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Infrastructure Sector Insight Series November 11, 2011 Ernst & Young (E&Y), in association with Prabhudas Lilladher, had conducted a conference on India Infrastructure. Rupa Shah Sector Update firstname.lastname@example.org We had organized a ‘Sector Insight series ‐ Part 2’ on Infrastructure to understand +91-22-66322244 the opportunities ahead and to gauge the current situation. The helpful insights were provided by Mr. Sushi Shyamal (Partner ‐ Infrastructure, E&Y) in separate sessions on Airports, Roads and Urban Infrastructure. Airports ‐ Past was eventful, so is the future: The key focus here was on lack of PL Construction Index v/s Sensex a common governing act or an agreement on pricing. India is the 9th largest PL Construction Index Sensex Aviation market in the world at present and is expected to be in the top five by 110 2020. The overall projected investment opportunity is pegged at US$150bn and 100 the target is to handle about 280m pax by 2020. However, the golden past, 90 when India created world class airports, especially in the last four years, seems 80 like a difficult proposition in the future. This is on account of lack of pricing 70 policies in place and failure of real estate play around assets. 60 50 Roads ‐ All is well: Roads would still be the most endearing asset from the Jul-11 Sep-11 Jan-11 May-11 Nov-10 Nov-11 perspective of private sector investment in the years to come, as only 2.1m kms Mar-11 (50%) has been upgraded till now. The immediate opportunity on plate is around 9000kms which will throw open investment opportunities of nearly Source: Bloomberg US$20bn. However, aggressive bidding by some small players, high cost of funding, high fund requirement and current liquidity crunch in India has led to some uncertainty over the prospects. Considering the high inflation, a hike in Stock Performance the toll rates if permitted, would be the key upside for operational projects. (%) 1M 6M 12M Sensex 8.2 (5.2) (16.1) Urban Infrastructure ‐ What is it and where will opportunities lie?: India will no Construction Index (4.1) (16.3) (43.2) longer reside in its villages, as the urban population is increasing by 3% p.a. Contrary to the popular belief, the bulk of urban population growth is likely to Ashoka Buildcon (3.9) (12.4) (23.4) occur in smaller cities and towns of less than 500,000 people. It is expected that Era Infra (0.3) (17.8) (35.0) urbanization will occur at five times the number by which GDP would have Gayatri Projects 1.1 (32.4) (64.5) multiplied by 2030. This will open up investment opportunities of US$700bn. GMR Infra 0.8 (31.5) (51.9) Key big sectors in this are Solid Waste Management (SWM) and Water Hind. Construction (0.2) (16.4) (56.6) supply/Sewerage. IL&FS Transp. 2.4 1.7 (35.4) IRB Infra 1.0 3.6 (35.5) Inference: India will continue with its growth; however, currently we need to endure IVRCL Asset 17.9 (45.0) (69.3) the current slowdown which has been reflected in the dismal performance over the IVRCL Infra 0.1 (49.2) (73.5) past 5-6 quarters. Thus, there has been an underperformance of companies like Larsen & Toubro (2.5) (9.7) (35.4) IVRCL, NCC, GMR, GVK and the likes in the markets. We feel that amidst Nagarjuna Const. (6.7) (45.8) (65.6) opportunities, construction and asset owners will continue to struggle due to Patel Eng. (0.6) (34.5) (74.3) difficulties like increased cost of financing and consequently, would have lower Punj Lloyd 1.7 (11.0) (56.2) Reliance Infra 16.3 (22.7) (55.9) ROEs. Hence, the incremental cash generation would not support future financing of Sadbhadv Eng. 5.2 4.2 (5.2) projects and the takers would be fewer. Companies with a stronger balance sheet and healthy operating portfolios like IRB, Ashoka Buildcon, L&T and RInfra could sail through. The others would have to part away with their stakes in the current assets or raise further equity. This proposition, however, seems like an uphill battle. Prabhudas Lilladher Pvt. Ltd. and/or its associates (the 'Firm') does and/or seeks to do business with companies covered in its research reports. As a result investors should be aware that the Firm may have a conflict of interest that could affect the objectivity of the report. Investors should consider this report as only a single factor in making their investment decision. Please refer to important disclosures and disclaimers at the end of the report Infrastructure Airports‐ Monopoly in the past, struggling at present Key Issues This segment lacks ‘Model Concession’ agreements, as in roads BOT, which governs the pricing and restricts the upsides/downsides of a project. India has airports which are comparable to the best in the world in terms of facilities, ambience and passenger handling capacity. However, the brunt of this asset creation is borne by the travellers (high airport charges). Levy and periodic increase in development fees has led to an increase in pricing for the end users and no respite is seen in the near future. However, Mr. Shyamal opines that, like the customers, the airport owners too are sensitive to further increase in ADF/UDF and hence, he does not expect any drastic increase in the same. Failure of real estate monetization around the assets was the biggest dampener to the airport owners, since while bidding funds, all these factors were also considered in the project viability. Mr. Shyamal believes that the revenue share offered by the bidders was not solely dependent on the real estate play and the present sorry state of the asset owners is due to the lack of policy measures and increase in project costs to make Indian airports one of the best in the world. New airports, especially in cities where an existing one is already operational, will be a greater risk to the bidders as the passenger mix, frequency of flying from that destination and protection from differences in costing and pricing will be the key issues. Thus, the IRR threshold would be higher than that of the older ones. Key Opportunities Civil aviation market is expected to witness a growth of more than 16% during 2010- 13 and will handle 280m passengers by 2020. For this, MOCA is estimating an expenditure of US$14bn in the near future to develop airport infrastructure in India. Significant value is yet to be created in operational projects in terms of an increase in non-aero revenues, real estate development and rationalization of pricing policies. India has 81 domestic airports; of which, 45 are operational. Development of non- metro airports will be a key in the future. Inference Airports will continue to face glitches in terms of regulatory changes until a proper framework is formed for its functioning and determining threshold returns. Thus, companies like GMR will have to bear the brunt of lower real estate returns and higher operating costs. Amongst all asset classes, Airports will continue to remain a ‘high‐ risk, high‐return’ game. November 11, 2011 2 Infrastructure Airport Opportunities Scenario With growing traffic at some of the metros like Bengaluru, there arises a need for capacity expansion at the existing airport or a need for another airport in the same state or town. However, this is one of the few examples of a prime metro but other states are not yet in such a dire situation. Thus, the new Greenfield airports are likely to come up in Tier 2 and 3 cities where there is ready traffic available. This could be the states of increased urbanisation or emerging trade centres. However, substantial work has been done in revamping Tier 2 airports and thus, we expect a slower activity in the coming months. Exhibit 1: Greenfield Airports on Radar Locations Status Exp Investment (Rs bn) Navi Mumbai Bidding process yet to begin 100 Greater Noida, UP Clearances awaited form GoUP NA Mopa, Goa Bidding process yet to begin 10 Kannur, Kerala Bidding process yet to begin 10 Ludhiana, Punjab Awarded to Bengal Aerotropolis 20 Shimoga, Karnataka Awarded to Maytas-NCC-Vienna 1 Gulbarga, Karnataka Awarded to Maytas-NCC-Vienna 1 Hassan, Karnataka Awarded to Jupiter Aviation 6 Source: Industry Exhibit 2: International Players Active / Interested in India Changi Airports, Singapore Hochtief, TAV, Turkey Germany Munich Fraport, Airports, Germany Germany Foreign Players in Airports ASA Mexico India Company South Africa (ACSA) Vienna Siemens International Project Airports, Venture Austria Malaysia Zurich Aiprots Airport, Holding Switzerland Berhad Source: Industry November 11, 2011 3 Infrastructure Roads present a hazy picture, opportunities galore Key Concerns Irrigational bidding has led to a belief and trend that the lowest bidder wins a project which is nearly unviable in terms of a financial payback. Balance sheets do not support the financing of these projects, leading to lack of execution, post winning the project. The above problem is aggravated by high cost of funding and lowered traffic growth as compared to the estimates, leading to single digit or negative IRRs. Also, there are many projects on sale but the buyers are few and no deal has happened in the immediate past. Key Opportunities Exhibit 3: India Road Length by Category Mr. Shyamal believes that the traffic growth has followed a ‘hockey-stick’ trend, 6% of roads carry 80% of traffic wherein the traffic in the initial years would be lower than expectation and 2.0%4.0% eventually reach the target during the life of the BOT. Also, if the inflation remains 13.0% National Highways high, the asset owners will be compensated with a toll hike to mitigate the funding gaps. Total State Highways 20.0% Length 4.2m kms Rural Roads India has network of 4.2km, of which, only 6% comprises of State and National Other PWD Roads highways. Thus, the future opportunity in terms of rural roads and PWD works is yet 61.0% Other Roads to come. Source: MORTH Inference Roads will continue to be the most active asset class in the future to come, Though the model of routing equity commitments through EPC margins looks lucrative, the process of asset creation/construction has taken a back seat on account of financial crunch. As the P/E deals dry up there could be some distress asset sale to peers who have a strong balance sheet and are ready to take a risk. Companies like IVRCL assets and NCC are already looking for buyers and any deals in this would help ease the future financing needs. On the other hand, companies who have strong operational current portfolio like IRB, ITNL, Ashoka Buildcon, L&T and RInfra would continue to win projects without any major financing hitches. Post the NHDP programme, there lays an extended opportunity in rural roads development. Thus, with a slight improvement in the financial liquidity situation, the execution is expected to improve. November 11, 2011 4 Infrastructure Abounding Opportunities With the completion of GQ, NHDP 3 & 5 phases are currently in the awarding phase. From FY12 till date, around 4000kms of road projects have been awarded and the target is to award around 7000kms. Also, 1,800 km worth of roads are under process. For current project in the size of Rs15-40bn, the numbers of players active are in the range of 7-8, while in projects lower than this, number of players have increased to 25. However, with MCA in place, the bidding process has become more transparent, but tight competition continues to exist. NHAI is also contemplating a makeover of the highways by setting up food courts, complexes, multiplexes, ATMs and amusement parks every 50 km on major routes to help unwind and rejuvenate the frequent travellers. Exhibit 4: NHDP ‐ Current Status Total by In kms Phase 1 Phase 1 & 2 NHDP Ph 3 NHDP Ph 5 NHDP Ph 6 NHDP Ph 7 SARDP NE NHDP Ph 4 NHDP Total Port Conn Others NHAI Type of Projects GQ NSEW 4 lane 6 Lane Expressway Ring Road/Bypass NE Roads 2 laning Total Length 5,846 7,300 12,109 6,500 1,000 700 388 14,799 48,254 380 1,390 50,024 Already Implemented 5,828 5,810 2,555 652 14,845 327 945 16,117 Under Implementation 26 994 6,256 2,004 0 43 114 1,230 10,553 57 431 11,041 Balance length for Award 0 420 3,380 3,863 1,000 659 276 13,577 22,899 0 20 22,919 Greenfield + Secondary Opportunity Secondary Sale Primarily Greenfield Primarily Greenfield Sale Source: NHAI Immediate 45% to be Opportunity: awarded 9,000 kms November 11, 2011 5 Infrastructure Exhibit 5: Bids in early 2011 Project Kms PC (Rs bn) Differential between L1 & L2 (as a % of PC) No of Bids Ahmedabad- Vadodara 102 21.2 59% 19 Kota-Jhalawar 90 5.3 4% 20 Beawar-Pali-Pindwara 244 23.8 12% 19 Nagpur-Wainganga 45 4.8 0% 15 Tindivanam-Krishnagiri 178 6.1 4% NA Barwa -Panagarh 122 16.5 0% NA Jabalpur-Lakhnadon 74 7.76 24% 4 Aurang-Orissa Border 150 10.2 9% 10 Jabalpur-Rewa 210 19.1 2% NA Kishangarh-Ahmedabad 556 53.8 2% 11 Hospet-AP Border 95 9.1 32% 10 Shivpuri-Dewas 330 28.1 27% 14 Gwalior-Shivpuri 125 10.5 21% 15 Source: NHAI, Industry Last 2-3 years have seen very aggressive bidding in the BOT sector on account of the trend of easy financing by banks and the model of recovering equity through EPC margins. With tightening of the monetary situation, recent bids have come to normalcy to some extent as the asset owners don’t have easy access to funds and the current projects are under tremendous pressure. However, collaboration by smaller players with International counterparts can again intensify the pricing and thus, make bigger projects very competitive. Exhibit 6: Recent Bids Project Kms PC (Rs bn) Differential between L1 & L2 (as a % of PC) No of Bids Vijayawada-Machilipatnam 63 6.5 1% 3 Patna-Buxar 125 11.3 1 Angul-Sambalpur 153 12.2 2% 7 Birmitrapur-Barkote 128 7.8 1 Meerut-Bulandshahr 63 2.1 2% 6 Lucknow- Sultanpur 124 10.1 5 Rohtak-Jind 53 2.8 66% 6 Source: NHAI, Industry November 11, 2011 6 Infrastructure Exhibit 7: P/E deals in the past Company Acquirer Stake Size (Rs bn) Date Soma JP Morgan NA 5 Aug 11 HCC Xander 14.5% 2.4 Jul 11 Isolux Morgan Stanley 49.0% 9 Apr 11 KMC 3i NA 5 Mar 11 Sadbhav NVP-Xander 22.2% 4 Aug 10 TRIL Actis 35.0% 3.45 Apr 09 Total 28.85 Source: E&Y Research, Industry Reports Companies, which are currently struggling with unavailable projects which were won 2-3 years back, are bearing the brunt of highly leveraged balance sheets and negative cash flows. This is making further cash generation and servicing of debt a highly risky preposition. Though there has not been a major incident of NPA in banks for BOT Road sector, we expect further need for cash to be imperative, triggering a stake sale situation. While the P/E transactions in the last two years were very handsomely dealt with, the current situation will not be an easy ride. Companies like IVRCL Assets, and NCC are currently looking out for equity partners, while companies like Reliance Infra and ILFS could be amongst the few interested parties on the buyer’s side. November 11, 2011 7 Infrastructure Urban Infrastructure – Ignored; thus, a restricted territory Key Concerns There is a lack of awareness among the city municipalities and state ministries about SWM and its success. Over 25% of the Municipal solid waste is not collected and 70% of the Indian cities lack adequate capacity to transport it. India has 16% of the world population, of which, only 4% of them have an access to fresh drinking water. The situation is much grimmer in the villages, but in its urban counterparts, on account of increasing population, the water supply hours have decreased on an average since1980s. Lack of interest from municipalities, lower tariffs, limited budgetary allocation, regulatory regime and subsidies has led to a perception amongst private players that ‘Water Supply’ is a high-risk sector in terms of financial viability. Also, banks have been reluctant in providing long-term finance for urban infra projects. Key Opportunities There have been some successes, especially in the Tier-2 cities, where some projects are awarded and are doing well on PPP basis. There is also a huge opportunity from Indian corporates in the areas of Industrial and Power plants water treatment. According to a study, by 2030, India’s two-third population will reside in the urban areas and there will be a demand for better living conditions, throwing an opportunity of US$700bn for creation/modernization of world class Urban Infrastructure. Inference Building of Urban Infrastructure was always perceived to be the job of the town head and the lack of it is currently accepted. The dismal condition in the SWM and WS sectors can improve only if the finances of municipalities improve or PPP is the only way out. This sector remains highly fragmented with major dominance by unlisted smaller players; however in listed space players like SPML, Ion Exchange and A2Z Infra are active and would benefit in future projects. In larger urban infra projects like Metro’s and Monorails players like L&T and RInfra has its sheer dominance. However, as Urbanisation process increases, this sector looks the most promising space in future. November 11, 2011 8 Infrastructure Urban India Growing... India has nearly 600m people living in cities, which is nearly twice the population of USA. Going forward it is estimated that 68 cities will have population of 1m plus, which is currently at 42. Thus, we expect a need for improvement of facilities to be a necessity and not a luxury. Exhibit 8: Growth of Urban India Urban Population (m) Urban Population as a % to Total Population (RHS) 600 50% 500 40% 400 30% 300 20% 200 100 10% 0 0% 1951 1991 2001 2021E Source: McKinsey Global Institute Investment in this sector has been on a very shaky note till now, where urban roads would be given the maximum preference as in the past. The Government has also placed emphasis on development of Urban Infrastructure with Water and Waste Services exceeding 70% of the planned expenditure. Today water supply and treatment (WS&T) market is estimated to be around US$12bn, where the Government is contributing to about 50%. Moreover, this market is growing at a rate of 15-20% every year. However, with increasing population and lower capex on water supply, the per capita availability of water is expected to decline. Exhibit 9: Projected Water Demand in India Exhibit 10: Per Capital annual availability of Water in India 1,600 1,800 1,400 1,600 1,200 1,400 1,000 1,200 1,000 (bcm) (m³) 800 800 600 600 400 400 200 200 0 0 2010 2025E 2050E 2005 2025E Source: Secondary Research Source: Secondary Research November 11, 2011 9 Infrastructure Exhibit 11: Relative Sector Share in Investment Requirements Solid Waste Street Lighting Others Traffic Support Mgmt 1% 8% Infra 1% 3% Building 3% Strom Water Drain Urban Roads 5% 44% Sewerage 6% Water Supply 8% Slum Redevelopment Urban Transport 10% 11% 30 Electronic Biomedical Waste 25 Waste 5% 8% 20 Hazardous (Rs bn) 15 Waste 17% 10 5 Municipal 0 Solid Waste 2008 2013E 70% Source: Industry However, SWM, which has given least share, would have to be done with earlier. This industry has the benefit of the least raw material cost and integrated logistics. The revenues realisation per tonne is Rs1,300/tonne and thus, has a sale potential of Rs70bn p.a. Currently projects are awarded to private parties in the area of collection and transportation sectors; however, on a smaller scale. Many of these projects are awarded in Tier 2 & 3 cities where a tipping fee is paid for collection and dumping the garbage. Some of the PPP in WS&T and SWM awarded are given in the next page. November 11, 2011 10 Infrastructure Exhibit 12: Contact Works in SWM Sr. No Project Project Type Capacity TPD State Awarded to 1 Deonar ISWM 2000 Mah UPL 2 Mulund Biomethanization 500 Mah UPL 3 Kanjurmarg ISWM 4000 Mah Antony Waste Handling Cell 4 Coimbatore Processing & Landfill 500 TN UPL 5 Rajkot Waste Processing 300 Guj Hanjer Bio-tech Energies 6 Surat Waste Processing 500 Guj Hanjer Bio-tech Energies 7 Pune Waste Processing 1200 Mah Hanjer Bio-tech Energies 8 Nagpur Waste Processing 600 Mah Hanjer Bio-tech Energies 9 Jawaharnagar ISWM 3000 AP Ramky Eviro Engineers 10 Kanpur Collection & ISWM 1500 UP A2Z Infra 11 Indore Collection 500 MP A2Z Infra 12 Patna Collection 600 Bihar A2Z Infra 13 Meerut Collection & ISWM 600 UP A2Z Infra 14 Varanasi Collection & ISWM 600 UP A2Z Infra 15 Delhi WTE 2000 Delhi Jindal 16 Chennai ISWM 2000 TN Hydroair Source: Industry Exhibit 13: PPP in Water Sr. No Project Operator Size Duration Scope 1 Tirupur IL&FS 185 mld 30 Years BOOT Industrial + domestic water 2 Chandrapur Gurukripa 3 Lakh ppl 10 Years O&M of City 3 Latur SPML,Uphos,Hydro Comp 3.5 Lakh ppl 10 Years O&M of City 4 KUWASIP Veolia 18000 conn 3.5 Years Upgradation & O and M 5 Nagpur Veolia 10000 conn 5 Years Upgradation & O and M 6 Salt Lake JUSCO 14 mld 30 Years BOT (WS & S) 7 Haldia JUSCO 230 mld 25 Years BOT 8 Madurai Hydro Comp 10000 conn 7.2 Years Upgradation & O and M 9 Mysore JUSCO 9 Lakh popul 6 Years Upgradation & O and M 10 Chennai Desal IVRCL-Befasa 100 mld 25 Years Bulk Water BOT 11 Bhiwandi SPML,Uphos,Hydro Comp 6 lakh Popul 30 Years Bilk Water +Mgmt 12 Nagpur Veolia-Vishvaraj 240000 cm pd 15 Years DBO new water prod plant 13 Aurangabad SPML-Vatech 11 Lakh popul 20 Years Upgradation & O and M 14 Goa SPML 100mld 5 Years DBOT of STP 15 Mumbai Airport Aquatech International 1000 cm pa 16 Bhavnagar Jindal Aquasource 45 mld 30 Years BOOT STP 17 Sitargang Jindal Aquasource 8000 cmpd 30 Years BOT CEPT 18 Naya Raipur Jindal Aquasource Water Supply BOT 19 Dewas Welspun- MSK 23mld 30 Years Industrial Raw Water Supply 20 Sonia Vihar Degremont 635mld 10 Years Bulk Water DBOT 21 Chembarambakkam Degremont 560mld 7 Years Bulk Water DBOT Source: Industry November 11, 2011 11 Infrastructure Prabhudas Lilladher Pvt. Ltd. 3rd Floor, Sadhana House, 570, P. B. Marg, Worli, Mumbai-400 018, India Tel: (91 22) 6632 2222 Fax: (91 22) 6632 2209 Rating Distribution of Research Coverage 70% 58.5% 60% % of Total Coverage 50% 40% 30% 21.8% 17.7% 20% 10% 2.0% 0% Buy Accumulate Reduce Sell PL’s Recommendation Nomenclature BUY : Over 15% Outperformance to Sensex over 12-months Accumulate : Outperformance to Sensex over 12-months Reduce : Underperformance to Sensex over 12-months Sell : Over 15% underperformance to Sensex over 12-months Trading Buy : Over 10% absolute upside in 1-month Trading Sell : Over 10% absolute decline in 1-month Not Rated (NR) : No specific call on the stock Under Review (UR) : Rating likely to change shortly This document has been prepared by the Research Division of Prabhudas Lilladher Pvt. Ltd. Mumbai, India (PL) and is meant for use by the recipient only as information and is not for circulation. 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