Road Contractors Set For A 200 bps Decline In Margins
According to CRISIL, the operating profitability of road EPC (engineering, procurement and construction) contractors is expected to decline by 200-250 basis points (bps) to a decadal low this fiscal.
However, the credit profiles of road EPC players will remain stable, supported by deleveraged balance sheets, prudent working capital management, and steady cash accrual, with strong awarding in the past two fiscals supporting revenue growth.
The Director of CRISIL Research, Aniket Dani says that, “Limited competition in HAM projects had supported healthy profit margins of road EPC players between fiscals 2018 and 2021. The changes in bid eligibility criteria and smaller package sizes have intensified competition, especially last fiscal. Average bid premiums nosedived to ~4% last fiscal from ~16% earlier. Proposed changes in networth eligibility criteria2 and additional performance security for abnormally low bids3 may moderate the competitive intensity.”
The escalated competition and sheer surge in the prices of raw materials - stell, bitumen and cement - had shrunk the operating margins of road EPC players by 200 bps last fiscal. Prices of these key raw materials surged 26%, 60% and 4% respectively in the previous fiscal and are expected to remain elevated this fiscal as well and the raw material cost forms 45-50% of overall cost of road EPC players.
The Director of CRISIL Ratings, Anand Kulkarni stated that, “Despite the declining profitability, the balance sheets of road EPC players will remain healthy. Revenue will grow 13-15% this fiscal, backed by robust order books, as reflected in the order book to revenue ratio of over 3 times. Healthy accrual and limited debt will support comfortable leverage, with total outside liabilities to networth ratio seen ~1.1 times this fiscal. Hence, the credit profiles of players should remain stable despite the current headwinds.”
A prolonged Russia-Ukraine war and its impact on commodity prices may affect credit profiles and will bear watching. Here are the few things to keep in mind reagrading the market-
1 Mid-size players: Revenue of <Rs 1,500 crore
2 Adjustment in networth calculation by deducting balance equity commitment in all under construction HAM projects
3 Bids at a discount of over 20%
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