Which way ahead

Nitin Jairam Gadkari — whose personal website describes him as a visionary performer – is taking a novel approach to address the country’s growing unemployment issue. He’s getting the jobless to plant 2 billion trees along the country’s 100,000 km of national highway network. To be administered under the Mahatma Gandhi National Rural Employment Guarantee Act, the Cabinet minister who straddles a number of portfolios — national highways, road transport and shipping and also additional charge of the rural development ministry — is confident of tackling two vexed issues with one stone: creating jobs and protecting the environment. While the jury is still out on this out-of-the-box solution, the Street is already blushing green with one particular stock, the Virendra Mhaiskar-owned IRB Infrastructure Developers, a prominent road construction company. While the company has nothing to do with Gadkari’s initiative, it has a lot to with the roads minister in power. 

Though IRB has been a sector favourite on the Street, the stock came under heavy weather in 2012 when media reports alleged that the company was given the marquee Mumbai-Pune Expressway contract, and other hefty deals, when Nitin Gadkari was Maharashtra’s PWD minister in the Shiv Sena-BJP government between 1995 and 1999. It was further alleged that the group had bought shares worth ₹1.85 crore in Gadkari’s Purti Sakhar Karkhana in 2001, and gave a loan of ₹165 crore to his company Purti Power & Sugar in 2010. The allegation was further compounded by governance issues when Goldman Sachs accused IRB of not adequately disclosing its November 2010 acquisition of a ₹107-crore aircraft.

The big blow came when Mhaiskar was investigated by the Central Bureau of Investigation in May 2012 for his possible involvement in the murder of RTI activist Satish Shetty in Maharashtra. Shetty had accused IRB Infrastructure and its subsidiary Aryan Infrastructure Investment of land-grabbing by forging documents and manipulating land records. Since then the stock continued to trend downward, sliding from its high of ₹154 in October 2012 to around ₹54 in October 2013. However, the rally on the broader market that began towards the end of 2013 saw the stock surge 72% to end the year at ₹93. With general elections looming closer and the markets sensing a BJP victory at the hustings, the stock continued its rally. The news of the company winning two contracts added to the feel-good factor since February-end. And as the opinion polls indicated a clear verdict for the BJP, the stock just took off. The subsequent arrival of Modi and his team, including Gadkari, saw the stock dishing out a mind-boggling 143% return at ₹192 (June 13) against the benchmark Sensex gaining 19% to 25,228.

Though analysts believe the company has the momentum going for itself with Gadkari in power, only a few admit it candidly. While Daljeet S Kohli of IndiaNivesh Securities feels close ties with Gadkari will help the company consolidate itself in the road building sector, Bharanidhar Vijayakumar from Spark Capital feels “sentiments” will improve. Is that indeed the case? 

The road less travelled

To begin with, the flurry with which the National Highways Authority of India (NHAI), a nodal agency of the transport and highways ministry, handed out contracts to road players has come down to a trickle. Between 2010 and 2012, road developers fell over each other to grab projects expecting high traffic and chose to bid at high premiums, resulting in a record 147 road projects worth ₹1.47 lakh crore being bid. 

The big leap in project awards was also because they were being let out to developers without land and other requisite approvals being in place. Also, the subsequent slowdown and capital squeeze saw developers, big and small, either giving up projects or failing to tie up the required funds. Not surprisingly, after awarding tenders for 6,800 km in FY12, the numbers fell to 1,128 km in FY13 and 1,646 km in FY14, mostly on engineering procurement and construction (EPC) mode as there were no takers for public private partnership (PPP) projects. In EPC mode, the government funds the project and the private developer just builds the road, while under PPP mode, the developer builds the road and makes his money through collection of toll or annuity. Over the past few years, road developers have been staying away from road projects after bidding aggressively.

Amidst a challenging environment, IRB has managed to grow its sales and profits at a CAGR of 20.78% and 3.32% to ₹3,732 crore and ₹460 crore, respectively, over FY10-FY14.

The reason, according to Mhaiskar, as mentioned in a Q3FY14 concall with analysts, is that the company has remained sector focused. “We have built on our abilities by sharpening our construction acumen, sharpening the tolling mechanisms, by bidding in a sensible manner, churning the portfolio and making it operational in a time-bound manner.” Today IRB is one of the largest BOT toll operators with 21 projects covering 9,295 lane km, of which 5,489 lane km is operational, including the marquee Mumbai-Pune Expressway.

More importantly, IRB’s gross toll collection has shown 20% CAGR to ₹4.6 crore/day over FY11-14. In FY14, despite moderate traffic growth, toll revenue increased by around 13%, led by an increase in toll rates as per contracts and start of toll collection on new projects. “I would like to take you back to a few years, when we used to just do toll auctions, and that habit of bidding out on an auction where we were committing for a fixed amount to be paid to the government had necessarily sharpened our abilities to evaluate the revenue forecasting, and that is very, very primary in understanding a BOT project,” explained Mhaiskar in the concall.

NHAI has set a target of tendering out projects totalling 6,000 km worth ₹55,000 crore in the current year and is looking at a new government to fast track the award of projects. Since the new fiscal began, IRB has bagged three new projects aggregating around ₹6,000 crore (Solapur-Yedeshi: ₹1,317 crore; Yedeshi-Aurangabad: ₹2,754 crore; and Kaithal-Rajasthan: ₹2,035 crore). As a result, the current order-book, too, has surged to ₹11,974 crore, over three times FY14 revenues. 

So it is not surprising that an overwhelming number of analysts are bullish on the stock — the Reuters Consensus estimates show 24 out of 29 analysts have either a buy or an outperformer rating on the stock. Even so, the road ahead for IRB is far from smooth.

Taking a toll

While the company’s order-book seems impressive, what also needs to be taken into cognizance is that the company has been levered quite a bit. From a debt-equity ratio of 1.43 times in FY10, as on date the number stands at 2.89 times, with over ₹10,000 crore debt on its books. Besides, its return ratios too are wilting.

From a high of 21% in FY10, the return on equity has come down to 18%. Going ahead, higher interest and depreciation on account of the Ahmedabad project, the biggest in IRB’s portfolio, commencing operations in FY16, also means the return ratios would taper down further. IRB will also need to infuse equity of ₹2,900 crore over the next three years (₹1,250 crore in FY 15; ₹950 in FY16 crore; and ₹700 crore in FY17). However, Mhaiskar is not too perturbed. “We would not like the debt-equity gearing to go beyond 3:1. And as regards cash generation, at the consolidated level, close to ₹900-950 crore is being generated annually, and that continuing for the next three years with the order-book visibility, equity investment should not be a problem at all. Some more incremental projects can certainly be looked at,” he mentions in the concall. 

The other area of concern is the risk of increasing political interference. Given that 41% of IRB’s projects are concentrated in Maharashtra, which is due for assembly elections this year, the company’s toll road projects have been facing some rough weather following public opposition to paying toll charges. In fear of losing the election, the Congress-NCP led combine in Maharashtra shut down 44 toll posts on June 9. Of these booths, 34 belonged to the public works department and 10 to the Maharashtra State Road Development Corporation. IRB has 11 BOT projects operating in Maharashtra, of which six are PWD projects. The closure has impacted four of these toll posts. This is one reason the stock slipped 12.5% in four sessions, from ₹219.35 to ₹191.75 on June 13, 2014. Kohli of IndiaNivesh Securities, though, expects the storm to blow over. “Markets are driven by sentiments. When investors realise that only 3% of IRB’s revenue is being affected by the government’s move, the outlook will change.” In contrast, Vijayakumar of Spark feels companies such as IRB, which thrive on the BOT model, might be adversely affected if such a precedent is set. 

Interestingly, institutional holding in the stock has increased from around 6% in June 2012 to 13% since the controversy broke out. The big investor in the stock is the Singapore-based fund manager, Sanjiv Duggal of HSBC, who has increased his stake cumulatively across two funds from 2.33% to over 6% as on March 2014. 

While there is no denying that IRB is the best play in the roads sector, the recent outperformance of the stock leaves hardly any room for appreciation in the near term. Bank of America Merill Lynch has downgraded the stock to neutral with a price target of ₹180 level, since it lacks near-term triggers. Kotak, too, has downgraded the stock with a revised target of ₹180. Considering that economic revival on the ground is still to take place, what with commercial vehicles and passenger vehicle sales continuing to trend down, the road ahead for IRB is a long and winding one. For risk-averse investors, there are better bets available on the street to invest in.