Indian Construction Sector Breaking the Gridlock Anandrathi March 2012

7/31/2019 Indian Construction Sector Breaking the Gridlock Anandrathi March 2012

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Anand Rathi Share and Stock Brokers Limited does and seeks to do business with companies covered in its research reports. Thus, investors should be aware that the firmmay have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision.Disclosures and analyst certifications are located in Appendix 1

Anand Rathi Research India Equities

Manish Valecha+9122 6626 6552

[email protected]

Jaspreet Singh Arora+9122 6626 6727

[email protected]

Construction

Sector Report

India I Equities

Key data Rating Price

( )

Target price

( )

Market cap

(US$m)

PE (core)

FY13e (x)

EV/EBITDA

FY13e (x)

P/BV

FY13e (x)

Target PE

(const. biz) FY13e

RoE %

FY13e

RoCE%

FY13e

Net gearing(x) FY13e

Ramky Buy 210 353 267 4.7 5.4 1.0 9.0 17.1 18.0 0.9

Pratibha Buy 44 73 90 4.4 3.9 0.7 7.0 16.6 18.6 1.0

KNR Buy 131 197 82 4.5 2.9 0.8 7.0 16.8 17.5 0.2

Simplex Buy 232 289 256 7.2 5.0 0.9 9.0 12.7 13.4 1.6

Supreme Buy 232 333 86 3.2 3.4 0.9 5.0 24.1 20.3 1.9

J Kumar Buy 172 239 106 5.0 3.3 0.9 7.0 19.4 24.4 0.2

Era Hold 140 164 565 7.0 7.0 1.2 9.0 11.4 13.1 1.8

NCC Sell 55 56 315 4.9 8.8 0.6 5.0 2.7 7.4 1.2

Source: Anand Rathi Research Note : Price as on 6 March 2012

9 March 2012

India Construction Sector

Breaking the gridlock

The construction sector is likely to see a turnaround in 2HFY13, as keyhurdles order slowdown due to policy inaction and clearance delays,high interest rates and debt/equity funding constraints are expectedto ease in 1HFY13. Positives include the expected recovery in industrialcapex, an equity market revival led by higher FII inflows, improveddebt available due to higher infra lending and the CRR cut. We expectbetter RoE, gearing and FCF over FY12-14 and initiate coverage with

an Overweight view. Top Buys: Ramky Infra, Pratibha and KNR.

Policy action to revive orderflows. Buoyancy in orders is expected inFY13-14, led by greater impetus on infra investments and governmentaction to revive stalled projects and approve new ones. A recent directiveto Coal India to make a minimum 80% of coal requirement available to thepower sector is a positive. Urban infra, road and water segments are likelyto dominate order flow. We estimate revenue and earnings CAGR of ourconstruction universe at 18% and 25%, respectively, over FY13-14e.

Fixed investment revival, easing monetary policy to aid turnaround.We expect a turnaround in fixed investment in 2HFY13, as a result of arevival in industrial capex due to better replacement demand. A high

positive correlation of fixed investment and our construction sector indexpoints towards sector re-rating. We expect 75-100bps repo rate cut byOct 12; a 100bps softening in interest rate would raise the NPM of ourconstruction universe by 20-60bps and the RoE by 50-150bps.

Rising access to capital. A recent revival in equity markets, including arise in FII investments ($7bn ytd 2012), is likely to help fund this capital-intensive sector. We expect improved debt liquidity, driven by a 50bpsCRR cut, a rise in infra loans and concessions in the coming Budget.

Valuation. We value the sector at 5-9x (in line with the eight-year average).We favour pure construction vs. BOT/other assets.Top Buys: Ramky(CMP: `210, TP: `353), Pratibha (CMP: `44, TP: `73) and KNR (CMP:

`131, TP: `197). Risks: low order flow; no major softening in interest rates.

Overweight

Sensex: 17173

Nifty: 5222


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9 March 2012 India Construction Sector Breaking the gridlock

Anand Rathi Research 2

India Construction Sector

Breaking the gridlock

Investment Argument and Valuation........................................................3

Policy action to revive orderflows ............................................................7

Easing monetary policy to help.............................................................. 21

Rising access to capital ......................................................................... 27

Company section ...................................................................................33

Ramky ..................................................................................................... 34

Pratibha................................................................................................... 45

KNR......................................................................................................... 57

Simplex.................................................................................................... 68

Supreme.................................................................................................. 78

J Kumar ................................................................................................... 90

Era......................................................................................................... 101

NCC....................................................................................................... 113

Annexures............................................................................................124


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Investment Argument and Valuation

The construction sector is likely to see a turnaround in 2HFY13, askey hurdles order slowdown due to policy inaction and clearancedelays, high interest rates and debt/equity funding constraints are

expected to ease in 1HFY13. Positives include the expected recoveryin industrial capex, an equity market revival led by higher FIIinflows, improved debt available due to higher infra lending and theCRR cut. We expect better RoE, gearing and FCF over FY12-14 andinitiate coverage with an Overweight view. Top Buys: Ramky Infra,Pratibha and KNR.

Policy action to revive order flows

Buoyancy in orders is likely in FY13-14, led by greater impetus on infrainvestments and government action to revive stalled projects and ensurefast-track approvals for new ones. The recent government directive to

Coal India to make available a minimum 80% of coal requirement to thepower sector is a positive. The pressure of upcoming elections is likely toboost the launch pipeline of infrastructure projects, resulting in a pick-upin order flows. Between Nov 12 and May 14, nine large states of India

will have assembly elections. This is in addition to the CentralParliamentary elections in 2014. The Planning Commission of India hasprojected investment of US$1trn or`50trn in infrastructure developmentduring FY12-17 (the XII Five-Year Plan), compared to US$428bn in theXI Five-Year Plan. This expenditure is 10% of GDP in the XII-Planperiod, compared to 7.5% of GDP in the XI-Plan period. The urbaninfra, road and water segments are likely to dominate order flow.

We estimate revenue and earnings CAGR of our construction universe at18% and 25%, respectively, over FY13-14e.

Easing monetary policy to aid turnaround

The recovery in fixed investments, easing monetary policy stance and lowerborrowing costs, along with policy action to revive order inflows, are likelyto turn around the construction sector in 2HFY13. Our economy teamexpects a turnaround in fixed investment from 2HFY13, as a result of arevival in industrial capex due to better replacement demand. If fixedinvestment turns negative or falls to low single digits, it normally takes 3-4quarters to return to 6% plus growth. At present, we are in the third quarterof low/negative fixed-investment growth. A high positive correlation offixed investment and our construction sector index points towards potentialsector re-rating. Our economy team expects a 75-100bps repo rate cut byOct 12; a 100bps softened interest rate would raise the NPM of ourconstruction universe by 20-60bps and RoE by 50-150bps.

Rising access to capital

Regular capital flows are crucial to the construction sector short-termfor working capital and long-term for capex requirements chiefly due tothe sectors negative free cash-flow (internal accruals insufficient). Weexpect the recent revival in equity markets, including the rise in FIIinvestments ($7bn ytd 2012) to aid in capital raising. Balance sheet

strength and dilution are key focus areas. We also expect debt liquidity toimprove, driven by a likely 50bps CRR cut, rise in infra lending andconcessions in the coming Budget.


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Valuation

We value stocks at 5-9x (in line with the last eight-year average). Wefavour: i) pure construction businesses vs. BOT/other assets (which needhuge equity funding), ii) high revenue visibility arising from large orderbooks, iii) high earnings growth, iv) low gearing and better capitalefficiency, leading to high return ratios. Top Buys: Ramky Infra (CMP:

`210 TP: `353), Pratibha (CMP: `44, TP: `73) and KNR (CMP: `131,

TP: `197).

We value our universe of construction stocks using the sum-of-partsmethod. We value their core construction businesses at a one-yearforward PE. We believe this method suits the industry, as the companiesfree cash-flow is normally negative for a substantial time due to the highcapex and working capital required.

We assign a multiple in line with the average of the last eight yearsmultiple for mid-cap construction companies with core interest in

construction (Simplex, Era) and an appropriate discount to the multiplefor small-cap companies. We value the BOT, power, industrial parks,integrated townships and real estate businesses using the P/BV method.

Fig 1 One-year-forward PE: Mean and standard deviation

Mean

+1SD

+2SD

-1SD

-2SD0

2

4

6

8

10

12

14

16

18

20

22

24

Mar-04

Sep-04

Mar-05

Sep-05

Mar-06

Sep-06

Mar-07

Sep-07

Mar-08

Sep-08

Mar-09

Sep-09

Mar-10

Sep-10

Mar-11

Sep-11

Mar-12

(x)

Source: Bloomberg, Anand Rathi Research (includes data for Simplex and Era)

We believe the improved macro-economic outlook, revival in equitymarkets and government impetus on infrastructure will drive a re-rating in

valuation of the construction sector in the next 1-2 years.

Fig 2 India construction sector: Valuation matrixKey data Ramky Pratibha KNR Simplex Supreme J Kumar Era NCC

PE core (x)

FY12e 5.7 5.5 5.1 12.9 3.9 6.0 9.2 5.3

FY13e 4.7 4.4 4.5 7.2 3.2 5.0 7.0 4.9

FY14e 3.9 3.0 3.7 5.0 2.5 4.2 5.9 3.6

P/BV (x)

FY12e 1.2 0.8 0.9 1.0 1.1 1.1 1.4 0.6

FY13e 1.0 0.7 0.8 0.9 0.9 0.9 1.2 0.6

FY14e 0.9 0.6 0.6 0.8 0.7 0.8 1.1 0.6

EV / EBITDA (x)

FY12e 5.8 4.7 3.3 6.0 3.8 4.0 7.3 10.2

FY13e 5.4 3.9 2.9 5.0 3.4 3.3 7.0 8.8

FY14e 5.0 3.4 2.4 4.3 2.8 2.6 6.5 8.2

Source: Anand Rathi Research


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Top Buys

We initiate coverage on eight companies with Buy ratings on Simplex (TP:`289), Ramky (TP:`353), Pratibha (TP:`73), Supreme (TP: `333),J. Kumar (TP:`239), KNR (TP:`197), a Hold on Era (TP:`164) and a

Sell on NCC (TP:`

56). Ramky is one of the sectors fastest-growing companies (40% CAGR

over FY08-11) due to its diversified order book and strong developerportfolio with limited equity outlay. Low leverage, healthy workingcapital management and better-than-peer return ratios are positives.

We initiate coverage with a Buy rating and a sum-of-parts price targetof`353.

Pratibhas strong and quality order book, together with higher-than-peer operating margins, is likely to lead to industry-leading returnratios. We estimate 29% earnings CAGR over FY13-14. We initiatecoverage with a Buy rating and a price target of`73.

KNR. A road specialist with strong margins, return ratios and balancesheet, KNRs aspirations in road BOTs are restricted to EPC cash-contracts. Key positives are its low net gearing, lack of equity dilutionand high return ratios. We initiate coverage with a Buy rating and aprice target of`197.

Fig 3 Anand Rathi Research (ARG) vs consensus ( m)PAT Ramky Pratibha KNR Simplex Supreme J Kumar Era NCC

FY12e

ARG 1,539 807 665 891 804 798 2,069 602

Consensus 1,713 796 551 1,011 798 706 1,942 744

Diff. (%) (10.2) 1.3 20.7 (11.9) 0.8 13.0 6.5 (19.1)

FY13e

ARG 1,864 997 753 1,549 966 950 2,226 652

Consensus 2,184 898 601 1,308 947 806 2,156 1,128

Diff. (%) (14.7) 11.0 25.3 18.4 2.0 17.8 3.2 (42.2)

FY14e

ARG 2,234 1,454 931 2,306 1,251 1,135 2,648 887

Consensus 2,521 - - 1,629 - 982 2,446 1,562

Diff. (%) (11.4) NA NA 41.6 NA 15.6 8.2 (43.2)

Source: Bloomberg, Anand Rathi Research

Risks

Rise in interest rates. A status-quo on interest rates (no majorsoftening) could continue to hit profit margins of constructioncompanies.

Financial risk. Given the nature of the sector, companies wouldneed to take on additional debt to fund capex or working capital.Deteriorating availability of debt funding due to a dip in infra lendingor liquidity constraints in banking channels would lead to projectdelays and cost overruns. Volatile and depressed equity markets couldalso pose a risk to select companies, given their equity commitment toBOT projects.

Order inflow growth lower than estimated. A major risk to our callis lower-than-expected order inflow, which would be bleak forrevenue-growth visibility and margins and, therefore, lower earningsgrowth.


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Policy action to revive orderflows

Buoyancy in orders is likely in FY13-14, led by a greater impetus oninfra investments and government action due to pressure fromstakeholders and the upcoming 2014 elections to revive stalled

projects and ensure fast-track approvals for new ones. A recentdirective to Coal India to make available a minimum 80% of coalrequirement to the power sector is a positive step. The urban infra,road and water segments are likely to dominate order flow. Weestimate the revenue and earnings CAGR of our constructionuniverse at 18% and 25%, respectively, over FY13-14e.

Tackling structural issues: a step in the right direction

Given the upcoming 2014 elections at the Centre and the governmentsincreased impetus for economic growth, we expect a proactive and clearpolicy environment (less uncertainty), going forward.

The last two years had seen a slew of inter-ministerial and industry vs.ministry disputes. Any ambitious plan to scale up investments ininfrastructure faced multiple headwinds of land acquisition and clearances,besides the regular issues of funding, operations and execution.

An initial measure began at the start of 2012, with the Prime Ministerstepping into the role of a mediator and key decision-maker to clearbottlenecks, thereby hastening the pace of implementation of projects andreviving project proposals. This was followed by similar mediation by thePrime Ministers Office (PMO) and the Finance Minister.

The PMO, led by principal secretary Pulok Chatterjee, is addressing issues

in six key areas ports, oil and gas, power, trade, pharma and roads. ThePMO has intervened (except for roads) in sectors where decision-makinghas been stalled as the groups of ministers involved were locked intopositions where they represented conflicting interest groups.

Power

One-third of the planned infrastructure expenditure constitutesinvestments slotted for the power sector. Despite an urgent need to raisecapacity to address the rising demand, investments are slow paced. Keyissues include:

Slowdown in bank lending. Banks have reached internal limits forlending to the sector, resulting in slower order inflow forconstruction. Government has given approval to banks to launchinfrastructure debt funds (IDF) that will raise debt from foreign anddomestic sources to finance large infrastructure projects. Recently, anICICI bank-led consortium launched Indias first IDF.

The Prime Minister has assumed therole of a mediator and key decision-maker to clear bottlenecks, thereby

hastening the pace of implementationof projects and reviving new project

proposals

The PMO, led by principal secretary

Pulok Chatterjee, has been active inaddressing issues in six key areas

ports, oil and gas, power, trade,pharma and roads


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Fig 4 Bank credit to the power sector (as percent of non-food credit)

4.0

5.0

6.0

7.0

8.0

19

-Dec-0

8

27

-Fe

b-0

9

24

-Apr-

09

19

-Jun-0

9

28

-Aug-0

9

23

-Oct-

09

18

-Dec-0

9

26

-Fe

b-1

0

23

-Apr-

10

18

-Jun-1

0

27

-Aug-1

0

22

-Oct-

10

17

-Dec-1

0

25

-Fe

b-1

1

22

-Apr-

11

17

-Jun-1

1

26

-Aug-1

1

21

-Oct-

11

30

-Dec-1

1

(%)

Source: RBI

Plants are running at less than a weeks supply of coal due toinadequate fuel supply from Coal India, the monopoly supplier (80%of domestic production). Plants now buy additional coal through e-auctions or import coal, which raises the cost of procurement.

Producers inability to revise electricity tariffs to counter costpressures. The PMO is looking at the industry request to set up anexpert body to evolve mechanisms to review contracts (power tariffhikes) impacted due to changes in the law in other countries such asIndonesia, fall in supply by Coal India and delay/denial inenvironment clearances to captive coal blocks.

To sort out other smaller but relevant issues, the Association ofPower Producers (APP) has requested certain measures such as

signing of long-tem gas-supply agreements, re-allocation of gas supplymeant for steel and fertilizer units to power plants, bulk coal andLNG imports, privatization of distribution firms, fast-track regulatoryclearances, speeding up of hydro-power plants in the North-East andreviewing documentation to bid for power projects.

The Prime Minister, in a recent directive, ordered Coal India to ensurecoal supplies for 20 years to 50,000 MW plants that are proposed to becommissioned by Mar 15. Coal India will be penalized if supplies fallbelow 80% of commitments, and given incentives if they rise above 90%.It would arrange for supply of coal through imports or arrangements withstate/Central PSUs that have been allocated coal blocks. Coal supplies

would, however, be restricted to power plants that commit to long-term

power supply to states. This directive would lead to signing fuel supplyarrangements after a gap of three years. (Refer to Annexure 1 for details on thedirective).

With some progress towards addressing the woes of the power sector, weexpect a revival of projects, leading to orders for construction companies.

Rail-freight corridor

The PMO has directed the Dedicated Freight Corridor Corporation ofIndia to expedite progress on the rail-freight corridor a stalled XI Five-

Year Plan project that was approved by the Cabinet Committee onEconomic Affairs in 2005. At least one phase of the western corridor is to

be operational by Sep 12.

The Prime Minister, in a recentdirective, ordered Coal India to ensure

coal supplies for 20 years to 50,000MW plants that are proposed to be

commissioned by Mar 15.


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Roads

Targeted investment in the road sector constitutes 15% of totalinfrastructure expenditure. The Ministry of Road Transport is looking toaward 15 projects for 1,547km of highways in this financial year, whileanother 11 projects for 1,731km would be considered for speedy

approval. This follows a directive from the PMO to ensure timely awardsfor the balance 2,800km projects that remain from the 7,300km (worth`570bn), (up from 3,360km in FY10 and 5,059km in FY11) of projectstargeted by the National Highway Authority of India (NHAI).

Given that the pace of construction is still far below the 20km per daytargeted, the next intervention from the PMO is likely to be in the area ofaddressing procedural issues.

Order-flow boost; real leg-up in 2HFY13

With most systemic structural issues in the process of being addressed, weexpect a ramp-up in the award of cash contracts both from the privatesector and government stables from 2HFY13, flowing through into FY14.

We expect the current trend of order-flow through mainly captive PPPprojects in roads and power to continue in the next 6-9 months. Orderinflows of construction firms within our coverage universe showed -40%to +40% growth in FY11.

Fig 5 Order inflow to pick up in 2HFY13

0

90

180

270

360

450

FY08

FY09

FY10

FY11

FY12e

FY13e

FY14e

-10

10

30

50

70

90

Order inflow Order inflow growth (RHS)

(%)(`bn)

Source: Company, Anand Rathi Research

Macro framework in place: huge infra-spending planned

The Planning Commission of India has projected investment of US$1trnor `50trn on infrastructure development during FY12-17 (the XII Five-

Year Plan) compared to US$428bn in the XI Five-Year Plan. Thisexpenditure is 10% of GDP in the XII-Plan period, compared to 7.5% ofGDP in the XI-Plan period. The private sector share is estimated at 50%in the XII-Plan period vs. 36% in the XI-Plan period. This implies, in thenext five years, opportunities for private construction companies will bethrice the worth of those in the last five years. For companies looking toincrease market share and supported by good balance sheets, this couldtranslate to three to four times the current opportunity.

The private sector share isestimated at 50% in the XII-Plan

period vs. 36% in the XI-Planperiod implying opportunities

worth three times as compared toXI plan period


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Fig 6 Infra spending in the XII Five-Year PlanSectors (US$bn @ 48/$) XI Five-Year Plan XII Five-Year Plan Sector share (%)

Electricity (incl. NCE) 138.9 324.0 32.4

Roads and bridges 65.4 153.0 15.3

Telecommunications 53.8 126.0 12.6

Railways (incl. MRTS) 54.5 127.0 12.7Irrigation (incl. WD) 52.8 123.0 12.3

Water supply and sanitation 29.9 70.0 7.0

Ports 18.3 43.0 4.3

Airports 6.5 15.0 1.5

Storage 4.7 11.0 1.1

Gas 3.5 8.0 0.8

Total 428.4 1,000.0 100

Source: Planning Commission, Anand Rathi Research

State and Central elections to boost order flows

Between Nov 12 and May 14, nine large states of India will haveassembly elections. This is in addition to the Central Parliamentaryelections in 2014. This, we believe, would boost the launch pipeline ofinfrastructure projects, resulting in a pick-up in order flows.

Fig 7 State-wise election scheduleMajor states Timeline Population % share

HP Nov 12 1

Gujarat Dec 12 5

Karnataka May 13 5

Rajasthan Nov 13 6

Delhi Nov 13 1

MP Nov 13 6

Chhatisgarh Nov 13 2

AP May 14 7

Central elections May 14 -

Orissa May 14 4

Maharashtra Oct 14 9

Haryana Feb 15 2

Jharkhand Feb 15 3

Source: Election Commission of India

Key themes: urban infra, roads and water

We expect order inflows in infrastructure to be led by the urban infra,transportation (roads) and water segments. Key constituents within urbaninfrastructure would be metros, airports and the Railways, besides otherssuch as ports. These sub-segments have two key positives: (1) the averageticket size is larger than works in other verticals and (2) construction workin such projects is comparatively large: 75% in Railways, 65% in watersupply, 60% in roads and 40-50% for metros, airports and ports. Inindustrial projects including power, the construction componentcomprises only 15-20%.


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Fig 8 Project mix: Dec 11Segments (%) NCC Era Simplex Ramky Pratibha Supreme J Kumar KNR

Water 12.0 - - 16.4 52.0 - 1.4

Irrigation 9.0 - - 10.8 11.0 0.3 5.0 3.9

Transportation 2.3 44.0 28.0 44.3 - 55.7 70.0 94.7

Building & housing 29.9 - 26.5 17.3 37.0 41.6 20.0

Industrial structures 3.2 37.0 14.0 7.5 - -

Power 29.7 19.0 25.5 3.7 - 1.9

Metals and mining 1.6 - - - - -

International 7.8 - - - - -

Others 4.5 - 6.0 - - 0.4 5.0

Total 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0

Source: Company

Urban infra

We expect urban infra to be the biggest driver of orders for constructionand infra companies during FY13-14. The government has initiated a

number of measures in essential infrastructure (water management, roads,housing, sanitation, sewage), transportation, both inter- and intra-city. It isaggressively looking at proposals regarding metro rail systems, Greenfieldairports and ports and modernization/expansion of the present ones. Theurgency level is high on these projects as the urban population in Indiaamounts to over 320m (the second-largest in the world), comprises about26% of the countrys population (expected to rise to over 40% by 2030)and contributes over 60% to GDP. Many of these projects are beingawarded on a PPP basis, which would shorten execution time andimprove efficiency.

Most urban-infrastructure projects in India have larger financing options,

given the interests of global agencies (the World Bank, the AsianDevelopment Bank, Japanese banks) in funding these.

Metro Rail

The rapid urbanization of large cities, combined with the exhaustion oftraditional rail/road mass-transport systems, has led to acute requirementof an improved transit system such as metro rail systems. According tothe Ministry of Urban Development, all Indian cities with a population ofover 2m (approx 30 cities) are being evaluated for metro rail feasibility. Inaddition, the metro projects are also being evaluated from the perspectiveof monetization of land at stations, which the government has not doneso far. In the tier-I category, the Mumbai Metro (phases I), Delhi Metro

(phase III), Bangalore, Chennai, Hyderabad, Jaipur are ongoing/near-termprojects entailing massive investment. In tier-II cities, Ahmedabad, Kochi,Chandigarh, Lucknow, Pune and others would throw up metro PPPopportunities in the short term and involve construction companies in a

very large way. This model is also likely to be followed in other big townsin India.

In tier-II cities, Ahmedabad, Kochi,Chandigarh, Lucknow, Pune andothers would throw up metro PPPopportunities in the short term andinvolve construction companies in a

very large way

We expect urban infra to be thebiggest driver of orders for

construction and infra companiesduring FY13-14, led by metro rail


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Fig 9 Status of various metro projectsRailway Status Cities

In operation Delhi, Kolkata, Bangalore

Under constructionChennai, Hyderabad, Jaipur, Mumbai, Navi Mumbai, RapidMetro Rail GurgaonMetro Systems

Planned

Bhopal, Chandigarh, Indore, Kanpur, Kochi, Lucknow,

Ludhiana, Nagpur, Patna, Pune, MetroLink Express connectingGandhinagar and Ahmedabad

Under construction Mumbai Monorail

Monorail systemsPlanned

Aizawl, Ahmedabad, Bangalore, Chennai, Delhi, Indore,Kanpur, Kolkata, Kozhikode, Navi Mumbai, Patna, Pune,Thiruvananthapuram

In operation Chennai Mass Rapid Transit SystemElevated rail systems

Planned Western Railway Elevated Corridor (Mumbai)


Airports

India has 125 airports, of which 11 are international. The Committee onInfrastructure initiated several policy measures that aim at time-bound

creation of world-class airports in India. Large-scale improvisation andexpansion in Indian airport infrastructure, coupled with activegovernment support for private participants, particularly in Greenfieldprojects, have enabled huge strides forward. In the past, all airports wereowned and operated by the Airports Authority of India (AAI).

The government aims to attract private investment in aviationinfrastructure on the lines of privatization of the Delhi, Mumbai,Hyderabad and Bangalore airports. Opportunities in FY13-14 wouldcome through building up Greenfield airport projects in Goa, Pune, NaviMumbai, Greater Noida, Kannur and many others. The government plansto spend`600bn on the airports sector during the XII Five-Year Plan.

Key private investment enabling policy measures are: 100% FDI permissible for existing airports; FIPB approval required

for FDI beyond 74%

100% FDI under the automatic route permissible for Greenfieldairports

49% FDI permissible in domestic airlines under the automatic route,but not by foreign airline companies; 100% equity ownership by non-resident Indians (NRIs) permitted

100% tax exemption for airport projects for 10 years.Ports

Most foreign trade is through ports. Indias ports suffer from congestion,cargo delays and inefficiencies. Average turnaround time at Indian ports isabout four days (against a few hours for most ports in south-east Asia).

To address these bottlenecks, the government in the XII Plan aims tospend over`1.7trn.

In the past, the government dominated maritime activity. The currentpolicy direction is oriented to encourage the private sector to take the leadin port development and operations. 100% FDI under the automaticroute is permitted for port development projects and 100% income-taxexemption is available for 10 years. Significant investment on a BOT basisdone so far is by foreign operators including Maersk (JNPT, Mumbai) and

P&O Ports (JNPT, Mumbai and Chennai), Dubai Ports International(Cochin and Vishakhapatnam) and PSA Singapore (Tuticorin).

The government plans to spend

`600bn on the airports sector duringthe XII Five-Year Plan

To address bottlenecks, the XII Plan

targets spending over`1.7trn in theport sector


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Railways

The Railways is on the verge of a major capacity enhancement andimprovement phase, throwing up vast opportunities for developers andconstruction contractors. We expect the Railways to roll out a largenumber of orders during FY13-14. The government plans to spend`5trn

on the Railways during the XII Five-Year Plan.An expert committee, headed by Sam Pitroda, recently recommendedinvestment of`8trn in the next five years to modernize operations. Mostof this expenditure would be through gross budgetary support, internalgeneration and public-private-partnership projects. Aiming at betterservice and embark on an expansion and modernization drive, thecommittee recommends spending on new lines, track modernization,bridge strengthening, signalling and safety systems, new stations andterminals and building dedicated freight corridors. It would also entailprocurement of new coaches, wagons and EMUs (electric multiple units).

Big-ticket infrastructure projects

The governments impetus on accelerating infrastructure-spends restslargely on implementation of big-ticket projects in urban infrastructure.

The Dedicated Freight Corridor and the Delhi-Mumbai IndustrialCorridor are two such examples that can step up the pace of investment.

Dedicated freight corridor. To reduce strain on existing rail tracks,the government plans to build a 10,122-km rail-freight corridor, at a

cost of`776bn. Approval so far has been granted for only theEastern and Western corridors, a 3,328-km stretch (Dadri to Mumbaiand Ludhiana to Howrah) that carries 55% of revenue-earning traffic.

The corridors, also known as dedicated freight corridors (DFC), haveseen slow progress so far due to the lack of time and attention from

the previous railway minister.

The PMOs latest directive to the nodal agency, the Dedicated FreightCorridor Corporation of India (DFCCI) to start work on a prioritybasis and ensure that one phase of the western corridor be operationalby Sep 12 is encouraging. The new lines would take the load off theexisting corridors where passenger and freight trains run at capacityutilization levels of 115-150%. The nodal lines would service a wholerange of cargo cities that would come up along these lines. Theproject is being implemented by government agencies with fundingprimarily from the Japanese government and the World Bank. TheDFCCI has completed two-thirds of land acquisition on both sides ofthe corridor and aims to complete the balance by Mar 12. It isaddressing issues of re-tendering on some stretches, stiff contractualclauses and delayed approvals from international lenders. Funds forpart of the Western corridor, Rewari to Vadodara and then to JNPThave been tied up, while funds for the Eastern corridor have yet tocome in.

Delhi-Mumbai Industrial Corridor. The recently-cleared Delhi-Mumbai Industrial Corridor (DMIC) involves the creation of1,483km of multi-modal, high axle load, dedicated freight line, six-lane intersection-free expressway, seven mega-cities (around 50 sq km

with 2m population), nine mega-industrial zones (250 sq km), threeports and six airports and a 4000MW power plant. The corridor will

pass through six states (UP, Delhi, Haryana, Rajasthan, Gujarat,Maharashtra) with end terminals at Dadri (NCR) and JawaharlalNehru Port in Mumbai. The project was cleared by the Union Cabinet

To reduce strain on existing railtracks, the government plans tobuild a 10,122-km rail-freight

corridor, at a cost of`776bn

The government plans to spend

`5trn on the Railways during theXII Five-Year Plan


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in 2011 and has secured mandatory approvals from all governmentdepartments. It is backed by financial and technical aid from Japanbesides financial assistance from the Government of India.

A band of 150 km on both sides of the freight corridor will bedeveloped with globally competitive environment and state-of-the-art

infrastructure to activate local commerce, enhance foreigninvestments, real-estate investments and attain sustainabledevelopment. In addition to the band, the project would also includedevelopment of requisite feeder rail/road connectivity tohinterland/markets and select ports along the western coast. Rajasthan(39%) and Gujarat (38%) together constitute 77% of the total length,followed by Haryana, Maharashtra with 10% each and UP, NCR 1.5% each of total length.

Roads

Construction companies have moved from being contractors todevelopers by entering road BOT projects in a major way. This, however,

exposes them to delays in land acquisition, right-of-way issues, clearancesand other risks, which they were not previously faced with. Such riskshave been key reasons for delays in execution of various projects in thepast.

We are positive on companies that are actively looking at roads either forthe cash-contract works of the NHAI/state governments or for the EPC

works secured as sub-contracts from the winning concessionaire. Themargin profile in these orders should be a slice better than regular roadcontracts, given the greater importance afforded to quality work andtimely completion. Companies under our coverage universe that areactively exploring this are Simplex, Supreme, J. Kumar and KNR.

Opportunity

India has the second-largest road network in the world, with over 4.24mkm. Roads carry 85% of passenger and 70% of freight traffic. Thenetwork consists of national highways, state highways, expressways, majordistrict roads, other district roads and village roads. National highwayscomprise only 2% of the road network but carry 40% of the traffic. Thesenational highways are too narrow for the kind of traffic they carry.Bottlenecks lengthen the time taken by suppliers to transport goods,leading to delays in delivery.

Fig 10 Road network in IndiaCategory km % of total

National highways 70,934 1.7

State highways 154,522 3.6

Major and other district roads 2,577,396 60.9

Rural roads 1,433,577 33.8

Total 4,236,429 100.0

Source: NHAI

An autonomous authority of the Government of India under the Ministryof Road Transport and Highways, the National Highways Authority ofIndia (NHAI) was constituted by Parliament on June 15, 1989, through

The National Highways Authority of India Act, 1988, and operationalizedin February 1995 on the appointment of a full-time chairman and other

members. Its scope was expanded in 1998 when the GoI announced theNational Highways Development Programme (NHDP) comprising theGolden Quadrilateral linking the four metros, with connectivity to major


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ports in the first phase, and the North-South and East-West corridors inthe second phase.

NHDP Nodal programme of the NHAI

The Government of India, through various phases of the NHDP,launched major initiatives to upgrade and strengthen the nationalhighways. The NHDP is one of the largest road-developmentprogrammes to be undertaken by a single authority in the world. Itinvolves widening, upgrading and rehabilitating about 54,000 km, at a cost

of`3trn. Of the projects in hand (48,000 km), about 15,500 km arecomplete and further implementation of 13,000 km is underway. TheNHAI plans to award the remaining 20,000 km in the next three years. Itis also undertaking another 1,770 km of development under portconnectivity and others, of which 1,287 km have already beencompleted.

Most of the projects to be developed would be through public-privatepartnership (PPP) on the build, operate and transfer (BOT) annuity or

BOT toll mode. This is a marked shift from earlier method (till 2005) ofawarding projects on a cash-contract basis, which had put the entirepressure of funding on the government.

Approved programme

The government has already approved projects under four-laning of6,359km (phase-I), four-laning of 6,702 km (phase-II), four-laning of12,109 km (phase-III), two-laning with paved shoulders for 5,000 km ofnational highways under phase-IVA, six-laning of 6,500 km (phase-V),1,000 km of expressways (phase-VI) and construction of ring roadsincluding improvement of NH links in cities, grade-separatedintersections, flyovers, elevated highways, rail over-bridges, underpasses

and service roads (phase-VII). Phases I and II collectively comprise theGolden Quadrilateral, the North-South and East-West Corridors, portconnectivity and other projects.

Fig 11 NHDP programme and work plan (31 Dec 11)Programmed GQ NS-EW

Phase I & IIPhase

IIIPhase

IVPhase

VPhase

VIPhase

VIINHDPTotal

Length (km) 5,846 7,300 12,109 14,799 6,500 1,000 700 48,254

Already four-laned (km) 5,831 5,914 3,023 - 709 - 7 15,484

Under implementation (km) 15 808 6,514 2,549 2,768 - 34 12,688

Balance length for award (km) - 420 2,572 12,250 3,023 1,000 659 19,924

Source: NHAI

The NHAI aims to award projects covering 7,300 km (worth`570bn) inFY12, compared to 3,359 km in FY10 and 5,059 km in FY11. It aims at asimilar rollout of projects every year for the next three years (FY13-15),covering the balance length for an award of ~20,000 km. We estimate3,000 km (worth`200bn) of projects to be released over Mar-Apr 12.

Apart from the NHDP, rural roads and refurbishment of old roads alsoopen up vast opportunities. The investment in roads during the XII Plan

is projected at`6trn, 100% more than the targeted XI-Plan investment.The private sector is expected to contribute ~50% of this investmentoutlay.

NHAI aims to award projects

covering 7,300 km (worth`570bn)in FY12, compared to 3,359 km in

FY10 and 5,059 km in FY11.

The NHDP involves widening,upgrading and rehabilitating about

54,000 km, at a cost of`3trn. TheNHAI plans to award the

remaining 20,000 km in the nextthree years


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Execution, the key

The NHAIs track record in terms of road construction run-rate has beenunimpressive: averaging a mere 4 to 7 km/day in the past four years. TheNHAI has been working towards the target of building 20 km ofhighways per day. To achieve this (7,000 km a year), given the average

three-year execution period, would imply that projects-under-executionhave to increase from the present ~13,000 km to 21,000 km. We believethat the target of 20 km/day appears over-ambitious and a morereasonable 12-14 km a day is achievable, given the multiple challenges theindustry faces from delay in construction (entire land not in possession orlabour/ material-sourcing issues) or financial closure. Even a 12 km/dayexecution would translate to a doubling of revenue in the road segmentfor the major companies.

Fig 12 Past road-length additions

0

1,100

2,200

3,300

4,400

5,500

FY01

FY02

FY03

FY04

FY05

FY06

FY07

FY08

FY09

FY10

FY11

1HFY12

Awarded Completed

(km)

Source: NHAI

NHAI funding issues sorted out

NHAI receives funding through (i) government support in the form ofthe capital base, cess fund, additional budgetary support, capital grant,maintenance grant, ploughing back of toll revenue and loans from theGoI; (ii) loans from multilateral agencies and (iii) market borrowings.

Fig 13 Investment required: 2,267bn

NHDP I

13%

NHDP II

15%

NHDP III

37%

NHDP IVA

3%

NHDP V

18%

NHDP VI

7%

NHDP VII

7%

Source: MoRTH, Anand Rathi Research

Fig 14 Funding sources: 2,267bn

Cess & Marketborrowings

35%

External

assistance

7%

BOT/SPV

49%

Private sector

2%

Government

spending

1%

Bugetary support

6%

Source: MoRTH, Anand Rathi Research

NHAI targets to build 20 km ofhighways per day. To achieve this

(7,000 km a year), given the averagethree-year execution period, would

imply that projects-under-executionhave to increase from the present~13,000 km to 21,000 km


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Government Support. Government support to the NHAI primarilystems from the yearly budgetary allocations of the GoI.

Cess.The GoI has, under the Central Road Fund Act, 2000, createda non-lapsable dedicated fund for the NHDP by levying a cess onhigh-speed diesel and petrol at`2 a litre.`0.50 per litre (levied in

2005-06) is allocated exclusively for NH. The allocation for balancecess of`1.5 a litre is as under:

50% of the cess collected from diesel is for rural roads The balance 50% cess from diesel and the entire cess on petrol,

the allocation of funds for different categories of roads are asunder:

1. 57.5% for NH2. 12.5% for road over-bridges/rail over-bridges (to be

constructed by the Railways)

3. 30% for roads other than NH. Market borrowings; 54 EC bonds. The NHAI can issue capital

gains tax-free bonds under Sec 54 EC of the Income-Tax Act, 1961.In this capital-gains-exemption bond, eligible investors can claim taxexemption by investing the component of long-term capital gains,either wholly or in part, in these bonds, within six months of thetransfer of the asset. The funds have a maximum investment limit of`5m in one financial year for an investor with a lock-in of three years.The NHAI raised`21,606m during FY11.

Loan assistance from multilateral agencies. The NHAI isimplementing some projects under the NHDP with externalassistance in the form of loans from multilateral development

agencies such as The World Bank (WB) and The Asian DevelopmentBank (ADB). Loans for NHAI projects tied up with these multilateralagencies, except for one ADB loan (for Surat Manor project), havebeen passed on to the NHAI by the GoI as 80% grant and 20% loan.

The loan component would be repaid to the government by theNHAI and repayments to those agencies would in turn be done bythe GoI.

Grants. The NHAI also has a provision to provide grants of up to40% of the project cost to render projects commercially viable.However, the quantum of the grant would be decided on a case-to-case basis and typically constitutes the bid parameter in BOT projects.

NHAI projects, with higher traffic volumes, have also receivednegative grants (upfront payments payable by successful bidders tothe NHAI) instead of grant/VGF as an outcome of the competitive-bidding process. Further, under the revised Model Concession

Agreement, projects under the BOT framework have been awardedon a revenue-share/premium basis, where the bidder offering thehighest revenue-share/premium is awarded the project. Theserevenues are also ploughed back to develop and maintain theNational Highways.

Public-private partnerships (PPP). PPP is the preferred mode ofdelivery for future phases of the NHDP. The common forms that arepopular in India and have been used to develop the NH are:

Build, Operate and Transfer (Toll) model Build, Operate and Transfer (Annuity) model


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Operate, Maintain and Transfer (OMT) model.Incentives for private-sector participation

The government has put in place policy, institutional and regulatorymechanisms, including a set of fiscal and financial incentives to encourageprivate-sector participation in roads. In order to augment the flow of

funds to the sector and to encourage private-sector participation in theroads sector, the government has taken several measures. These are:

Declaration of the road sector as an industry Provision of a capital grants subsidy of up to 40% of the project cost,

to enhance viability of projects, on a case-to-case basis

Duty-free import of certain identified high-quality construction plantsand equipment

100% tax exemption in any consecutive 10 years within a period of 20years on completion of the construction, provided the projectinvolves addition of new lanes

Provision of encumbrance-free sites, i.e., the government should meetall expenses relating to land and other pre-construction activities

Foreign direct investment up to 100% in the roads sector.Water supply including waste-water management and sanitation

In the past three years the water sector in India grew 18-20% to cater tothe dire need to create infrastructure to ensure sustainable water supplyfor the countrys agricultural, industrial and domestic use. While 85% ofurban India has access to water supply, service quality is poor and mostusers receive water of dubious quality and only intermittently. Besides thetraditional work of laying pipelines, the scope has extended today to

distribution systems, water treatment, recycling plants, sewerage plantsand water management. The waste-water treatment segment is seeing highgrowth rates due to growing industrialization and urbanization,intensifying regulatory measures and investment in sanitation.

The XII Five-Year Plan aims at providing drinking water, sanitation andwaste management to 100% of the urban population. According to therecommendations of the working groups of the Planning Commission forthe XII Five-Year Plan, an outlay of over`2.8trn has been suggested forrural domestic water supply, including the component of the NationalRural Drinking Water Programme (NRDWP). This would be ~305% ofthe actual allocation in the XI Five-year Plan for the sector. The Central

outlay would be 45% and states would contribute 55% of the expenditure.

According to the PlanningCommission, for the XII Five-Year

Plan, an outlay of over`2.8trn hasbeen suggested for rural domestic

water supply


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Fig 15 Investments in domestic water and sanitation

0

100

200

300

400

500

1969-1974

1974-1979

1980-1985

1985-1990

1992-1997

1997-2002

2002-2007

2002-2012

Centre State

(`bn)

Source: Planning Commission

According to recommendations of the working groups of the Planning

Commission for the XII Five-year Plan, an outlay of over`

441bn hasbeen suggested for sanitation, aiming to increase such facilities to 100%,from 74% now. Waste-water treatment also offers huge opportunities tocompanies in this space as only 69% of the water is treated.

Fig 16 Sanitation levels in rural India

0

10

20

30

40

50

60

70

80

2000-01

2001-02

2002-03

2003-04

2004-05

2005-06

2006-07

2007-08

2008-09

2009-10

2010-11

2011-12

(%)


Fig 17 Waste water generation and treatment(MLD) Class 1 (Population 0.1-1 m) Class II city (Population >1 m) Total

Wastewater generated 35,558 2,697 38,255

Waste treatment capacity 11,554 234 11,788Missing capacity 24,004 2,463 26,467

Untreated 68% 91% 69%

Source: Central Pollution Control Board Annual report 2009

Urban India will require huge investment in building and keeping pacewith water and sewage infrastructure needs. In the past five years theJNNURM has been an important game-changer in this sector, providingmuch-needed public funding to build and refurbish assets. Under the

JNNURM the bulk (70% of`600bn) of the projects are for water andsewage. Other major schemes include the NRDWP and ARWSP.

According to the Planning

Commission for the XII Five-YearPlan, an outlay of over`441bn has

been suggested for sanitation


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Fig 18 Segment-wise breakdown of JNNURM outlay

Water supply

projects

32.1%

Sewerage

projects

24.4%

Drainage

13.7%

Preservation of

water bodies

0.2%

Other urban

sectors

29.6%


State-level urban affair department and public health and engineering

departments operate and maintain water supply and sewerage services. Asa result, the public sector has been and continues to be dominant in thewater and waste-water sector. However, because of the large capitalinvestment required and since most state governments and local bodiesdo not have the required resources, there is a vast need for private-sectorparticipation in the water and waste-water sector. We expect a huge flowof orders from water and sanitation projects. The emphasis on solutionsto drinking water problems, besides the current boom in industrialconstruction, all point to a future replete with opportunities in water.


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Easing monetary policy to help

Our economy team expects a turnaround in fixed investment from2HFY13, as a result of a revival in industrial capex due to betterreplacement demand. A high positive correlation of fixed

investment and our construction sector index points towardspotential sector re-rating. We expect 75-100bps repo rate cut by Oct12. A 100bps softening in interest rate would raise NPM 20-60bpsand RoE 50-150bps of our construction universe. Falling inflation,easing monetary policy stance and lower borrowing costs are likelyto turn around the construction sector in FY13.

Macro-economic indicators point to a recovery

Contraction in fixed investment

Due to the policy deadlock, high interest rate and economic uncertainty,

real fixed investment contracted 1.2% in 3QFY12, a second quarter ofnegative growth.

If fixed investment turns negative or falls to low single digits, it normallytakes around 3-4 quarters to return to 6% plus growth. At present, we arein the third quarter of low/negative fixed-investment growth. Thus, thetrend suggests that fixed investment might pick up in the coming quarters.

Also, replacement demand is expected to result in a turnaround in fixedinvestment.

Fig 19 Real fixed investment negative in 3QFY12

-5

0

5

10

15

20

Jun-0

1

Mar-

02

Dec-0

2

Sep-0

3

Jun-0

4

Mar-

05

Dec-0

5

Sep-0

6

Jun-0

7

Mar-

08

Dec-0

8

Sep-0

9

Jun-1

0

Mar-

11

Dec-1

1

(Rea

lgrowth

,%)

Fixed investment

Peak of global

financial crisis

Source: GoI

High positive correlation: fixed investment and construction index

The construction sector performance is highly correlated with theperformance of fixed investment in the economy. A turnaround in fixedinvestment in 2HFY13 on account of replacement capex is likely to bepositive for the construction sector.

If fixed investment turns negative orfalls to low single digits, it normallytakes around 3-4 quarters to return

to 6% plus growth.


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Fig 20 High positive correlation between fixed investment & construction index

0

10

20

30

40

50

60

70

80

90

100

Feb-0

8

Apr-08

Jun-0

8

Aug-0

8

Oct-08

Dec-0

8

Feb-0

9

Apr-09

Jun-0

9

Aug-0

9

Oct-09

Dec-0

9

Feb-1

0

Apr-10

Jun-1

0

Aug-1

0

Oct-10

Dec-1

0

Feb-1

1

Apr-11

Jun-1

1

Aug-1

1

Oct-11

Dec-1

1

(Index)

-6

-3

0

3

69

12

15

18

21

(Growth

,%)

Construction index Fixed investment (RHS) Source: GoI

Construction sector: turnaround on the cards

Growth inconstruction (component of GDP) had fallen to a crisis low in1QFY12. Thereafter, in 2QFY12 it recovered (grew 4.3%) and in 3QFY12grew 7.2%. If the trend continues, it would boost performance ofconstruction companies, going forward.

Fig 21 Construction sector begins an upswing

0

2

4

6

8

10

12

14

Dec-0

6

Mar-

07

Jun-0

7

Sep-0

7

Dec-0

7

Mar-

08

Jun-0

8

Sep-0

8

Dec-0

8

Mar-

09

Jun-0

9

Sep-0

9

Dec-0

9

Mar-

10

Jun-1

0

Sep-1

0

Dec-1

0

Mar-

11

Jun-1

1

Sep-1

1

Dec-1

1

(G

rowth

,%)

Construction activities

Peak of global

financial crisis

Source: GoI

Fig 22 IIP and construction index

0

10

20

30

40

50

60

7080

90

100

Feb-0

8

Apr-08

Jun-0

8

Aug-0

8

Oct-08

Dec-0

8

Feb-0

9

Apr-09

Jun-0

9

Aug-0

9

Oct-09

Dec-0

9

Feb-1

0

Apr-10

Jun-1

0

Aug-1

0

Oct-10

Dec-1

0

Feb-1

1

Apr-11

Jun-1

1

Aug-1

1

Oct-11

Dec-1

1

(Index)

-9

-6

-3

0

3

6

9

1215

18

21

(Growth,

%)

Construction index Industrial production (RHS) Source: GoI


24/135


25/135



Any change in interest rates would also affect the fundamentals of BOTprojects, considering their highly-leveraged nature. Apart from increasingthe interest during construction (IDC) portion of the cost of BOTprojects, an increase in interest rates also affects debt-servicing ability. Therecent aggressive bidding for BOT projects has already lowered the equityinternal rates of returns (IRR) earned by developers on such projects.

With BOT projects being sensitive to interest-rate movements, a softeningof the interest-rate scenario would lift their IRRs. This would aidcompanies in securing better valuations while inducting private investorsat the project/subsidiary levels. Within our coverage universe, companiesthat have greater exposure to BOT and would gain the maximum benefiton account of the drop in interest rates are Era, NCC and Supreme.

Fig 26 EBITDA constituents FY10(%) NCC Era* Simplex Ramky Pratibha Supreme J Kumar KNR

PAT 4.0 6.8 2.8 5.5 6.1 7.4 8.2 7.1

Tax 2.3 3.5 1.5 1.4 2.1 3.1 4.1 4.7

Depreciation 1.1 2.1 3.4 0.6 1.2 3.8 2.0 3.7

Interest 2.8 7.5 2.5 3.4 5.3 4.1 2.0 1.0

Other income (0.1) (0.7) (0.4) (0.4) (0.0) (0.5) (0.8) (1.1)

EBITDA margin 10.1 19.1 9.8 10.5 14.7 17.9 15.6 15.4

Source: Company * EBITDA margin for Era includes margin for equipment rental business

Fig 27 EBITDA constituents FY12e(%) NCC Era* Simplex Ramky Pratibha Supreme J Kumar KNR

PAT 1.2 5.0 1.6 4.9 5.6 5.6 7.8 7.7

Tax 0.6 2.2 0.8 2.2 2.0 2.6 3.5 3.8

Depreciation 1.6 2.3 3.2 1.0 1.3 2.2 1.9 5.3

Interest 5.2 10.4 3.8 3.3 6.4 6.5 3.1 1.1

Other income (0.2) (1.0) (0.4) (0.7) (0.3) - (0.6) (1.2)

EBITDA margin 8.4 18.9 9.0 11.0 14.9 17.1 15.7 16.8Source: Anand Rathi Research, *EBITDA margin for Era includes margin for equipment rental business

Respite from hyper inflation

The wholesale price index (WPI)-based inflation has softened to 6.6% inJan 12, the lowest in 26 months. Inflation had been near the double digitsfor around two years before it started softening, in Dec 11. The sharprises in food and crude-oil prices have been major reasons for the rise inaverage inflation in India. Along with the favourable base, a decline in

vegetable prices has been the key factor behind the sharp softening ofWPI inflation in the last two months.


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Fig 28 Inflation near double digits for around two years

-2

0

2

4

6

8

10

12

May-05

Oct-05

Mar-06

Aug-06

Jan-07

Jun-07

Nov-07

Apr-08

Sep-08

Feb-09

Jul-09

Dec-09

May-10

Oct-10

Mar-11

Aug-11

Jan-12

(Inflation,

%)

Period of

high inflation

Source: GoI

Record production in foodgrain helps soften inflation

A record production of foodgrain in the kharif seasonhas led to softeningfood prices in the last two months. Inflation for primary food articles haseased to 2.3% in Jan 12 after being in the double digits between Sep 09and Oct 11 (average inflation: 16.1%).

Fig 29 Primary inflation has sharply softened

150

160

170

180

190

200

210

Sep-09

Nov-09

Jan-10

Mar-10

May-10

Jul-10

Sep-10

Nov-10

Jan-11

Mar-11

May-11

Jul-11

Sep-11

Nov-11

Jan-12

(Index)

0

4

8

12

16

20

24

(Inflation,

%)

Primary articles index Primary articles inflation (RHS) Source: GoI, RBI

Inflation to soften further

A sharp softening in primary food prices and a favourable base would leadto further softening of inflation. The key risk to this assumption is

escalating international fuel prices. Any major increase in administeredfuel prices after the state elections would push up inflation again.Factoring in the risks, we expect inflation to hold below 8% in FY13. Inour base case scenario, inflation is likely to fall to ~6.3% by Mar 12. Weexpect inflation to keep softening till Sep 12 to ~5.6% and then startinching up to ~7.4% by Mar 13.

We expect inflation to hold below 8%in FY13. In our base case scenario,

inflation is likely to fall to ~6.3% byMar 12


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Fig 30 Inflation to be contained in FY13

9.5 9.59.8

9.1

7.4

6.5 6.2

5.4

6.6

7.4

4

6

8

10

12

Dec-10

Mar-11

Jun-11

Sep-11

Dec-11

Mar-12

Jun-12

Sep-12

Dec-12

Mar-13

(Inflatio

n,

%)

WPI

Actual 14-mth estimate

Source: GoI, RBI, Anand Rathi Research

Monetary stance to ease; RBI to front-load monetary easing

Inflation has softened sharply since Dec 11 and growth indicators are atcrisis low levels (a low single-digit industrial-production growth, negativefixed-investment growth and GDP growth at a three-year low). Thus, weexpect the RBI to ease monetary policy to provide support to the falteringeconomy. However, the non-food manufactured-products inflation (6.7%in Jan 12), which the RBI interprets as a proxy for demand-side pressuresis still higher than the RBIs comfort zone of 4-5%. A very favourablebase would bring non-food manufactured inflation down from the presenthighs. According to our estimates, non-food manufactured-productinflation is likely to soften in 1H CY12. This, coupled with deterioration ingrowth indicators, could lead to a considerable softening of policy rates bythe RBI. Our assumption is that inflation would start inching up again

after Sep 12 and we expect 2HFY13 to be better than 1HFY13 in termsof economic growth. Therefore, the RBI has a narrow window to takemonetary-easing actions. We expect a 75-100bp cut in the repo rate tillOct 12, with the first cut starting in Mar 12.

We expect a 75-100bp cut in therepo rate till Oct 12, with the first

cut starting in Mar 12

Fig 31 Policy rate likely to soften in 1HFY13

-3

-1

1

3

5

7

9

Oct-07

Jan-08

Apr-08

Jul-08

Oct-08

Jan-09

Apr-09

Jul-09

Oct-09

Jan-10

Apr-10

Jul-10

Oct-10

Jan-11

Apr-11

Jul-11

Oct-11

Jan-12

(yoy,

%)

4

5

6

7

8

9

10

(%)

Non food manufactured inflation Repo rate (RHS)


Fig 32 RBI to take monetary easing actions in 1HFY13

4

5

6

7

8

9

10

Feb-08

May-08

Aug-08

Nov-08

Feb-09

May-09

Aug-09

Nov-09

Feb-10

May-10

Aug-10

Nov-10

Feb-11

May-11

Aug-11

Nov-11

Feb-12

May-12

Aug-12

Nov-12

(%)

Repo rate

Actual Estimate



28/135



Rising access to capital

Construction companies need equity and debt at parent andsubsidiary levels in order to ensure growth. We expect the recentrevival in equity markets, including the rise in FII investments

($7bn ytd 2012) to aid in capital raising; balance sheet strength anddilution would be key focus areas. We also expect debt liquidity toimprove, driven by a 50bps CRR cut, rise in infra lending andconcessions in the coming Budget.

Access to capital is crucial to growth

Regular capital flows are crucial to the construction sector short-termfor working capital and long-term for capex requirements chieflybecause of the sectors negative free cash-flow (internal accrualsinsufficient). A severe fund crunch had hit construction companies in thelast six quarters due to a rise in receivables, reduction in mobilization and

advances (for new projects awarded), disbursement delays/no freshfunding from banks and stock-market weakness/volatility. The sector wasfaced with similar pressures in FY09 but had emerged unscathed thefollowing year on improved macro-economic factors, fiscal stimuli andfund infusion through equity dilution and easy availability of new debt.

With FY11/12 seeing a repeat of FY09, we expect the funding crunch toease off only in FY13 (mostly in the latter half). The easy access to capitalfrom both channels of debt and equity (stock market or PE) would behuge positives.

Private-sector funding requirement to increase manifold

The private-sector share in the XII-Plan period ($1trn investment) is

estimated at 50% (vs. 36% in the XI-Plan period). For privateconstruction companies, this implies opportunities in the next five years

worth thrice those of the last five years. The role of the private sectorshould be much higher in Central government projects than in stategovernment projects, especially in roads, where the PPP model would bepreferred. Therefore, it is imperative that private funding channels beenhanced and mechanisms improved.

Fig 33 Private-sector funding requirement to increase manifold

50%50%

Public sector Private sector


36%

64%

The private-sector share in the XII-

Plan period ($1trn investment) isestimated at 50% (vs. 36% in the

XI-Plan period)

XI-Plan XII-Plan


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30/135



System liquidity to improve; 50bps cut in CRR likely by Mar 12

Despite the 50bps cut in the CRR in Jan 12, liquidity in the system hasnot improved. For the last five months, the liquidity shortage has beenmore than`1trn daily. The RBIs comfort zone is +/-1% of NDTL (netdemand and time liabilities). Given the current liquidity situation in the

market, our economy team is of the view that the RBI might cut the CRRby another 50bps by Mar 12. This is expected to improve overall liquidityin the system, thereby benefiting the infrastructure sector.

Fig 35 Acute shortage of liquidity in the last five months

-2,000

-1,500

-1,000

-500

0

500

1,000

May-1

0

Jun-1

0

Jul-10

Aug-1

0

Sep-1

0

Oct-10

Nov-1

0

Dec-1

0

Jan-1

1

Feb-1

1

Mar-11

Apr-11

May-1

1

Jun-1

1

Jul-11

Aug-1

1

Sep-1

1

Oct-11

Nov-1

1

Dec-1

1

Jan-1

2

Feb-1

2

Mar-12

(NetLAF,

`bn)

Net liquidity

RBI's

comfort zone

RBI cut SLR

by 100bps

Source: GoI, RBI, Anand Rathi Research

Strain on sub-contractor-dependent companies to ease

With increasing order-book sizes, as also average ticket size and projectcomplexity over the years, larger construction companies have come torely partly on smaller sub-contractors to execute works awarded them.Most such sub-contractors face contraction in funding available frombanks besides issues of higher interest rates, leading to difficulty infunding working capital. This results in a strain on the parent contractor.

With improved liquidity in the banking channels at lower interest rates, weexpect less strain on the sub-contractors, thereby benefiting constructioncompanies.

Low cost of borrowing to help construction sector

The credit growth rate for the fortnight ending 10 Feb 12 has declined toa two-year low of 15.7%. As the RBI cut the repo rate, banks are likely topass this on to consumers in order to improve credit off-take. Thus, we

expect borrowing costs in the next one year to come down from presentlevels. There is a negative correlation between interest rates and theconstruction index. Therefore, a softening borrowing-cost scenario islikely to provide the requisite boost to the construction sector in FY13and FY14.

Given the current liquidity situationin the market, our economy team is of

the view that the RBI may cut the

CRR by another 50bps by Mar 12


31/135



Fig 36 Negative correlation between interest rates and construction index

0

10

20

30

40

50

60

70

80

90

100

Feb-0

8

Apr-08

Jun-0

8

Aug-0

8

Oct-08

Dec-0

8

Feb-0

9

Apr-09

Jun-0

9

Aug-0

9

Oct-09

Dec-0

9

Feb-1

0

Apr-10

Jun-1

0

Aug-1

0

Oct-10

Dec-1

0

Feb-1

1

Apr-11

Jun-1

1

Aug-1

1

Oct-11

Dec-1

1

(Index

)

2

3

4

5

6

7

8

9

10

(%)

Construction index Repo rate (RHS) Source: RBI, Bloomberg

Equity-market revival

The Nifty has gained 16% ytd CY12, whereas the CNX MidCap and CNXInfra have gained 32% and 24%, respectively. In that period, FII inflowsin Indian equity have touched ~$7bn, compared with $110m outflow inCY11 (DIIs invested $1.5bnand -$550m in CY11 and CY12 ytdrespectively). This was led by a declining trend of adverse events/newsboth on the global and domestic fronts. The recent revival in Indianequity markets, coupled with stable global and Indian economies, augurs

well for future flows of FIIs, resulting in increased appetite for growth(and beaten down) sectors such as infrastructure. This, we believe, wouldopen the gates to capital-raising opportunities for companies inconstruction, backed by the rising risk-appetite of foreign investors. Thepolicy continuity from the PMO and the RBIs policy shift from inflation

to growth would also provide a fillip.

Our interaction with industry participants suggests a revival of pendingcapital-raising deals in the last two months. The overwhelming responseto the recent IPO issue of the Multi-Commodity Exchange (MCX) hasalso provided a ray of hope. We expect a spate of fund-raising activities(QIPs, IPOs) in the construction and infrastructure sectors starting from2QFY13. This would help address the equity commitments of manyconstruction companies or lower gearing levels.

PE-backed project funding to continue

With many stocks available at attractive valuations, several construction

and infrastructure companies in the last two years have raised equity fromprivate-equity investors either at the parent or intermediate holdingcompany levels. Companies also raised equity by selling minority stakes tostrategic investors at the SPV (special-purpose-vehicle) level. This is likelyto continue during FY13-14 as well, driven by acute requirements ofequity capital and the sharper focus of cash-rich PE investors on theinfrastructure sector.

Our interaction with some of the PE funds and construction companiesindicates a strong pipeline of deals that are stuck for valuation reasons. Animproved and stable stock market should help convert some of thesedeals.

The Nifty has gained 16% ytdCY12, whereas the CNX MidCap

and CNX Infra have gained 32%and 24%, respectively. In that period,

FII inflows in Indian equity havetouched ~$7bn, compared with

$110m outflow in CY11


32/135



Fig 37 Recent fund raisings: Construction and infrastructureCompany Date PE funds who invested Amount raised (US$m)

Supreme Infrastructure India Feb-12 3i Infra 61

HCC Concessions Jul-11 Xander Investment Holding 55

GVR Infra Projects Jul-11 IDFC PE 33

GVK Energy Dec-10 Actis, GIC 155GVK Energy Nov-10 3i, Others 267

Pratibha Industries Oct-10 ChrysCapital 22

GMR Energy Jun-10 IDFC PE, Argonaut, Ascent Capital, Others 100

GMR Energy Apr-10 Temasek 200


Real estate largest beneficiary of better capital access

Liquidity and interest rates have strong bearings on the performance ofthe real estate sector, given large bank funding requirements both fromsuppliers and buyers. Improved liquidity in the banking sector, lessaversion to the sector, softening of interest rates and a vibrant equitymarket are all positives for the real-estate sector. This, combined withproject launches, should result in better order-flows for constructioncompanies during FY13-14.

Eighty percent of demand in the real-estate sector still arises from thehousing sub-segment. After price stabilization in some markets andchanges in the kind of housing units offered by developers, projectslaunched in the last two years have seen good traction across cities. The

volume of sales in the middle-income and affordable housing sub-segments by developers has been commendable, reflecting the positiveoutlook regarding such projects. This has attracted more developers toenter this arena.

Focus on affordable homes

In the last couple of years, most property developers have shifted focus toaffordable housing, shunning townships and non-core assets they hadaccumulated as they grew. Volume-driven mass/affordable housing hasbecome the name of the game. In these segments, execution is whatmatters. The Maharashtra government has recently signed an agreement

with real-estate developers in Mumbai to construct 500,000 affordablehouses in the Mumbai Metropolitan Region (MMR) for middle and lowerincome groups. The project, entailing investment of`150bn, wouldprovide ample orders for construction companies. We expect similarinitiatives taken by other states such as Andhra Pradesh to be positive forthe construction sector.

The Maharashtra government hasrecently signed an agreement with

real-estate developers in Mumbai toconstruct 500,000 affordable houses

in the MMR for middle and lowerincome groups


33/135




34/135



Company section


35/135

Anand Rathi Share and Stock Brokers Limited does and seeks to do business with companies covered in its research reports. Thus, investors should be aware that the firmmay have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision.Disclosures and analyst certifications are located in Appendix 1

Anand Rathi Research India Equities

Key financials (YE Mar) FY10 FY11 FY12e FY13e FY14e

Sales (`m) 18,613 27,305 31,128 37,354 44,824

Net profit (`m) 1,027 1,574 1,539 1,864 2,234

EPS (`) 20.8 27.5 26.9 32.6 39.0

Growth (%) 51.2 32.3 (2.2) 21.1 19.8

PE Core (x) 7.3 5.5 5.7 4.7 3.9

EV/EBITDA (x) 7.1 6.2 5.8 5.4 5.0

PBV (x) 2.4 1.4 1.2 1.0 0.9

RoE (%) 27.5 23.9 16.2 17.1 17.7

RoCE (%) 22.9 21.6 17.9 18.0 17.8

Dividend yield (%) - 2.1 2.1 2.1 2.4

Net gearing (x) 0.8 0.6 0.8 0.9 0.9


India I Equities

Manish Valecha+9122 6626 6552

[email protected]

Jaspreet Singh Arora+9122 6626 6727

[email protected]

Construction

Initiating Coverage

Rating: Buy

Target Price: `353

Share Price: `210

Relative price performance

RMKY

Sensex

150

200

250

300

350

Mar-11

May-11

Jul-11

Sep-11

Nov-11

Jan-12

Mar-12

Source: Bloomberg

Key data RMKY IN / RAMK.BO

52-week high / low `330 /`182

Sensex / Nifty 17173 / 5222

3-m average volume US$0.1m

Market cap `12.0bn / US$267m

Shares outstanding 57.2m

Shareholding pattern (%) Dec 11 Sep 11 Jun 11

Promoters 66.9 66.9 66.9

- of which, pledged 7.9 7.9 0.0

Free float 33.1 33.1 33.1

- Foreign institutions 3.3 3.3 3.3

- Domestic institutions 7.1 7.1 7.4

- Public 22.7 22.7 22.4

9 March 2012

Ramky Infrastructure

Rapid growth, strong balance sheet; Buy

Ramkys diversified order book and strong developer portfolio withlimited equity outlay make it one of the fastest-growing companies inthe sector (40% CAGR over FY08-11). Low leverage, excellent working-capital management and good return ratios are strong positives. Weinitiate coverage with a Buy and a sum-of-parts target price of 353.

Fast-growing and diversified order book. Increasing focus on the fast-growing water and transportation segments has upped the order book to`138bn (4.7x TTM revenues). This, together with L1 projects of`21bn,gives good revenue visibility over FY13-14. No segment brings in over20% to the order book, except for transportation. Ramky is spread acrossIndia, with exposure in Andhra Pradesh down to 25%, from 30% inFY07. It is also exploring opportunities in select overseas territories suchas Oman, Qatar and Saudi Arabia, in addition to its operations in Gabon.

Robust portfolio with low equity outlay. Ramky has a portfolio of 19BOT assets, of which eight are in road. The remaining equity outlay inthe road projects (including three new projects) is `7.8bn, which is to befunded via internal accruals. The other projects are in nascent stages spread across segments such as bus stands, SEZs and corporate parks

with funding via real estate sales. Ramky has the advantage of arrangingequity for BOT projects without pressure of dilution at parent/SPV level.

Strong financial profile. Ramky has one of the lowest gearings in thesector (standalone: 0.6x) and strong working-capital management despitehigh government exposure (70% of order book). Return ratios are likelyto remain stable at ~18% over FY12-14. We estimate Ramky to be one ofthe few sector companies with positive free cash flow over FY13-14.

Valuation. Our sum-of-parts-based price target of`353 is based on 9xFY13e PE for the core business (`293), in line with other midcap target

multiples, and 1x Dec 11 P/BV of investment (`60). Risk: Dip in OPM.


36/135

9 March 2012 Ramky Infrastructure Rapid growth, strong balance sheet; Buy


Quick Glance Financials and Valuations

Fig 1 Income statement ( m)Year-end: Mar FY10 FY11 FY12e FY13e FY14e

Net revenues 18,613 27,305 31,128 37,354 44,824

Revenue growth (%) 27.6 46.7 14.0 20.0 20.0

- Op. expenses 16,666 24,446 27,704 33,245 39,894

EBIDTA 1,946 2,859 3,424 4,109 4,931

EBITDA margin (%) 10.5 10.5 11.0 11.0 11.0

- Interest expenses 627 684 1,032 1,207 1,432

- Depreciation 105 193 300 325 370

+ Other income 70 139 205 205 205

- Tax 257 548 758 918 1,100

Effective tax rate (%) 20.0 25.8 33.0 33.0 33.0

Reported PAT 1,027 1,574 1,539 1,864 2,234

+/- Extraordinary items - - - - -

+/- Minority interest - - - - -

Adjusted PAT 1,027 1,574 1,539 1,864 2,234

Adj. FDEPS (`/share) 20.8 27.5 26.9 32.6 39.0

Adj. FDEPS growth (%) 51.2 32.3 (2.2) 21.1 19.8


Fig 3 Cash-flow statement ( m)Year-end: Mar FY10 FY11 FY12e FY13e FY14e

PAT 1,027 1,574 1,539 1,864 2,234

+ Non-cash items 129 231 375 425 470

Cash profit 1,157 1,805 1,914 2,289 2,704

- Incr./(decr.) in WC 1,046 3,262 2,674 38 1,845

Operating cash-flow 110 (1,457) (760) 2,250 858

- Capex 126 2,460 800 500 500

Free cash-flow (16) (3,917) (1,560) 1,750 358

- Dividend - 299 301 301 335

+ Equity raised 15 3,353 0 (0) (0)

+ Debt raised 840 2,018 2,200 2,000 3,500

- Investments 74 1,540 200 3,972 2,534

- Misc. items - - - - -

Net cash-f low 765 (385) 139 (523) 989

+ Op. cash & bank bal. 619 1,384 999 1,138 615

Cl. Cash & bank bal. 1,384 999 1,138 615 1,604Source: Company, Anand Rathi Research

Fig 5 PE band

4x

6x

8x

10x

0

50

100

150

200

250

300

350

400

Nov-10

Mar-11

Jul-11

Nov-11

Mar-12

(`/share)

Source: Bloomberg, Anand Rathi Research

Fig 2 Balance sheet ( m)Year-end: Mar FY10 FY11 FY12e FY13e FY14e

Share capital 494 572 572 572 572

Reserves & surplus 3,768 8,318 9,556 11,119 13,018

Net worth 4,263 8,890 10,128 11,691 13,590

Minority interest - - - - -

Total debt 4,739 6,757 8,957 10,957 14,457

Def. tax l iab. (net) (7) 32 107 207 307

Capital employed 8,995 15,678 19,191 22,854 28,353

Net fixed assets 1,386 3,653 4,153 4,328 4,458

Investments 601 2,141 2,341 6,313 8,847

- of which, liquid - - - - -

Net working capital 5,623 8,885 11,559 11,598 13,443

Cash and bank balance 1,384 999 1,138 615 1,604

Capital deployed 8,995 15,678 19,191 22,854 28,353

Net debt 3,355 5,758 7,819 10,342 12,852

WC days 100 97 120 113 102

Book value (`/sh) 86 155 177 204 238Source: Company, Anand Rathi Research

Fig 4 Ratio analysis @ 210Year-end: Mar FY10 FY11 FY12e FY13e FY14e

P/E (x) 10.1 7.6 7.8 6.4 5.4

P/E core (x) 7.3 5.5 5.7 4.7 3.9

P/B (x) 2.4 1.4 1.2 1.0 0.9

EV/EBITDA (x) 7.1 6.2 5.8 5.4 5.0

RoE (%) 27.5 23.9 16.2 17.1 17.7

RoCE (%) 22.9 21.6 17.9 18.0 17.8

Fixed asset turnover (x) 11.4 9.8 7.1 7.3 7.9

Dividend yield (%) - 2.1 2.1 2.1 2.4

Dividend payout (%) - 16.4 16.7 13.8 12.8

Interest exp./sales 3.4 2.5 3.3 3.2 3.2

Debtors (days) 113 142 150 145 140

Revenue growth (%) 27.6 46.7 14.0 20.0 20.0

PAT growth (%) 51.2 53.2 (2.2) 21.1 19.8

EBITDA growth (%) 41.1 46.9 19.8 20.0 20.0

EPS growth (%) 51.2 32.3 (2.2) 21.1 19.8Source: Company, Anand Rathi Research

Fig 6 Order book vs book-to-bill

0

25

50

75

100

125

150

175

200

225

FY07

FY08

FY09

FY10

FY11

FY12e

FY13e

FY14e

2.0

2.5

3.0

3.5

4.0

4.5

5.0

Orderbook Book to bill (RHS)

(`bn) (x)



37/135

9 March 2012 Ramky Infrastructure Rapid growth, strong balance sheet; Buy


Investment Argument and Valuation

Ramkys diversified order book and strong developer portfolio withlimited equity outlay make it one of the fastest-growing companiesin the sector (40% CAGRover FY08-11). Low leverage, excellent

working-capital management and good return ratios are strongpositives. We initiate coverage with a Buy, and a sum-of-parts pricetarget of 353.

Fast-growing and diversified order book

Ramkys order book has grown from `14bn in FY06 to `138bn (4.7x TTMrevenues) in 3QFY12. Together with L1 projects of`21bn, this gives itgood revenue visibility over FY13-14. The company has a well-diversifiedorder book in segments such as water, waste water, transportation,irrigation, buildings, power and industry. No segment brings in more than20% of the order book, except for transportation which accounts for 39%

of the o

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