Infrastructure

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

jain.vaibhav@religare.in hardik.shah@religare.in suhas.hari@religare.in

8tn Planning commission has revised down 11th plan spend estimate from Rs3.548 131. NHs handle 40% of the total traffic (see fig below).Infrastructure Sector Update 26 August 2010 Significant project awarding ahead ~34. BRO State PWDs Connectivity Union capitals.1tn of investment during the 11th plan with 52% of the spend targeted on national highways. highways.1 79.000kms – despite accounting for only 2% of India’s total road network. major district roads 29% Source: RCML Research. Southern and western states account for bulk of the traffic as against northern.National highways . state highways with double the network (1. other states Main roads. 6% of the road network carries 80% of the total traffic in India.1 4 Traffic (%) 40 Development agency NHAI. Fig 2 . important towns. national highways. In the original plan. strategic locations State capitals.8 100 20 100 State PWDs MoRD MoRD – Ministry of Rural Development 11th plan spend – revised down to Rs 2.1tn in roads Rural roads 14% Other state spend on roads 5% State highways. In March ’10.763 2. the Planning Commission revised down the 11th plan spend estimate to Rs 2. Thus.40. Of this. Roads handle 85% of the total passenger traffic and 60% of the total freight traffic.8tn. Of this. railway stations 40 14.000 3. district centres.3mn km. the network of National Highways (NHs) extends over 70.000km) account for 4% of the total network and handle 40% of the traffic. foreign highways.~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. and north eastern states. major ports. 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). State PWDs. markets. Planning Commission had envisaged Rs 3. due to delays in project awards by NHAI. Fig 1 .Composition of original estimate of 11th plan spend of Rs 3.1tn to Rs 2.650. rural roads Production centres.3tn during the 10th five-year plan.210 Length (%) 2. eastern. state capitals. In comparison. Planning Commission National highways 52% 2 .8tn Roads and highways saw a plan spend of Rs 1.320.000km to be awarded over next few years The Indian road network consists of 3.899 467.

Infrastructure Sector Update 26 August 2010 12th plan – expect Rs 4.6tn spend Spend on roads & highways should increase to Rs 4.419 459 2.1 100. 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.271 Share (%) 39.600 Share (%) 18. Planning commission Fig 4 .2 44.787 Share (%) 32.6tn on roads and highways over 12th plan.Private sector likely to account for 44% of spend* State 37% Private 44% State highways. The increase in spend on state highways is likely to be at a similar rate as seen in the past. private sector participation in state highways is likely to be limited as policy changes are still pending at the state government level.0 12th plan (RCML est.Composition of likely spend of Rs 4.6 37. However.031 4.0 Source: RCML Research. 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.5 100. Fig 3 .3 100.6tn in 12th plan We estimate a spend of Rs 4.712 2.6tn in 12th plan Other state spend on roads 3% Rural roads 14% Fig 5 .12th Plan: Investments trend Particulars (Rs bn) Centre State Private Total investments 10th plan actual 505 674 92 1. Spend on rural roads has seen a consistent increase since the inception of Pradhan Mantri Gram Sadak Yojana (PMGSY) in 2000. major district roads 24% Source: RCML Research National highways 59% Source: RCML Research Centre 19% * primarily on NHAI projects 3 .0 11th plan revised 909 1.6 50.0 7.7 53.) 857 1.9 16.

bypasses and flyovers and other structures Total Source: NHAI Status as of March 2010 Total length (km) 7.700km of GQ 1.328 4.109km Two-laning of 20.Current status of National Highways in India Four-laned and above 17% Only 17% of national highways are four-lane or above.000 5. bypasses on BOT basis-toll/annuity Source: RCML Research. Fig 6 .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.580 214 13. NHAI Fig 8 . Given the fact that only 17% of the national highways in India are four-laned (or above). NS-EW corridors.161km of NS-EW corridor projects Four-laning of 12.000km Six-laning of 6.494 Length Length completed under Imp.813 To be awarded (in km) 6 606 6.707 20.076 1.587 164 1. Transport and Highways Fig 7 . Ministry of Roads.210 41 6.109 20. port connectivity & others Four/six-laning of NS-EW corridor.000km of national highways in a phase-wise manner NHDP-III NHDP-IV NHDP-V NHDP-VI NHDP-VII Description Four-laning of 7.647km including 6.Infrastructure Sector Update 26 August 2010 National highways spend – largely driven by NHAI Out of 70. NHAI is responsible for development of ~3/4th of the network.Development of national highways by NHDP – phases-wise details Phase NHDP-I NHDP-II NHAI will develop ~55.500 1.465 1.040 659 34.094 Four-laning of GQ. offering a huge opportunity for development Single lane/Intermediate lane 30% Double lane 53% Source: RCML Research. NHAI has a large job at hand.040km expressways with full access control 700km of ring roads.498km including 5.000 6.822 1. (km) (in km) 7.500km including 5.498 6.647 12. NHAI.848km of Golden Quadrilateral (GQ) and 980km of North-South (NS) and East-West (EW) corridor projects Four-laning of 6.576 3.Key road projects ahead Phases Description I II 34.500km of national highways in India.040 700 54. others Four-laning projects III 4 .

Infrastructure Sector Update 26 August 2010 Fig 9 .Negative grant .000 12.287 971 FY11E FY12E FY13E FY14E FY15E 5 .096 4.Annuity Length awarded (km) Source: NHAI * BKC – B.300 Fig 11 .000 We expect most project award activity to get over by FY14 BOT-Toll BOT-Annuity 14.Trend in road project award activity (km) 5.000 0 FY01 FY02 FY03 FY04 FY05 FY06 FY07 FY08 FY09 FY10 Apr10 Source: RCML Research.773 5.000 3.000 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 2.000 3. K.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. Chaturvedi Dec '09 . Chaturvedi committee report in November ‘09 .Expected trend in project award activity (km) 15.059 14 10 2 2 1.000 4.Apr '10 24 13 9 1 1 2. NHAI Fig 10 .K.360 3.Revenue sharing .000 6.000 0 FY10 Source: RCML Research 8.000 1.Positive grant .

budgetary support Share of private sector Borrowings Total (B) Source: NHAI Rs bn 3.113 1. Sources of funds Cess funds External assistance (grant and Loan) Net surplus from toll revenue Negative grant Budgetary support Addl.380 2. Estimated expenditure Project construction Payment to annuity Interest on borrowed funds Repayment of Borrowing Total (A) B.351 6 .174 33 14 393 2.Infrastructure Sector Update 26 August 2010 Fig 12 .888 8.606 98 1.NHAI financing plan up to 2030-31 Particulars A.076 783 1.127 3.919 9.

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%. this can be lowered to 33% and then to 26%.Infrastructure Sector Update 26 August 2010 Fig 13 . 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. the project will be tested for BOT annuity. 26% stake to be maintained only for two years after commercial operations begin • Apart from freeing up capital once the project is operational. 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. 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. overall cap of 5% for the entire sixlaning programme • Individual projects in low-traffic GQ stretches may get VGF up to 20%. a detailed project report (DPR) must be made by developers • This would resolve lender objections on non-availability of project upside to developers. 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.080km to be awarded in phase 5 • So far. promoters must hold 51% for two years into completion and thereafter 33% till the concession period ends • Thereafter. 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.Key recommendations of 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. if the concessionaire augments the highway. which affected the financial closure of some works and caused delays • However. on completion and for three years into operations. annuity and EPC. it will be accepted (21% for difficult areas) Source: Chaturvedi Committee Report – November 2009 7 . In case of a poor response. whichever is earlier • Bidders can skip the RFQ. If annuity IRR is 18%. on its failure. K. to a cash contract • A project not found suitable for BOT (toll) can be implemented on annuity basis. concurrently not sequentially Waterfront mechanism • Project is first invited on BOT (toll) basis. 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. the concession would continue • NHAI would use the DPR to arrive at the project cost. it is converted to BOT (annuity) and finally. within a cap of 500km out of 5. 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. based on the current traffic growth.

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. as ‘new connectivity’ road projects typically lead to faster development of the hinterland.A.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 . investment by state governments in the road sector is progressing well.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 . 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. On the rural roads front. Big developers with a strong financial position would be benefited. Fig 15 . given the criticality of such projects towards achieving inclusive economic growth in the country. In addition. state governments like Andhra Pradesh.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. 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. particularly since such projects are entirely funded by central government.Infrastructure Sector Update 26 August 2010 Fig 14 .(Project cost . Uttar Pradesh and Gujarat have awarded road projects to the private sector on BOT basis.5tn in state highways. 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 12.25% of the project cost Project cost between Rs 20bn-30bn 50% of (Project cost . As per a recent review conducted by the Planning Commission. 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. the progress has been good in the past few years. We expect the momentum of investment in rural road projects to continue.Rs 20bn) Project cost Rs 30bn . In addition.

000km over the next few years.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 . 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.

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

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