The credit profile of most construction entities must remain resilient: Icra

The report, however, warned that growth would very much depend on the sustainability of the recent decline in commodity prices, as higher prices in the past for commodities such as bitumen and steel, and increased competition are expected to reduce business operating profits of about 100-200%. basis points (bps).

The report says construction GVA (gross value added) is expected to grow by 9-11% in fiscal 2023 due to the government’s focus on infrastructure development, a strong backlog and a weak base effect.

The cumulative book-to-revenue ratio of the sample of 12 ICRA entities is around 3.2x, indicating a strong outlook for revenue growth in the medium term.

While roads and buildings continue to represent the bulk of the backlog, metropolitan/urban infrastructure, water and sewerage have seen significant backlog expansion in recent years.

The industry is grappling with input cost pressures, amid a substantial increase in the costs of key commodities, particularly steel, bitumen and cement. A sharp increase in raw material prices along with increased competition will negatively impact industry profitability, with operating profitability expected to decline by 100 to 200 basis points in the current fiscal year, according to the report of the rating agency.

Giving more insight on this, Abhishek Gupta, Sector Head and Assistant Vice President, Corporate Ratings, Icra said, “Over the past five years, the backlog of construction companies in the sample has increased at a CAGR of 12% remaining between 3x and 4x billing, supported by increased capital spending in the infrastructure sector by central and state governments. Growth has been much higher for some medium-sized entities, which have grown significantly over this period as relaxations of bidding criteria during Covid have increased their ability to place orders.”

Gupta said some large companies were also able to expand their order book at a good pace during this period. “Due to a strong order book, Icra expects segment revenues to grow by 12-14% in fiscal year 2023e. Going forward, order intake in the road, railway and drinking water sectors is expected to be healthy, supported by growing government allocations,” he added.

On the other hand, a sharp increase in commodity prices observed in fiscal year 2022, if sustained, can reduce players’ profitability by 100 to 200 basis points in fiscal year 2023. some moderation in steel prices over the past 6-8 weeks, steel prices were still 40% higher (compared to March 2021), which will continue to dampen profitability, said the ICRA.

Similarly, fuel prices and bitumen prices have also seen a sharp increase over the past year. The increase in commodity prices has been much higher than the overall inflation rate and therefore inflation-linked price escalation clauses (in some contracts) will not be able to absorb the increase in raw material prices.

Icra adds that working capital cycles for most industry players have remained moderate with an average receivables cycle of less than 90 days. The availability of customer advances has reduced the overall reliance on working capital borrowings from the banking sector. In addition, government relief measures (monthly billing frequency, reduced BG requirements, etc.) have helped contractors’ cash flow, thereby supporting working capital intensity.

The interest coverage indicators of most industry players remained at a comfortable level (3-4 times). Despite cost pressures, Icra expects industry players to remain resilient amid a stable working capital cycle, limited investment requirements, healthy accrued liabilities and a moderate leverage. In addition, if the recent easing in commodity prices continues, this would to some extent ease the pressure on the profitability of construction companies.

“ICRA expects moderate operating profitability in the near term due to input cost pressure and strong competition; however, the benefits of better execution will to some extent offset the negative impact. A rise in interest rates, combined with an expected moderation in operating margins, could lead to some moderation in debt coverage metrics in fiscal year 2023, however, most construction entities are expected to be resilient and should maintain their credit profile,” adds Gupta.

In the medium term, as scale is expected to expand while maintaining profitability, the credit profile should gradually improve. However, the exceptions will be entities bidding aggressively or taking on large asset ownership projects (like BOT, HAM projects) involving equity commitment, which is significant relative to cash flow generation expected from operations.

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