Like hundreds of enterprising entrepreneurs before him, Vishnubhai Patel started off his journey in the world of business not with a flash-bang start-up launch but through the failsafe but predictable route of joining his family business. The training and business insights he received during his time at Bhavna Construction seem to have paid off, however, given the success of the company Patel went on to launch nearly three decades ago — Sadbhav Engineering. Now among India’s most successful engineering and infrastructure construction companies, Sadbhav Engineering operates in three key segments — road construction, irrigation and mining. Apart from its dominance in the road sector, where it undertakes cash contracts, Sadbhav has emerged as one of the largest build-operate-transfer (BOT) players in the country.
As a result of Sadbhav’s astute bidding and timely execution, the company today has an order book of ₹8,350 crore in Q2FY15, with its stock delivering a 241% return over the past year. Analysts believe that three key factors explain Sadbhav’s phenomenal performance. “The company believes in selectively bidding for projects in the roads sector. It stays away from projects where competition is really high and bids aggressively for projects its peers cannot take on. This is why Sadbhav has been able to deliver and execute projects well ahead of schedule,” says Kunal Sheth, a research analyst with Prabhudas Lilladher Securities.
Result of inaction
The last government’s indecision shrunk Sadbhav’s road order book
Indeed, between FY07 and FY09, Sadbhav’s peers — such as HCC and Ramky Infrastructure — overbid for projects and ended up missing deadlines and revenue projections due to delays in clearances and lower than expected traffic growth. This led to a dip in response to NHAI projects in FY10, an opportunity that Sadbhav made the most of, bagging nearly ₹5,000 crore worth of projects that year in the road sector alone. “The company has been very consistent in bagging orders in the mining, BOT and cash contract roads segments. Also, it only bids for projects in which the margins are between 7.5-8%, even at the expense of revenue growth. This enables the company to complete its order book in the ensuing two to three years,” adds Nitin Arora, an analyst at Emkay Global.
Playing to strengths
And that is not the end of Sadbhav’s ingenuity. As Bhavin Vithlani of Axis Capital writes in his report, “The management of Sadbhav Engineering is very selective about choosing projects along industrial corridors, which results in lower land acquisition and environmental clearance hurdles and higher commercial traffic.” What this implies is that the company opts for only those road projects that are along contiguous stretches of land, resulting in optimum utilisation of equipment between projects and significant time and cost savings. Traditionally, the bulk of Sadbhav’s revenue and order inflows has come from its road construction business, which, between 65-75% of its order book, remained the key growth driver for the company till two years ago. But the slump in the road sector over the last two years owing to a host of issues has led to an increase in the share Sadbhav’s irrigation and mining components contribute to its overall business — in Q2FY15, these sectors contributed 23% and 33%, respectively, to its order book, out of a backlog of ₹8,346 crore.
“Over the years, Sadbhav has developed expertise in the mining sector, bidding for larger projects and opting for joint ventures. Once this space revives, it has the potential to turn into a ₹1,500-crore business for the company over the next five years,” says Sheth. Though the last financial year has been exceptionally sluggish for the mining segment, with several coal projects being blocked or held up, between FY12 and FY13, the company’s order book inflows from the mining segment shot up by four times — from ₹332 crore to ₹1,266 crore. Even in the irrigation segment, which at present contributes just ₹280 crore (10% of FY14 revenue) to revenue, Sadbhav has been involved in several key projects, chief among them being the execution of the country’s largest concrete pipelines as part of the Narmada Canal project. So far, the company has restricted itself to two key states in this segment — Gujarat and Maharashtra. If and when the NDA chooses to act on the prime minister’s ambitious plan to interlink the major rivers in the country, there will be scope for the company to gain further traction in this segment.
“Most other known players in this segment — such as IVRCL and Nagarjuna Construction Company — have overleveraged balance sheets and face debt challenges. Sadbhav, on the other hand, has chosen to raise debt only to the extent that it can service; its debt to equity ratio has consistently been under 1. The company has always been profitable, growing from an operating profit of ₹30 crore in FY03 to ₹250 crore in FY14,” says Sheth. Sadbhav currently boasts of a debt to equity ratio of 0.91 and an interest coverage ratio of 2X. The company seems comfortable in terms of future capital requirements as well. Analysts expect that Sadbhav might need ₹840 crore over the next two-and-a-half years in order to clear pending equity for three BOT projects, fund future BOT projects, increase its stake in existing projects and provide capex for its mining business.
Long road ahead
Sadbhav is well placed to bid for new road projects that are expected to be opened by NHAI
To meet this capital requirement, the promoters in September 2014 announced a qualified institutional placement (QIP) for ₹250 crore and the conversion of 80 lakh warrants held by them into equity. Sadbhav raised ₹250 crore at ₹216 a share and raised another ₹70 crore through the warrants. Another available funding route for the company is the proposed IPO of its subsidiary, SIPL. Incorporated in 2007 as an asset-holding company for road, infrastructure and other BOT projects, SIPL develops, operates and maintains road infrastructure assets and also handles financial closure and management of Sadbhav’s special purpose vehicles (SPVs). SIPL’s proposed IPO has the potential to raise ₹500 crore, plus an additional ₹130 crore from non-convertible debenture proceeds. Another ₹340 crore could be generated by the standalone entity through the securitisation of its road projects.
Road to success
Clearly, the company is heavily dependent on the road sector for its future growth, making it hostage to regulatory overhang. Under the ambit of regulator National Highways Authority of India, the government in 2001 launched a major initiative to revamp India’s roads sector, with several engineering, procurement and construction (EPC) contracts being handed out. In fact, between 2001 and 2005, out of a total of 6,700 km awarded, 5,350 km were through the EPC route. However, to increase private sector participation in infrastructure development, the government pushed the BOT route as the preferred method to hand out contracts between 2006 and 2012, handing out 21,200 km (through BOT) of a total 24,500 km. Encouraged by high traffic growth and easy funding, the private sector bid freely for projects, only to see traffic growth stall over the next two years due to a slowdown in GDP growth. Delays in clearances also led to cost overruns, with bank funding drying out thanks to stretched balance sheets.
However, of late, there has been a concerted effort by the government to revive the sector through various policy initiatives. According to Sheth, these include relaxing environmental clearance norms, easier exit norms to enable faster asset monetisation, rescheduling of premiums, NHAI takeover of projects that are in limbo and setting up of finance corporations to fund projects. In the light of these developments, Sadbhav is sitting on a huge opportunity, with the NHAI expected to award road projects worth ₹15,000 crore through the EPC route in FY15. The ministry of road transport and highways is also expected to award contracts for 3,000 km of roads, chiefly through the EPC route. Additionally, 6,000 km of stalled BOT projects are expected to come up for re-bidding through both the EPC and BOT mode.
This situation gives Sadbhav a unique opportunity to capitalise on: many of the smaller players who bid for NHAI’s BOT assets in the past are at present busy grappling with execution delays and low traffic growth and, hence, refraining from bidding for new projects. Also, high premium payments due to aggressive bidding earlier and high interest costs have resulted in a mismatch of cash flows to meet payment obligations. In such a scenario, a player like Sadbhav, with its stronger balance sheet and selective bidding approach, would be at a competitive advantage while bidding for BOT projects.
Toll revenue is expected to jump exponentially in the next few years
Sadbhav’s founder and chairman Patel elaborates, “In the BOT segment, the present scenario is that a lot of the projects are halted and there are a lot of cross defaults. So there will be minimal competition. We will bid for projects that have a total size ranging from ₹700-2,000 crore. However, it all depends upon the ground realities. If the ground challenges are minimal and all clearances are in place we may bid for projects of a larger size.” Moreover, with seven of its existing BOT projects enjoying 70-100% industrial movement, traffic growth has picked up considerably. And Sadbhav’s management is working to take full advantage of it.
“In the last four months, we have started consolidating stakes in our SPVs, because according to our assessment, the bottom has been reached for traffic growth. Majority stake will always be helpful in terms of return, considering the long concession period available,” reveals Patel. With six more projects supposed to come on stream by end-FY17, toll revenue is expected to grow at a CAGR of 38% between FY14 and FY17. Correspondingly, the company’s operating profit is expected to rise to ₹550 crore from the present ₹250 crore, more than enough to service the interest costs of the loans Sadbhav will raise to fund these projects.
Mining for glory
The backseat driver of Sadbhav’s future growth could be its mining segment, which has seen significantly increased order inflows of late. There has been a renewed focus on its mining activity — primarily, removal of overburden and mining of minerals — owing to the poor fortunes of its roads business in FY13 and FY14. Increased subcontracting by Coal India to increase the production of coal to the targeted 400 million tonne per annum is expected to hike the removal of overburden by a factor of six to eight times from current levels, providing Sadbhav with a robust opportunity for growth. The company is also expected to bid for overburden removal work for SAIL. Sadbhav is also looking at becoming a mining development operator through a joint venture partnership and bidding for projects in the ₹2,000 crore-4,000 crore range.
Though the mining segment is expected to deliver a 16% CAGR in inflows between FY14 and FY16, the higher revenue and margins from this space should take Sadbhav’s Ebitda margins to 11% over the same time period as well. With strong revenue visibility in the construction business, Sadbhav’s revenue growth is expected to remain accelerated over the next six quarters. Emkay Global expects the company to grow its construction revenue at a CAGR of 18% between FY14 and FY16, with the road segment accounting for 65% of the revenue share. In fact, given the rising share of mining in the company’s order books, Emkay expects a CAGR of 13% in order book inflows for the company between FY14 and FY16.
The laggard in this tale, then, is the irrigation sector, which contributes little to the company’s revenues. Besides, even though big bang projects — such as the interlinking of rivers across India — have been announced on a national scale, there is little to show in the form of implementation. However, analysts are optimistic about the company’s chances in the marketplace. “Ebitda is up 53%, revenue is up 58% and interest costs have risen a meagre 5% on a quarter-on-quarter basis in Sadbhav’s Q2FY15. Which company in the infrastructure arena today boasts of a 58% growth in revenue,” asks Sheth.
Patel is gung-ho about margins going forward. “In H2FY15, we should post 20-27% year-on-year revenue growth in the EPC space. In the BOT space we have excellent orders in hand. Diesel prices have reduced by ₹6 per litre and bitumen prices, that constitute nearly 35-38% of material costs in the road space, have fallen. If this trend continues, we should post 11% Ebitda margins in FY15.” If Sadbhav continues to capitalise on the opportunities created by the sluggish performance of its rivals, the growth story of the company will go a long way, like the roads it builds.