Sector Update

26 August 2010

Sector Update

26 August 2010

Infrastructure (Roads)
Strong project awarding ahead; project selection the key
NHAI intends to award projects extending ~9000km, both during FY11 and FY12 (projects of ~2,800km awarded so far in the current fiscal). Moreover, we note that an improvement in the availability of finance has lead to faster financial closure of projects. However, the sector faces risks emanating from 1) delays in acquiring land and securing environment clearances and 2) aggressive project bidding for small/medium sized projects. We believe that companies with strong financials and in-house construction capabilities will be in a better position to access low-cost finance and mitigate execution-related risks. Importantly, a careful selection of projects would be a key game changer for players. We remain positive on India’s infrastructure sector considering the recovery in the country’s economic growth and corporate capex, along with political stability and improved fund availability. Our top picks are L&T and RELI. Key rationale: Significant project awarding form NHAI in the near term: NHAI has set a target to award projects extending ~ 9000km, both during FY11 and FY12. So far in this fiscal, it has awarded projects of ~2800km. Rs 220bn outlay for FY11 under PMGYS: For the development of rural roads, NHAI has earmarked out an outlay of Rs 220bn for FY11 under the PMGSY scheme. NHAI to raise Rs 25-30bn via 54EC bonds in FY11: NHAI raised ~Rs 7bn so far in this fiscal and plans to raise an additional Rs 18-23bn by the end of March ’11. This will improve its liquidity position to provide VFG to developers. Availability of finance and quick financial closure: Credit demand for infrastructure sector is picking up. We note that an improvement in exposure of banks to the infrastructure segment over the past one year expedited the financial closure of projects (to 2-3 months now vs months last year). Key concerns: Land acquisition and environmental clearance: Bottlenecks in acquiring 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 the the has 4-6

Road sector – Significant project awarding ahead
Only 17% of national highways are four-lane or above, offering a huge opportunity for development Spend on rural roads has seen a consistent rise under the PMGSY scheme Balance of ~34,000km from NHDP programme to be award over next few years Project awarding under NHDP picks up post acceptance of Chaturvedi committee report in Nov’09 Awarded ~2,800km so far in FY11 v/s target of ~9,000km We expect most project award activity to get over by FY14 Estimate plan investments of Rs 4.6tn, 59% in National Highways Construction opportunities of Rs 4.4tn over FY12-17 Key risk: delay in project awarding due to land acquisition and environmental clearance

Recommendation snapshot
Company (Rs) Ahluwalia HCC IRB Infra IVRCL L&T NCC Patel Engg. Punj Lloyd RELI Simplex Infra CMP 215 62 295 160 1,853 154 378 113 1,017 470 Target 250 70 280 210 2,100 210 470 100 1390 490 Rating Buy Hold Hold Buy Buy Buy Buy Sell Buy Sell

Vaibhav Jain
(91-22) 6766 3464

Hardik Shah
(91-22) 6766 3465

Suhas Harinarayanan
(91-22) 6766 3404

RCML: Winner of LIPPER-STARMINE broker award for “Earnings Estimates in Midcap Research 2008” | “Honourable Mention” in Institutional Investor 2009 | Voted amongst Top 5 most improved brokerages by 1 Asia Money Poll 2009 | RCML Research is also available on Bloomberg FTIS <GO> and Thomson First Call

Of this. major ports.Composition of original estimate of 11th plan spend of Rs 3. Planning Commission had envisaged Rs 3. State PWDs.899 467. strategic locations State capitals. due to delays in project awards by NHAI.National highways .000kms – despite accounting for only 2% of India’s total road network. Of this.40. other states Main roads. NHs handle 40% of the total traffic (see fig below). state highways with double the network (1.210 Length (%) 2.000km) account for 4% of the total network and handle 40% of the traffic. highways.000km to be awarded over next few years The Indian road network consists of 3. important towns.000 3.1tn to Rs 2.8 100 20 100 State PWDs MoRD MoRD – Ministry of Rural Development 11th plan spend – revised down to Rs 2. Fig 1 .1 4 Traffic (%) 40 Development agency NHAI.3tn during the 10th five-year plan. rural roads Production centres. the Planning Commission revised down the 11th plan spend estimate to Rs 2. 6% of the road network carries 80% of the total traffic in India. national highways. In the original plan. Fig 2 . major district roads 29% Source: RCML Research. Roads handle 85% of the total passenger traffic and 60% of the total freight traffic. district centres. Thus. railway stations 40 14.8tn.8tn Planning commission has revised down 11th plan spend estimate from Rs3. Planning Commission National highways 52% 2 .3mn km.8tn Roads and highways saw a plan spend of Rs 1.Infrastructure Sector Update 26 August 2010 Significant project awarding ahead ~34.763 2.320. In March ’10. BRO State PWDs Connectivity Union capitals. foreign highways. Southern and western states account for bulk of the traffic as against northern. 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).1 79. eastern. state capitals.1tn in roads Rural roads 14% Other state spend on roads 5% State highways. and north eastern states.~2% of Indian road network but handle ~40% of traffic Road network National Highways State highways Major district roads Rural and other roads Total Source: RCML Research Length (km) 70. In comparison.1tn of investment during the 11th plan with 52% of the spend targeted on national highways.548 131.650. the network of National Highways (NHs) extends over 70. markets.

9 16. 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.1 100. major district roads 24% Source: RCML Research National highways 59% Source: RCML Research Centre 19% * primarily on NHAI projects 3 .2 44.Infrastructure Sector Update 26 August 2010 12th plan – expect Rs 4.6tn on roads and highways over 12th plan.3 100.6tn in 12th plan We estimate a spend of Rs 4.787 Share (%) 32.6 37.6tn spend Spend on roads & highways should increase to Rs 4.6tn in 12th plan Other state spend on roads 3% Rural roads 14% Fig 5 . private sector participation in state highways is likely to be limited as policy changes are still pending at the state government level.) 857 1.Private sector likely to account for 44% of spend* State 37% Private 44% State highways.0 7. The increase in spend on state highways is likely to be at a similar rate as seen in the past.271 Share (%) 39.0 12th plan (RCML est.5 100.0 Source: RCML Research.Composition of likely spend of Rs 4. Our estimates 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. Spend on rural roads has seen a consistent increase since the inception of Pradhan Mantri Gram Sadak Yojana (PMGSY) in 2000.6 50.600 Share (%) 18.031 4.12th Plan: Investments trend Particulars (Rs bn) Centre State Private Total investments 10th plan actual 505 674 92 1. Fig 3 .419 459 2.7 53. However.0 11th plan revised 909 1.712 2. Planning commission Fig 4 .

076 1.040 659 34. bypasses on BOT basis-toll/annuity Source: RCML Research. others Four-laning projects III 4 . NHAI Fig 8 .707 20. NHAI. Fig 6 . bypasses and flyovers and other structures Total Source: NHAI Status as of March 2010 Total length (km) 7.822 1.813 To be awarded (in km) 6 606 6.210 41 6. offering a huge opportunity for development Single lane/Intermediate lane 30% Double lane 53% Source: RCML Research.576 3.Current status of National Highways in India Four-laned and above 17% Only 17% of national highways are four-lane or above.500km including 5.000 6.465 1.040km expressways with full access control 700km of ring roads. Given the fact that only 17% of the national highways in India are four-laned (or above).328 4.000km of national highways in a phase-wise manner NHDP-III NHDP-IV NHDP-V NHDP-VI NHDP-VII Description Four-laning of 7.580 214 13. (km) (in km) 7.700km of GQ 1. NHAI is responsible for development of ~3/4th of the network. Ministry of Roads.498km including 5. NS-EW corridors.647 12.000km Six-laning of 6.494 Length Length completed under Imp.000 5.161km of NS-EW corridor projects Four-laning of 12.094 Four-laning of GQ.Infrastructure Sector Update 26 August 2010 National highways spend – largely driven by NHAI Out of 70.000km of work has to be awarded over next few years IV V VI VII Two-laning with paved shoulders Six-laning of GQ and High density corridor Expressways Ring roads. port connectivity & others Four/six-laning of NS-EW corridor.587 164 1. NHAI has a large job at hand. Transport and Highways Fig 7 .Development of national highways by NHDP – phases-wise details Phase NHDP-I NHDP-II NHAI will develop ~55.Key road projects ahead Phases Description I II 34.848km of Golden Quadrilateral (GQ) and 980km of North-South (NS) and East-West (EW) corridor projects Four-laning of 6.109 20.109km Two-laning of 20.500km of national highways in India.498 6.647km including 6.040 700 54.500 1.

000 0 FY01 FY02 FY03 FY04 FY05 FY06 FY07 FY08 FY09 FY10 Apr10 Source: RCML Research.268 EPC 9.Number of projects awarded between April ’09 to April ’10 Apr-Nov '09 No of projects awarded Project awarding picked up post acceptance of B.300 Fig 11 . NHAI Fig 10 .000 12.Infrastructure Sector Update 26 August 2010 Fig 9 .000 FY10 saw a pick up in road project award activity after three years of lull BOT-Toll Most projects awarded on EPC basis till FY06 BOT-Annuity EPC Policy issues impacted award activity in FY07-09 2.Positive grant . K.000 0 FY10 Source: RCML Research 8.059 14 10 2 2 1.Revenue sharing .000 1.Expected trend in project award activity (km) 15.000 3.096 4.K.360 3.Annuity Length awarded (km) Source: NHAI * BKC – B.Trend in road project award activity (km) 5.000 6.773 5.Negative grant .000 We expect most project award activity to get over by FY14 BOT-Toll BOT-Annuity 14.Apr '10 24 13 9 1 1 2. Chaturvedi Dec '09 .000 4.000 3. Chaturvedi committee report in November ‘09 .287 971 FY11E FY12E FY13E FY14E FY15E 5 .

606 98 1.380 2.113 1. Sources of funds Cess funds External assistance (grant and Loan) Net surplus from toll revenue Negative grant Budgetary support Addl.919 9. budgetary support Share of private sector Borrowings Total (B) Source: NHAI Rs bn 3.888 8.351 6 .Infrastructure Sector Update 26 August 2010 Fig 12 .174 33 14 393 2.NHAI financing plan up to 2030-31 Particulars A.076 783 1.127 3. Estimated expenditure Project construction Payment to annuity Interest on borrowed funds Repayment of Borrowing Total (A) B.

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

On the rural roads front.5% of the total project cost Positive: This will check the name lending practice to some extent Technical criteria for individual consortium Score to be counted only to the extent of its equity stake in the consortium Positive: This will check project execution delays Source: News paper articles State roads and rural roads Investment momentum continues The Planning Commission had envisaged an investment of Rs 1. particularly since such projects are entirely funded by central government.Road works done under PMGSY scheme over FY05-10 Length of road works completed ('000 kms) 200 160 120 80 41 40 0 FY06 FY07 FY08 FY09 FY10 23 31 73 41 52 50 106 152 Expenditure (Rs bn) 179 Spend on rural roads has seen a consistent rise under the PMGSY scheme Source: National Rural Roads Development Agency Note – FY10 number has been estimated based on 9mFY10 actual 8 . given the criticality of such projects towards achieving inclusive economic growth in the country.Rs 20bn) Project cost Rs 30bn . as ‘new connectivity’ road projects typically lead to faster development of the hinterland.Rs 30bn) RCML view Positive: Developer would prioritise attainment of financial closure rather than bidding for more projects without achieving financial closure of existing projects Positive: It will improve project execution.25% of the project cost Project cost between Rs 20bn-30bn 50% of (Project cost . We expect the momentum of investment in rural road projects to continue. the progress has been good in the past few years. 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 N. state governments like Andhra Pradesh. irrespective of the stake of individual consortium member Net worth criteria for individual consortium Every consortium member should have a net worth of at least 12.5tn in state highways.A. In addition. Big developers with a strong financial position would be benefited.(Project cost .Infrastructure Sector Update 26 August 2010 Fig 14 . Net worth criteria Consortium should have a net worth of at least 25% of project cost irrespective of the project size Consortium (not individual consortium member) should have a net worth of at least 25% of project cost irrespective of the project size Technical score is counted at consortium level. Uttar Pradesh and Gujarat have awarded road projects to the private sector on BOT basis. In addition.Recent policy changes Area Financial closure norms Old provision Revised provision The road developer would not be eligible for the project bidding if its three or more NHAI BOT projects are pending financial closure Project cost up to Rs 20bn . As per a recent review conducted by the Planning Commission. investment by state governments in the road sector is progressing well. major district roads and rural roads during the 11th plan period (on FY07 prices). investing in such projects will also help enhance the government’s political mileage. Fig 15 .

6tn on roads and highways over the 12th plan. with private sector contribution at 44% (primarily for NHAI projects). We estimate a spend of Rs 4.Infrastructure Sector Update 26 August 2010 Our view: We expect project awarding of ~34. 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 . Companies with strong financials and in-house construction capabilities will find it easier to access low-cost finance and mitigate execution risks.000km over the next few years.

Any opinion expressed (including estimates and forecasts) is given as of the date of this report and may be subject to change without notice. Paranjpe ‘B’ Scheme. complete. may be taken or transmitted into the United States. and share prices are given as at close of business on. Canada. Australia. nor any copy of it.Infrastructure Sector Update 26 August 2010 Coverage Profile By recommendation (%) 60 50 40 30 20 1 0 0 55 36 9 Buy Hold Sell (%) 80 60 40 20 0 > $1 bn $200mn . and any of its connected or affiliated companies or their directors or employees. Any failure to comply with this restriction may constitute a violation of relevant local securities laws. 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. Neither this document. including the risk of capital loss. If you have received this document in error please telephone Nicholas Malins-Smith on +44 (0) 20 7382 4479. or be relied upon in connection with. for any purpose whatsoever. not misleading or as to its fitness for the purpose intended and it should not be relied upon as such. Vile Parle (E). Stock recommendations are based on absolute upside (downside) and have a 12-month horizon. RCM. in whole or in part. Mumbai 400 057. which is authorised and regulated by the Financial Services Authority in connection with its UK distribution. We note that future price fluctuations could lead to a temporary mismatch between upside/downside for a stock and our recommendation. South Africa or Japan or into any jurisdiction where it would be unlawful to do so. This document is confidential and is supplied to you for information purposes only. nor shall it.$1 bn 34 2 < $200mn By market cap (US$) 64 Recommendation interpretation Recommendation Buy Hold Sell Expected absolute returns (%) over 12 months More than 15% Between 15% and –5% Less than –5% Recommendation structure changed with effect from March 1. GYS Infinity. may have a position in any of the securities or may have provided corporate finance advice. form the basis of. It may not (directly or indirectly) be reproduced. Ireland. other investment services in relation to any of the securities or related investments referred to in this document. Our asset management area. 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. th Disclaimer This document is NOT addressed to or intended for distribution to retail clients (as defined by the FSA). The material in this report is based on information that we consider reliable and accurate at. Religare Capital Markets Ltd 4 Floor. RCM accepts no liability whatsoever for any direct. or the fact of its distribution. This document is issued by Religare Capital Markets plc (“RCM”) in the UK. the date of this report but we do not warrant or represent (expressly or impliedly) that it is accurate. Our target price represents the fair value of the stock based upon the analyst’s discretion. RCM is a member of the London Stock Exchange. any contract relating to such action or any other matter. Subhash Road. 10 . 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. our proprietary trading desks and investing businesses may make investment decisions that are inconsistent with the recommendations or views expressed in this briefing note. further distributed to any person or published. 2009 Expected absolute returns are based on share price at market close unless otherwise stated.

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