Government policies such as enabling back end premium payment, compensating concessionaires for delays, relaxing exit norms and one-time fund infusion by NHAI are expected to address liquidity-related concerns faced by the developers, besides helping the road sector regain the confidence of developers and lenders.
The initiatives that will have a direct bearing on the pace of execution include awarding projects after securing 80 per cent right of way, expediting projects stuck midway, delegating the power to grant forest clearances to regional offices, filing online for clearances to construct road over bridges (ROBs) and road under bridges (RUBs) and increasing the limit on sand mining. Further, for speedy availability of encumbrance-free land, the NHAI has delegated power to regional officers to demolish structures on the right of way and to shift utilities as and when needed. Most of these measures were fully implemented by the end of FY2015, and therefore FY2016 saw a sharp pick up in execution by 37 per cent, with the execution rate of Ministry of Road Transport and Highways (MoRTH) reaching 16.6 km/day. The pace of execution further increased by 35 per cent in FY2017 to 22.6 km/day and, in Q1 FY2018, is expected to be 2269 km at 25.21 km/day.
HAM: The most preferred mode in FY2017
Till FY2014, projects were awarded based on the waterfall mechanism, which first explores toll model of BOT (build operate transfer), followed by annuity BOT and then EPC (engineering, procurement and construction), depending on the traffic density along the project stretch. Low private sector participation slowed down the project awarding process and it became time-consuming to shift to the EPC mode and restart the award process. This was the primary reason for the low awards in FY2013 and FY2014. This process was subsequently scrapped and replaced by a system wherein a committee, headed by the Secretary of the MoRTH, would decide on the mode (BOT/EPC) of awarding projects. Further, upfront land acquisition, clearances from the Ministry of Environment and Forests (MoEF) and more number of EPC contracts have spiked the interest of developers and contractors in road projects.
Hybrid Annuity Model (HAM), a mix of EPC and annuity BOT models, wherein the government and the private enterprise share the total project cost in the ratio of 40:60 was introduced. The HAM garnered a favourable response from both the EPC and the BOT players.
Currently, it is the most preferred mode of awarding projects by the NHAI. Around 53 per cent of the projects in FY2017 were awarded through the HAM route, compared to 8 per cent in FY2016, and it is likely to increase in FY2018. Till March 2017, a total of 43 projects, covering 2,641 km, were awarded through the HAM (34 in FY2017 and 9 in Q4 FY2016) route.
However, given the low equity requirement for the HAM, lenders are concerned about the developers' commitment till the end of the concession period, especially given that many of them have limited experience in the development space (many tier II developers have won HAM projects). Assuming the debt-to-equity ratio of 75:25, the developer's equity requirement is just 15 per cent of the total project cost, as 40 per cent of the cost will be reimbursed by the NHAI during the construction phase itself. When EPC works are executed in-house, the net equity adjusted for EPC profits is even lower, and hence lesser incurred risks for the developers. As a result, three HAM projects have been cancelled till date owing to the developers' inability to achieve financial closure within stipulated timelines.
Acceleration of M&A deals
Asset sales in the road sector have picked up over the last 30 months with the relaxation in exit policy. Sponsors in around 20 road assets involving a total cost of Rs 123.27 billion have monetised their assets as opposed to around Rs 70 billion in the preceding 50 months. Three out of the 20 are state road projects and the remaining are national highway (NH) projects. Out of the 17 NH projects, 16 were awarded before 2009 and are the direct beneficiaries of the May 2015 policy decision on relaxation of the exit policy for projects awarded before 2009.
In about 31 per cent of the transactions, returns to the developer had been negative, indicating loss on investment. Developers with a weak credit profile disposed their assets at a loss, as liquidity took precedence over profit-making for them. The ones with the highest returns were secondary sale transactions, wherein the sponsors are private equity investors. As the valuations have improved, following a favourable outlook on toll collections and decline in interest rates, the asset sale transactions are expected to gather momentum.
Projects with at least five to seven years of operational track record provide more comfort as the base traffic, growth rates and expenditures pertaining to regular/periodic maintenance would have been established. Further, issues related to user acceptability of toll rate revisions and toll leakages, if any, are also addressed. The merger and acquisition (M&A) opportunities in the road sector are the highest among various infrastructure sub-sectors with around 88 operational NH projects, totalling 7,192 km, with a total project cost of Rs 693.27 billion and median operational track record of four years.
Change of ownership (including additional equity infusion in a few cases) has significantly improved the refinancing ability of road SPVs. Many projects have refinanced debt with extended tenure and lower interest rate. This, coupled with the strong profile of the sponsor, has significantly improved the credit ratings for project SPVs, post the stake sale. SPVs rated in the AA category and above have not witnessed any change in rating while the ones rated in the A category and below have undergone changes in rating. Nine out of 20 SPVs witnessed an upward movement in credit rating. The median upward transition in these cases is four notches.
Monetisation of 75 projects through toll-operate-transfer route expected to fetch around Rs 356 billionIn August 2016, the CCEA had authorised the NHAI to monetise public-funded NH projects which are operational and have been generating toll revenues for at least two years after the commercial operations date (COD) through the toll-operate-transfer (TOT) model. Seventy-five operational national highway projects totalling 4,376 km completed under public funding have been preliminarily identified for potential monetisation using the TOT model. According to ICRA estimates, the total value of the 75 projects proposed to be awarded through the TOT is estimated at Rs 356 billion.
For these 75 projects, the median vintage in terms of toll collection track record stood at 5.22 years. Out of these, nearly 26 projects (35% of total) are on the annuity BOT and the remaining 65 per cent has been implemented on EPC basis. Of the portfolio, 25 projects (33%) are part of the Golden Quadrilateral (GQ), which experiences high traffic density. The average toll collection in GQ per day is Rs 1.6 million, whereas in non-GQ stretches, it is Rs 0.7 million per day.
The operational nature of these assets eliminates execution risk and the traffic risk is relatively lower when compared to greenfield projects as the base traffic and growth trends are established for a majority of the stretches. Nonetheless, projecting traffic growth for a 30-year period will be challenging. Given the long concession period, there could be a requirement for capacity augmentation (lane upgrades). There is no obligation on the TOT concessionaire to take up augmentation; the NHAI can employ a third party contractor for lane upgrades. However, the O&M and tolling obligation rest with the TOT concessionaire. In the absence of a long tenure debt, TOT projects equivalent to 75 to 80 per cent of the concession fee would require refinancing at a later stage. Further, forecasting traffic for a 30-year period is extremely challenging, given the dynamic nature of the road network with many state highways getting upgraded to national highways on a regular basis. For many non-BOT stretches which were irregularly maintained in the past, the major maintenance requirement could be significantly higher, once the TOT concessionaire takes over the project. Hence, there is a possibility of dispute on quality-related issues.
Also, given that the TOT concessionaires are expected to absorb at least 20 per cent of the loss in toll collections without compensation, the bidders may factor this in their bid concession fee. This, along with the discounting rate of 9.25 per cent for arriving at the IECV, may result in bidders quoting cautiously to start with.
On October 24, 2017, the cabinet has approved the proposal for Bharatmala Pariyojana Phase I, for national highway development of 24,800 km, along with other programmes which involve around 83,000 km of development by FY2022. This could result in a significant jump in annual awards - more than 25,000 km per annum over the next three years - consequently providing huge opportunities for road contractors. After National Highways Development Project (NHDP), Bharatmala Pariyojana is the largest road development programme to be undertaken by the Government of India. NHDP, the largest highways project ever undertaken in the country till date, is being implemented by the NHAI since 2000 and had achieved a progress of 26,255 km as on March 31, 2017. Given this track record, completing 83,000 km by FY2022 looks extremely ambitious.
NHDP execution suffered on account of both funding- and approval-related issues. While the dependence on the private sector investments for the new programme is low when compared to the 12th Five Year Plan which could result in faster awards; securing right of way by complying with the Right to Fair Compensation and Transparency in Land Acquisition, Rehabilitation and Resettlement (RFCTLARR) Act is going to be a challenge. Therefore, the success of the programme critically hinges on the pace of land acquisition along with other requisite approvals.
The estimated funds required for the development of national highways under various schemes and the proposed Phase I of Bharatmala Pariyojana is about Rs 692,324 crore up to FY2022. The sources of funds include gross budgetary support (GBS) including the national highways' share of the central road fund (CRF) cess, toll remittance, expected monetisation of national highways through the TOT route, market borrowings by the NHAI and private sector investment. The estimated share of private sector investment and expected monetisation through the TOT route during this period is about Rs 106,000 crore and about Rs 34,000 crore respectively; which together form about 20.22 per cent of the total estimated fund requirement of Rs 692,324 crore.
- Shubham Jain, Vice President and Sector Head, Corporate Ratings, ICRA Ltd