisms for state and city governments, the progress remains tardy. Tardy
progress on these fronts leads to poor service delivery, slow decision making and
lack of accountability and transparency in urban bodies. Whilst there are a few
examples of good governance in India (Mumbais BEST and Kolkata Municipal
Corporation), we believe there is a lot to be done on the urban governance issues
before investments in infrastructure bear returns.
How real is the urban opportunity?
Whilst the sheer scale of deficiency in urban infrastructure will require heavy
investments, funding and governance issues will keep the investments staggered overthe next couple of decades. Considering the fact that the urban infrastructure
investments are also falling behind plans, we do not expect the US$1.2 tn envisaged
by McKinsey study to be invested over next two decades. However, even if we
consider a 75% implementation ratio to the suggested investment plans, we expect
Rs1 tn (US$23 bn) to be invested annually in the next five years (2010-15) followed by
Rs1.6 tn (US$35 bn) to be invested annually over the next five years (2015-20). These
numbers are achievable and these are much closer to the investments suggested in
the XIth plan: Rs6.2 tn (US$133 bn) over 2007-12 i.e., Rs1.25 tn (US$27 bn) annually.
Given the high civil intensity of segments such as transportation and housing (which
may also account for ~80% of total investments), we believe that urban infrastructure
can create a construction business opportunity (considering 60% construction
intensity) of Rs7.8 tn (US$173 bn) over the next decade or US$14 bn annually for next
five years followed by another five years of demand for US$21 bn annually ofconstruction services.
Nature of urban opportunity raises importance of relationships
Figure 4 Circle of influence of Indian infrastructure players
Source: Company data, press reports, Execution Noble research
I - Politician
on the board
of the
company
GMR, IVRCL,
Sadbhav, Maytas,
Unity Infra, Sew,Soma, Madhucon,
Patel, Indu, HCC,
Gammon
Sadbhav
Engineering,
Nagarjuna, PatelEngineering,
CCCL, IVRCL
GVK,
Gayatri Construction
Lanco, Madhucon,
Progressive
Constructions
II - Close
relationship of
the promoters
with
politicians
III - Strong
association of
the promoters
with
politicians
IV - Ex-
members of
ministry or
government
bodies as
directors or
senior
management
Lack of single point authority in
Indian cities and the disjointed
relationship between metropolitan
authorities and local municipalities
We expect Rs1 tn (US$23 bn) to be
invested annually in the next five
years (2010-15)
Considering 60% construction
intensity, opportunity for
construction industry can be US$14
bn annually for next five years
followed by another five years ofannual demand of US$21 bn
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Recommendation summary in the infrastructure universe
Table 15 Summary of our recommendations and estimates in Indian infrastructure
Company MarketCap
Stance Embeddedvalue
Constructionbusiness
value
Fair value Upside/(downsi
de)
Constructionbusiness
P/E
Compstanding
Comments
(US$mn) (Rs/share) (Rs/share) (Rs/share) (%)
FY10 FY11
Punj Lloyd 957 SELL - 121 121 -10% 15.0 9.9 2nd
largest Indian constructioncompany with presence across Asia.Dismal operational and businessperformance hit its competitivenessin its mainstay oil & gas E&C business
IVRCL 1,067 BUY 63 152 215 15% 15.0 12.2 IVRCL is not only the 3rd
largestIndian construction company but alsothe fastest growing and the leadingirrigation construction company
Nagarjuna 1,024 BUY 57 134 190 2% 17.3 14.6 5th
largest construction company withwell diversified business segmentsand increasing exposure in the MiddleEast. Currently facing pressure on its
investments in DubaiHCC 761 BUY 85 77 162 38% 8.1 5.4 Despite having one of the strongest
prequalifications, a relatively weakerconstruction company. However,valuation upgrades of embeddedassetLavasa can improve valuations
Simplex 486 BUY - 479 479 4% 14.7 12.1 A pure play construction companywith highly competitive cost structureand a leader in industrial segments
CCCL 356 BUY - 108 108 20% 18.2 12.7 A pure play construction companywith highly competitive cost structureand a leader in industrial andcommercial segments looking toexpand into urban infrastructure
GVK Power 1,478 SELL - - 39 -11% NA NA One of the most diversifiedinfrastructure developers but facing
challenges in funding ambitiousacquisitions
Source: Company data, Industry, Execution Noble research
We havent rated Punj Lloyd amongst the Indian players as most of its operations are outside India
TOP PICKS AMONGST CONSTRUCTION COMPANIES
CCCL (CCCL.IN, BUY, market cap US$356 mn) - Undiscovered industry
leader
CCCLs industry leading cost structure and highly professional organisation make it
one of the top Indian construction companies. Whilst business performance in FY09
months was disappointing, we believe its strengths in turnkey structural (industrial
and building) projects will make it a beneficiary of the corporate capex upswing.
With consensus building in modest growth expectations, we expect CCCL to surprise
on the upside as its EBITDA margins improve sharply and company reports strong
revenue growth after a dismal FY09 and better FY10. Despite the poor liquidity of the
stock, we believe the stock price to outperform its larger, more liquid peers on
account of: (a) EBITDA growth being ahead of its peers over FY10-12 due to a
combination of private and public orders; (b) low risk of equity dilution; and (c) much
sharper increase in return ratios (RoE and RoIC) vis-a-vis its peers. Using a DCF-
model, we value CCCL at Rs108 (implying 35% upside and 15X FY11 earnings). Whilstthe stock currently trades in line with its largest peers, its stronger prospects justify
buying it. For more details please refer to our note dated 8 th Jan 2010.
CCCL will outperform its larger, more
liquid peers
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HCC (HCC.IN, BUY, market cap US$761 mn) - Everything hinges on Lavasa
Whilst macro factors are driving order momentum in the construction business for
HCC, valuation upgrades for Lavasa will be the key driver for the stock. We believe
that a further lift in unit sales in Lavasa and its likely IPO will be the main triggers for
the stock even if the construction business does not grow as rapidly as management
expects (Rs100 bn of revenues by FY13). We value Lavasa at Rs31 bn as against theascribed Rs100 bn valuation implied by each of the last seven transactions since Jun-
08. Key risks to our call are a drop in sales at Lavasa and higher-than-expected equity
issuance.
Real estate investments (247 Park and Lavasa) and BOT assets account for 52% of our
SOTP-based value of Rs162. We value the construction business at Rs77/share, i.e., 13X
FY11 earnings, implying a 10% discount to its peers. Lavasas valuation is the key risk.
For more details, please refer to our note dated 30th Nov 2009.
IVRCL (IVRC.IN, BUY, market cap US$1,067 mn) Uncertain times for a proven
player
Challenges in IVRCLs dominant business segmentirrigationled to uninspiring
financial performance in FY10 and similarly uninspiring stock performance over the
last six months (up 4%). However, recent order inflow and improved execution (visiblein Q4FY10) indicate robust revenue growth over the next couple of years. We find the
core business valuations attractive (12X FY11 eps) and do not see any cash
requirements arising from subsidiaries which could have possibly impacted parent
valuations. We value construction business at Rs152/share and subsidiaries at
Rs63/share. For more details, please refer to our note dated 19th April 2010.
Relative valuations of construction companies
Nearly all of the leading Indian EPC companies have taken up the role of developer in
the last 3-4 years with some of them having large portfolios of roads, power assets
and real estate. Roads remain the most common, followed by real estate and power
projects. Given that the embedded valuation from these BOT assets may vary
amongst these companies, comparing them on relative valuations sometimes doesnot make sense. Moreover, if the BOT assets have contracted the EPC business to the
parent EPC company, that may not be a true reflection of the competitive standing of
these companies. We provide the relative valuations for these companies on a stand-
alone basis after deducting the embedded value derived from holdings in listed
entities and unlisted BOT or real estate assets. We use consensus estimates to
calculate embedded value for all the companies.
Table 16 Relative valuations (based on consensus) on a stand-alone basis
Company Price Marketcap
Embeddedvalue
Embeddedvalue
Price excl.embedded
value
Embeddedvalue as%age of
market cap
P/E (X) P/B (X) EV/EBITDA (X)
(Rs) (Rs bn) (Rs/share) (Rs bn) (Rs/share) FY11 FY12 FY11 FY12 FY11 FY12
L&T 1,787 1,086 365 222 1,422 20% 23.4 19.0 4.2 3.6 15.7 12.3
Punj Lloyd 136 45 0 0 136 0% 14.0 11.3 1.3 1.2 7.3 6.6
IVRCL 187 50 65 17 122 35% 11.4 9.0 1.3 1.2 6.3 6.8
Nagarjuna 185 47 41 11 144 22% 15.1 12.2 1.5 1.4 7.2 7.4
HCC 118 36 68 21 49 58% 11.0 9.0 0.9 0.9 5.5 5.9
Patel 422 29 163 11 258 39% 10.3 9.0 1.2 1.0 5.8 5.8
Simplex 461 23 0 0 461 0% 14.1 11.5 2.0 1.7 6.5 5.7
Gammon 214 27 112 14 103 52% 7.5 6.7 0.6 0.5 4.4 4.2
CCCL 90 17 0 0 90 0% 14.4 11.7 2.4 2.0 8.4 6.8
Madhucon 146 11 103 8 44 70% 5.4 3.9 0.5 0.5 0.7 0.6
Sadbhav 1,310 17 731 9 579 56% 9.8 8.3 1.6 1.4 4.3 5.0
Average (excluding L&T and Punj) 37% 11.0 9.0 1.3 1.2 5.5 5.4
Average 32% 12.4 10.1 1.6 1.4 6.6 6.1Source: Bloomberg, Company data, Industry, Execution Noble researchNote: For calculation of embedded value we use consensus estimates
Valuation upgrades for Lavasa will be
the key driver for the stock
Improvement in execution with the
improving order flow momentum willdrive further valuation re-rating
We provide the relative valuationsfor these companies on a stand-alone
basis after deducting embedded
value
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Figure 5 IVRCL appears undervalued whilst Patel appears
overvalued
Figure 6 Simplex and Nagarjuna appear overvalued
Source: Bloomberg, Company data, Execution Noble researchNote: Size of the bubble denotes stand-alone earnings CAGR over FY08-10
Source: Company data, Execution Noble researchNote: Size of the bubble denotes Investment in subsidiaries as %age of networth
Figure 7 Patel appears overvalued and Gammon appears
Undervalued on EV/order book
Figure 8 HCC and Nagarjuna appear overvalued;
Sadbhav appear undervalued
Source: Bloomberg, Company data, Execution Noble research
Note: Size of the bubble denotes book-to-bill ratio based on last reported order books
Source: Company data, Execution Noble research
Note: Size of the bubble denotes EBITDA CAGR over FY08-10
Relative valuations for developers
In order to compare valuations of infrastructure companies across sectors we useEV/EBITDA and P/B. We believe EV/EBITDA multiples of the company should reflect
the infrastructure asset duration, risk, tax rates and growth; companies with long
duration assets, lower risk, lower tax rates and higher growth should trade at higher
multiples.
Given that airports have one of the highest remaining asset lives amongst
infrastructure assets, these should trade at higher multiples. Road assets with lower
durations should trade at lower multiples to energy and airports (although, tax
exemptions on roads provide support to EV/EBITDA multiples). However, (a) the lack
of a historical risk profile for most kinds of assets; and (b) the under construction
status of most assets, are limitations to using EV/EBITDA multiples religiously in the
context of the Indian infrastructure developers.
CCCL
Gammon
IVRCL
Madhucon
Nagarjuna
Patel
Sadbhav
Simplex
4
8
11
15
18
10% 20% 30%
PricetoEarningsFY11E
PAT CAGR FY10-12E
CCCL
Gammon
HCC
IVRCL
Patel
Nagarjuna
Madhucon
Sadbhav
Simplex
0
1
2
5% 10% 15% 20%
P/BF
Y11E
(X)
RoE FY10
CCCL Gammon
HCC
IVRCL
Madhucon
Nagarjuna
Patel
Sadbhav
Simplex
(20)
(10)
0
10
20
30
40
50
60
70
80
90
0 50 100 150 200 250 300
EV(Rsbn)
Latest order book (Rs bn)
CCCL
Gammon
HCC
IVRCL
Madhucon
Nagarjuna
Patel
Sadbhav
Simplex
0
3
5
8
10
5% 10% 15% 20% 25%
EV/EBITDAFY11E(X)
EBITDA CAGR FY10-12E
We believe asset duration is a critical
element of valuation for
infrastructure assets
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P/B vs RoE. We expect companies with higher ROE to trade at higher multiples.
However, with all of the companies having majority of their assets under construction
this may not be a true representative. A company with higher assets under
construction may have lower net earnings and larger equity in CWIP thus depressing
the reported ROE.
Table 17 Relative valuation of infrastructure developers
Company CMP Mkt Cap Mkt Cap P/B P/E EV/EBITDA
(Rs bn) (US$ mn) FY11 FY12 FY11 FY12 FY11 FY12
Reliance Infra 1,201 294 6,393 1.5 1.4 19.1 16.3 19.1 14.3
JPA 125 265 5,755 2.8 2.4 20.9 15.6 16.2 12.1
GMR 59 230 4,992 2.5 1.9 75.5 45.3 20.7 16.2
GVK 43 68 1,483 1.9 1.6 26.6 17.9 14.2 10.8
Gammon Infra 27 19 420 2.7 NA 133.0 133.0 15.5 10.6
Average 2.3 1.8 55.0 45.6 17.1 12.8
Road developer
IRB 261 87 1,885 3.3 2.6 17.9 15.6 9.4 7.6
ITNL 292 57 1,232 NA NA 12.4 NA NA NA
Port developer
Mundra 731 293 6,367 6.9 5.5 29.8 19.7 22.2 16.5
All average 3.1 2.6 46.1 37.6 16.8 12.6
Source: Bloomberg, Company data, Execution Noble research
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Contact details
Saurabh Mukherjea,Head of Indian Equitiest. +91 22 4211 0901 e: [email protected]
Sales
Pramod Gubbi t +91 22 4211 0902 e:[email protected] Ramachandran t +44 20 3364 6736 e: [email protected]
Sector leads
Banks and Financial Services:
Aditi Thapliyal t +91 22 4211 0904; e [email protected]
Pankaj Agarwal t +91 22 4211 09213; e [email protected]
Consumer:
Ashwin Shetty t +91 22 4211 0905; e [email protected]
Infrastructure:
Nitin Bhasin t +91 22 4211 0909; e [email protected]
Binoy Jariwala t +91 22 4211 0909; e [email protected]
Power:
Bhargav Buddhadev t 91 22 4211 0910; e [email protected]
Technology:
Ankur Rudra t +91 22 4211 0906; e [email protected]
Soumitra Chatterjee t +91 22 4211 0906; e soumitra.chatterjee @execution-noble.com
Economy and Country Research:
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