Build, and they will come

Vikram Sharma, a freshly minted civil engineer, was barely 24 when he entered the family business, Supreme Asphalts, in 1998. Asphalt is used in road construction and the company started by his father Bhawanishankar Sharma subsisted on supplies made to civil contractors. A few years later in 2002 when it reached revenues of ₹20 crore, the company was renamed Supreme Infrastructure to reflect its growing ambitions. 

Supreme started off as an EPC (engineering, procurement and construction) contractor in the roads business before moving to constructing bridges, then buildings and eventually into untested areas such as water, power and railways. Until it listed itself in October 2007, Supreme’s revenue was entirely driven by EPC contracts that it bagged for road construction. It then decided to up the ante by bidding for built-operate-transfer (BOT) projects on its own. The chasm between an EPC contractor and a BOT operator is wide. Not only do you need much deeper pockets to bid and deliver on time, there is tremendous bureaucracy to navigate. Sharma, who is now managing director, explains, “In 2009, BOT was the flavour of most large road projects. Getting into that segment was a strategicdecision, keeping in mind our execution capabilities.”

Like most other infrastructure players, Supreme’s growth has come on the back of government contracts. And that dependence continues even now. Government-backed orders comprised 76% of the FY13 order-book of ₹6,044 crore. Within the order-book, EPC contracts for road, bridges and buildings dominate. 

Present tense

It is not a great time to be running an infrastructure business. Not only are new projects hard to come by, most companies in the sector have loaded their balance sheets with debt. Goutham Reddy, executive director at the Hyderabad-based Ramky Group, says it has been the worst phase in at least a decade. “Even during the global financial crisis, there was liquidity in the market. The lack of it today is a big concern,” he says. This drying up of investor interest has led to its own set of problems. “Most of them had large equity components for their BOT projects in anticipation of money coming from private equity players. That has not materialised,” adds Reddy. If that was not bad enough, over the past five years, the cost of debt has moved up sharply from 8% to 12%. Reddy sums up the situation as one where equity is being substituted by debt with the latter getting to be a very expensive proposition.

Supreme is no exception. Consolidated debt has increased from ₹991 crore in FY12 to ₹1,439 crore in FY13. Sharma, however, believes his company willgradually repay the term loans obtained for funding the equity portion of BOT projects. His confidence emanates from the BOT projects that the company is executing and which when complete will throw off cash flows that will help in debt reduction. The company has a portfolio of 10 BOT projects, of which four are operational and the rest expected to start tolling by end-FY15. 

Sharma elaborates, “Part of the term loans obtained has been used for funding BOT projects. To address the high debt we are looking at securitising existing operational BOT projects. The securitisation of the Manor Wada & Patiala-Nabha-Malerkotla project could happen in the next two to three quarters. We are looking at private equity funds, REIT fund, business trusts, etc., to fund the balance equity requirement of BOT projects and reduce debt at the parent level.”

Amit Anwani of KC Securities, one of the few analysts tracking Supreme Infra, thinks the debt level in FY14 may remain flat or at the most increase slightly. Though he has a buy rating on the stock, he is worried about the tendering and execution delay across the road and construction industry. He says, “The risk of project delays/ clearance delays cannot be ignored. Also, L1 [the lowest bid price] tenders are always proxy till they are confirmed; however, considering Supreme’s FY13 order inflow, its order flow in FY14 could be moderate.”

Business as usual

This fear of delay owing to the impending general election is playing on almost every analyst’s mind, but Sharma considers it a temporary hiccup. “Our current order-book covers our growth strategy for the next two years. Since we are working in 11 states, we have low dependence on any single state government or the central government. For existing BOT projects we have all clearances and sanctions required to achieve the commercial operations date.”

He also allays fears about delayed execution at Supreme’s Jaipur Ring Road BOT project. “There have been some delays due to land acquisition issues, but the project has now started and made significant progress. We expect to finish it before the scheduled timeline.” That might just be true but what is equally evident is a rise in receivables. Government contracts where the payments would come in 80-90 days are now getting stretched to 120-130 days. On his part, Sharma believes that the growth in Supreme’s FY13 receivables is in line with growth in turnover and also in line with the industry trend.

The current order-book also has an unexecuted EPC component of ₹1,546 crore that belong to Supreme’s own BOT projects. While the company does maintain that in-house EPC execution takes care of execution risk, how does it ensure that it gets the best possible price? “We give a small portion of the EPC contract to a third party and based on that pricing, decide on an arm’s length pricing for Supreme Infra as an EPC contractor. Due to our backward linkage, we are as competitive if not better than other EPC contractors.” In the future, Supreme plans to grow both the EPC and BOT business as separate entities. 

After his last experience, it might have dawned on Sharma that PE funds and most market financiers are fair weather friends. So, even if Supreme is eager to sell a stake in its BOT projects, given general market conditions, it might have to offer either a very sweet deal or hold back till the environment improves. Supreme did sell a 49% stake in Supreme Infrastructure BOT Holdings to 3i Capital for ₹306 crore. While infusion of ₹200 crore did happen, the events that unfolded later at 3i India have put the remaining ₹106 crore in jeopardy. Given the not-so-favourable view of the UK principals about India, Supreme might have to fend for the cash itself. Sharma says he is more than ready for it. “Our total equity requirement for BOT projects is about ₹175 crore over the next two years (including ₹106 crore that was expected from 3i). Only four of our projects will need this funding; the rest are fully funded.”

Watch this space

A weak economy could affect its projected toll revenues, as many other BOT road developers are realising to their peril. Here, too, Sharma says that actual inflows from projects under operations have been up to expectations so far and can only get better. “Our internal collection estimate once all our BOT projects are operational in 2016, is around ₹500 crore a year, which comes to about ₹1.3-1.4 crore a day.”

Supreme may have bid for the right BOT projects but none of it is getting reflected in the stock price. One reason could be the prevailing investor mood for infrastructure stocks, the other could be that investors believe that its earlier sparkling numbers cannot be maintained going forward. Supreme’s current market cap of ₹330 crore is overshadowed by its long term borrowing of ₹1,439 crore and short-term borrowings of ₹1,559 crore. As an additional surety, the promoters have pledged one-third of their holding. Though Sharma reiterates that pledged shares are only an additional security, he has been propping up his holding through market purchases.

After touching a high of about ₹350 in April 2012, the stock now trades at ₹196. Trading volume has dried up considerably and average volume on the NSE has dropped from 25,000 for January to March to about 6,000 shares for April to June. The average volume in the April to June quarter last year was around 16,000 shares. On the BSE it is even more abysmal: there have been days when less than 500 shares have been traded. 

The saving grace for shareholders who subscribed to the initial public offering (IPO) is that the current price of ₹196 is above the IPO price of ₹108 in October 2007 and the compounded return comes to 11% over a period of about six years. 

For now, investors face the double whammy of an out-of-favour sector and an illiquid counter. Given the overall uncertainty around infrastructure companies, investors can avoid buying the stock at thecurrent level.