Infrastructure Sector Update 26 August 2010

Sector Update 26 August 2010

Road sector – Significant project awarding ahead

Infrastructure (Roads)
™ Only 17% of national highways are four-lane or above,
Strong project awarding ahead; project selection the key offering a huge opportunity for development

NHAI intends to award projects extending ~9000km, both during FY11 and FY12 ™ Spend on rural roads has seen a consistent rise under the

(projects of ~2,800km awarded so far in the current fiscal). Moreover, we note PMGSY scheme

that an improvement in the availability of finance has lead to faster financial ™ Balance of ~34,000km from NHDP programme to be
closure of projects. However, the sector faces risks emanating from 1) delays in award over next few years
acquiring land and securing environment clearances and 2) aggressive project
bidding for small/medium sized projects. We believe that companies with strong ™ Project awarding under NHDP picks up post acceptance

financials and in-house construction capabilities will be in a better position to of Chaturvedi committee report in Nov’09

access low-cost finance and mitigate execution-related risks. Importantly, a ™ Awarded ~2,800km so far in FY11 v/s target of
careful selection of projects would be a key game changer for players. We remain ~9,000km
positive on India’s infrastructure sector considering the recovery in the country’s
economic growth and corporate capex, along with political stability and ™ We expect most project award activity to get over by

improved fund availability. Our top picks are L&T and RELI. FY14

™ Estimate plan investments of Rs 4.6tn, 59% in National

Key rationale:
Highways
™ Significant project awarding form NHAI in the near term: NHAI has set a
target to award projects extending ~ 9000km, both during FY11 and FY12. ™ Construction opportunities of Rs 4.4tn over FY12-17

So far in this fiscal, it has awarded projects of ~2800km. ™ Key risk: delay in project awarding due to land

™ Rs 220bn outlay for FY11 under PMGYS: For the development of rural acquisition and environmental clearance

roads, NHAI has earmarked out an outlay of Rs 220bn for FY11 under the
PMGSY scheme. Recommendation snapshot
™ NHAI to raise Rs 25-30bn via 54EC bonds in FY11: NHAI raised ~Rs 7bn so Company (Rs) CMP Target Rating

far in this fiscal and plans to raise an additional Rs 18-23bn by the end of Ahluwalia 215 250 Buy
March ’11. This will improve its liquidity position to provide VFG to HCC 62 70 Hold
developers.
IRB Infra 295 280 Hold
™ Availability of finance and quick financial closure: Credit demand for the IVRCL 160 210 Buy
infrastructure sector is picking up. We note that an improvement in the L&T 1,853 2,100 Buy
exposure of banks to the infrastructure segment over the past one year has
NCC 154 210 Buy
expedited the financial closure of projects (to 2-3 months now vs 4-6
Patel Engg. 378 470 Buy
months last year).
Punj Lloyd 113 100 Sell
Key concerns:
RELI 1,017 1390 Buy
™ Land acquisition and environmental clearance: Bottlenecks in acquiring
Simplex Infra 470 490 Sell
land and obtaining environmental clearances is the main cause for delays in
project awarding activities, financial closure and execution.

™ Aggressive bidding: Concerns exist on aggressive bidding for small/mid

sized projects. Mega projects remain largely protected from this risk.

Our view:
™ We expect project awarding of ~34,000km over the next few years. We
estimate a spend of Rs 4.6tn on roads and highways over the 12th plan, with
private sector contribution at 44% (primarily for NHAI projects).

™ Companies with strong financials and in-house construction capabilities will

find it easier to access low-cost finance and mitigate execution risks.

™ Careful project selection would be a key play for small/medium size projects
given the aggressive bidding seen in the backdrop of intense competition

™ We are positive on the infrastructure sector and our top picks are L&T and
RELI

Vaibhav Jain Hardik Shah Suhas Harinarayanan

RCML: Winner of LIPPER-STARMINE broker award for “Earnings Estimates in Midcap Research 2008” |
(91-22) 6766 3464 (91-22) 6766 3465 (91-22) 6766 3404 1
“Honourable Mention” in Institutional Investor 2009 | Voted amongst Top 5 most improved brokerages by
jain.vaibhav@religare.in hardik.shah@religare.in suhas.hari@religare.in Asia Money Poll 2009 | RCML Research is also available on Bloomberg FTIS <GO> and Thomson First Call
 Infrastructure Sector Update 26 August 2010

Significant project awarding ahead

~34,000km to be awarded over next few years
The Indian road network consists of 3.3mn km. Of this, the network of National
Highways (NHs) extends over 70,000kms – despite accounting for only 2% of India’s
total road network, NHs handle 40% of the total traffic (see fig below). In comparison,
state highways with double the network (1,40,000km) account for 4% of the total
network and handle 40% of the traffic. Thus, 6% of the road network carries 80% of the
total traffic in India. Roads handle 85% of the total passenger traffic and 60% of the total
freight traffic. Southern and western states account for bulk of the traffic as against
northern, eastern, and north eastern states.

Fig 1 - National highways - ~2% of Indian road network but handle ~40% of traffic
Road network Length (km) Length (%) Traffic (%) Development agency Connectivity
Union capitals, state capitals, major ports,
National Highways 70,548 2.1 40 NHAI, State PWDs, BRO
foreign highways, strategic locations

State capitals, district centres, important

State highways 131,899 4 State PWDs
towns, national highways, other states
40
Major district roads 467,763 14.1 State PWDs Main roads, rural roads

Production centres, markets, highways,

Rural and other roads 2,650,000 79.8 20 MoRD
railway stations
Total 3,320,210 100 100
Source: RCML Research MoRD – Ministry of Rural Development

11th plan spend – revised down to Rs 2.8tn

Planning commission has revised down
11th plan spend estimate from Rs3.1tn to
Rs 2.8tn
Roads and highways saw a plan spend of Rs 1.3tn during the 10th five-year plan. In the
original plan, Planning Commission had envisaged Rs 3.1tn of investment during the
11th plan with 52% of the spend targeted on national highways. Of this, 45% was
expected on national highways managed by NHAI while remaining 7% was expected
on national highways maintained by state governments and Border Roads Organization
(BRO). In March ’10, the Planning Commission revised down the 11th plan spend
estimate to Rs 2.8tn, due to delays in project awards by NHAI.

Fig 2 - Composition of original estimate of 11th plan spend of Rs 3.1tn in roads

Rural roads
Other state spend 14%
on roads
5%

National
highways
State highways, 52%
major district
roads
29%

Source: RCML Research, Planning Commission

2
 Infrastructure Sector Update 26 August 2010

12th plan – expect Rs 4.6tn spend

Spend on roads & highways should We estimate a spend of Rs 4.6tn on roads and highways over 12th plan. Our estimates
increase to Rs 4.6tn in 12th plan build in an increase in spend on NHs and improvement in private sector participation –
this improvement was brought about after the central government revised the policy
framework (in FY10) governing BOT road project development in India.

The increase in spend on state highways is likely to be at a similar rate as seen in the
past. However, private sector participation in state highways is likely to be limited as
policy changes are still pending at the state government level.

Spend on rural roads has seen a consistent increase since the inception of Pradhan
Mantri Gram Sadak Yojana (PMGSY) in 2000. We have assumed a steady state growth in
PMGSY spend that is primarily sponsored by the central government but reflects as part
of the state government outlay.

Fig 3 - 12th Plan: Investments trend

10th plan Share 11th plan Share 12th plan Share
Particulars (Rs bn)
actual (%) revised (%) (RCML est.) (%)
Centre 505 39.7 909 32.6 857 18.6
State 674 53.0 1,419 50.9 1,712 37.2
Private 92 7.3 459 16.5 2,031 44.1
Total investments 1,271 100.0 2,787 100.0 4,600 100.0
Source: RCML Research, Planning commission

Fig 4 - Composition of likely spend of Rs 4.6tn in 12th plan Fig 5 - Private sector likely to account for 44% of spend*

Rural roads
Other state
14%
spend on State Private
roads 37% 44%
3%

State
highways, National
major highways Centre
district roads 59% 19%
24%

Source: RCML Research Source: RCML Research * primarily on NHAI projects

3
 Infrastructure Sector Update 26 August 2010

National highways spend – largely driven by NHAI

Out of 70,500km of national highways in India, NHAI is responsible for development of
~3/4th of the network. Given the fact that only 17% of the national highways in India are
four-laned (or above), NHAI has a large job at hand.

Fig 6 - Current status of National Highways in India

Four-laned and
Single
above
Only 17% of national highways are lane/Intermediate
17%
four-lane or above, offering a huge lane
opportunity for development 30%

Double lane
53%

Source: RCML Research, NHAI, Ministry of Roads, Transport and Highways

Fig 7 - Development of national highways by NHDP – phases-wise details

Phase Description
Four-laning of 7,498km including 5,848km of Golden Quadrilateral (GQ) and 980km
NHDP-I
of North-South (NS) and East-West (EW) corridor projects
NHDP-II Four-laning of 6,647km including 6,161km of NS-EW corridor projects
NHAI will develop ~55,000km of NHDP-III Four-laning of 12,109km
national highways in a phase-wise
NHDP-IV Two-laning of 20,000km
manner
NHDP-V Six-laning of 6,500km including 5,700km of GQ
NHDP-VI 1,040km expressways with full access control
NHDP-VII 700km of ring roads, bypasses on BOT basis-toll/annuity
Source: RCML Research, NHAI

Fig 8 - Key road projects ahead

Total Length Length To be
Phases Description length completed under Imp. awarded
(km) (km) (in km) (in km)
Four-laning of GQ, NS-EW corridors,
I 7,498 7,328 164 6
port connectivity & others
Four/six-laning of NS-EW corridor,
II 6,647 4,465 1,576 606
others

34,000km of work has to be awarded III Four-laning projects 12,109 1,580 3,822 6,707
over next few years
IV Two-laning with paved shoulders 20,000 - - 20,000

Six-laning of GQ and High density

V 6,500 214 1,210 5,076
corridor

VI Expressways 1,040 - - 1,040

Ring roads, bypasses and flyovers and

VII 700 - 41 659
other structures

Total 54,494 13,587 6,813 34,094

Source: NHAI Status as of March 2010

4
 Infrastructure Sector Update 26 August 2010

Fig 9 - Trend in road project award activity

(km) BOT-Toll BOT-Annuity EPC
5,000

4,000 Most projects Policy issues

awarded on EPC impacted award
3,000 basis till FY06 activity in FY07-09

FY10 saw a pick up in road project

2,000
award activity after three years of lull
1,000

0
FY01 FY02 FY03 FY04 FY05 FY06 FY07 FY08 FY09 FY10 Apr-
10

Source: RCML Research, NHAI

Fig 10 - Number of projects awarded between April ’09 to April ’10

Apr-Nov '09 Dec '09 - Apr '10
No of projects awarded 14 24
- Positive grant 10 13
Project awarding picked up post
- Negative grant - 9
acceptance of B.K. Chaturvedi
- Revenue sharing 2 1
committee report in November ‘09
- Annuity 2 1
Length awarded (km) 1,300 2,059
Source: NHAI * BKC – B. K. Chaturvedi

Fig 11 - Expected trend in project award activity

(km) BOT-Toll BOT-Annuity EPC
14,268
15,000

12,000
8,773
We expect most project award activity 9,000
to get over by FY14
6,000 5,096
4,287
3,360
3,000
971

0
FY10 FY11E FY12E FY13E FY14E FY15E

Source: RCML Research

5
Infrastructure Sector Update 26 August 2010

Fig 12 - NHAI financing plan up to 2030-31

Particulars Rs bn
A. Estimated expenditure
Project construction 3,380
Payment to annuity 2,076
Interest on borrowed funds 783
Repayment of Borrowing 1,888
Total (A) 8,127
B. Sources of funds
Cess funds 3,606
External assistance (grant and Loan) 98
Net surplus from toll revenue 1,174
Negative grant 33
Budgetary support 14
Addl. budgetary support 393
Share of private sector 2,113
Borrowings 1,919
Total (B) 9,351
Source: NHAI

6
 Infrastructure Sector Update
Fig 13 - Key recommendations of B. K. Chaturvedi committee
Area Old provision
Single bid • Single bid projects must go for re-bidding
• VGF for six-lane packages restricted to
VGF 10%; overall cap of 5% for the entire six-
laning programme
• 40% grant equally distributed during
construction and O&M period
Grant
• For 2009 projects, entire 40% grant
payable in the construction period
• NHAI can terminate the contract if
average daily traffic in any accounting
Termination year exceeds the design capacity
clause
• However, if the concessionaire augments
the highway, the concession would
continue
• Winning bidder must hold 51% in SPV
during construction; on completion and
for three years into operations, this can
be lowered to 33% and then to 26%,
Developer held till the end of concession
exit policy
• In some cases, promoters must hold 51%
for two years into completion and
thereafter 33% till the concession period
ends
• Bid disqualified if a bidder holds more
Conflict of
interest than 5% in another company that is
applying for the same project
• Request for prequalification in the RFQ
Pre- process is specifically for individual
qualification projects or a set of projects (up
to three)
• Project is first invited on BOT (toll) basis.
Waterfront
In case of a poor response, it is converted
mechanism
to BOT (annuity) and finally, on its
failure, to a cash contract
Source: Chaturvedi Committee Report – November 2009
26 August 2010
Revised provision RCML view
• NHAI board empowered to accept • Project awarding will be expedited
single bids, if reasonable
• Overall VGF raised to 10% • This will bolster the success of project
awards
• Individual projects in low-traffic GQ
stretches may get VGF up to 20%, • So far, several projects failed to attract
within a cap of 500km out of bids as developers were demanding
5,080km to be awarded in phase 5 higher VGF
• Entire grant to be paid during the • Receipt of upfront grant would
construction period improve the equity IRR by 1–2%
• If traffic exceeds the design capacity, • This would resolve lender objections
a detailed project report (DPR) must on non-availability of project upside to
be made by developers developers, which affected the
financial closure of some works and
• NHAI would use the DPR to arrive at caused delays
the project cost; based on the current
traffic growth, it would calculate the • Extension of the concession period is a
extension in concession period (max 5 key positive though preparation of the
years) required to attain 15% IRR DPR could prove contentious
• Contractor equity no longer blocked
• Minimum 51% stake to be maintained
for the entire concession period
during construction
• Apart from freeing up capital once the
• Thereafter, 26% stake to be
project is operational, this would
maintained only for two years after
encourage developers to concentrate
commercial operations begin
on their area of expertise
• Award of projects would improve as PE
• 5% conflict of interest provision
investors were often disqualified due to
raised to 25%
their passive shareholding of over 5%
• Prequalification to be an annual • Bidders can skip the RFQ, thereby save
exercise valid for 12 months or till 30 on time and resources
September, whichever is earlier
• Applicant can seek prequalification
assessment at any time in the year
• Bids will be invited on all three modes
of delivery – toll, annuity and EPC,
concurrently not sequentially
• A project not found suitable for BOT • Supports speedy awarding of projects
(toll) can be implemented on annuity and cost savings
basis, subject to cap of overall work
• 18% equity IRR – a positive for
plan
developers
• Before implementation on EPC basis,
the project will be tested for BOT
annuity. If annuity IRR is 18%, it will
be accepted (21% for difficult areas)
7
 Infrastructure Sector Update 26 August 2010

Fig 14 - Recent policy changes

Area Old provision Revised provision RCML view
The road developer would not be
Positive: Developer would prioritise attainment of
Financial eligible for the project bidding if its
N.A. financial closure rather than bidding for more projects
closure norms three or more NHAI BOT projects are
without achieving financial closure of existing projects
pending financial closure

Consortium should have a
Net worth net worth of at least 25%
criteria of project cost irrespective
of the project size
Project cost up to Rs 20bn - 25% of the
project cost
Project cost between Rs 20bn-30bn -
50% of (Project cost - Rs 20bn)
Project cost Rs 30bn - (Project cost - Rs
30bn)
Positive: It will improve project execution. Big
developers with a strong financial position would be
benefited. Small developers would be disqualified to bid
for large projects – such bidding would stretch their
balance sheet while elongating the process of attaining
financial closure and leading to execution delays

Consortium (not
Net worth individual consortium
Every consortium member should have
criteria for member) should have a Positive: This will check the name lending practice to
a net worth of at least 12.5% of the total
individual net worth of at least 25% some extent
project cost
consortium of project cost irrespective
of the project size

Technical score is counted

Technical
at consortium level,
criteria for Score to be counted only to the extent
irrespective of the stake of Positive: This will check project execution delays
individual of its equity stake in the consortium
individual consortium
consortium
member
Source: News paper articles

State roads and rural roads

Spend on rural roads has seen a
consistent rise under the PMGSY
scheme
Investment momentum continues
The Planning Commission had envisaged an investment of Rs 1.5tn in state highways,
major district roads and rural roads during the 11th plan period (on FY07 prices). As per
a recent review conducted by the Planning Commission, investment by state
governments in the road sector is progressing well. In addition, state governments like
Andhra Pradesh, Uttar Pradesh and Gujarat have awarded road projects to the private
sector on BOT basis.
On the rural roads front, the progress has been good in the past few years, particularly
since such projects are entirely funded by central government. We expect the
momentum of investment in rural road projects to continue, given the criticality of such
projects towards achieving inclusive economic growth in the country. In addition,
investing in such projects will also help enhance the government’s political mileage, as
‘new connectivity’ road projects typically lead to faster development of the hinterland.

Fig 15 - Road works done under PMGSY scheme over FY05-10

Length of road works completed ('000 kms) Expenditure (Rs bn)

200 179
152
160

120 106

73
80
52 50
41 41
31
40 23

0
FY06 FY07 FY08 FY09 FY10

Source: National Rural Roads Development Agency Note – FY10 number has been estimated based on 9mFY10 actual

8
Infrastructure Sector Update 26 August 2010

Our view:

We expect project awarding of ~34,000km over the next few years. We estimate a
spend of Rs 4.6tn on roads and highways over the 12th plan, with private sector
contribution at 44% (primarily for NHAI projects).

Companies with strong financials and in-house construction capabilities will find it
easier to access low-cost finance and mitigate execution risks.

Careful project selection would be a key play for small/medium size projects given the
aggressive bidding seen in the backdrop of intense competition

We are positive on the infrastructure sector and our top picks are L&T and RELI

9
 Infrastructure Sector Update 26 August 2010

Coverage Profile

By recommendation By market cap (US$)

(%) (%)
60 55 80
64
50
36 60
40
30 40 34
20 9 20
10 2
0 0
Buy Hold Sell > $1bn $200mn - $1bn < $200mn

Recommendation interpretation

Recommendation Expected absolute returns (%) over 12 months

Buy More than 15%

Hold Between 15% and –5%

Sell Less than –5%

Recommendation structure changed with effect from March 1, 2009

Expected absolute returns are based on share price at market close unless otherwise stated. Stock recommendations are based on absolute upside (downside) and have a
12-month horizon. Our target price represents the fair value of the stock based upon the analyst’s discretion. We note that future price fluctuations could lead to a temporary
mismatch between upside/downside for a stock and our recommendation.

Religare Capital Markets Ltd

th
4 Floor, GYS Infinity, Paranjpe ‘B’ Scheme, Subhash Road, Vile Parle (E), Mumbai 400 057.

Disclaimer
This document is NOT addressed to or intended for distribution to retail clients (as defined by the FSA).
This document is issued by Religare Capital Markets plc (“RCM”) in the UK, which is authorised and regulated by the Financial Services Authority in connection with its UK
distribution. RCM is a member of the London Stock Exchange.
This material should not be construed as an offer or recommendation to buy or sell or solicitation of any offer to buy any security or other financial instrument, nor shall it, or
the fact of its distribution, form the basis of, or be relied upon in connection with, any contract relating to such action or any other matter. The material in this report is based
on information that we consider reliable and accurate at, and share prices are given as at close of business on, the date of this report but we do not warrant or represent
(expressly or impliedly) that it is accurate, complete, not misleading or as to its fitness for the purpose intended and it should not be relied upon as such. Any opinion
expressed (including estimates and forecasts) is given as of the date of this report and may be subject to change without notice.
RCM, and any of its connected or affiliated companies or their directors or employees, may have a position in any of the securities or may have provided corporate finance
advice, other investment services in relation to any of the securities or related investments referred to in this document. Our asset management area, our proprietary trading
desks and investing businesses may make investment decisions that are inconsistent with the recommendations or views expressed in this briefing note.
RCM accepts no liability whatsoever for any direct, indirect or consequential loss or damage of any kind arising out of the use of or reliance upon all or any of this material
howsoever arising. Investors should make their own investment decisions based upon their own financial objectives and financial resources and it should be noted that
investment involves risk, including the risk of capital loss.
This document is confidential and is supplied to you for information purposes only. It may not (directly or indirectly) be reproduced, further distributed to any person or
published, in whole or in part, for any purpose whatsoever. Neither this document, nor any copy of it, may be taken or transmitted into the United States, Canada, Australia,
Ireland, South Africa or Japan or into any jurisdiction where it would be unlawful to do so. Any failure to comply with this restriction may constitute a violation of relevant
local securities laws. If you have received this document in error please telephone Nicholas Malins-Smith on +44 (0) 20 7382 4479.

10