[ecis2016.org] A sharp increase in prices of major commodities, in the past, combined with increased competition, is expected to impact operating profitability by 100-200bps, says ICRA.
The construction industry in India is set to witness a healthy revenue growth in the medium term, says rating agency ICRA in a recent report. The construction GVA is expected to grow at 9-11% in FY2023, owing to the government’s emphasis on infrastructure development, a robust order book, and a low base effect.
The aggregate order book-to-sales ratio of ICRA’s sample of 12 entities stands at around 3.2x, indicating a strong revenue growth prospect over medium term.
While roads and buildings continue to account for a bulk of the order book, metro/urban infrastructure, water and sanitation have seen significant expansion in the order book in recent years. The industry is grappling with input cost pressure, in the backdrop of a substantial increase in major commodity costs, particularly steel, bitumen, and cement. Sharp increase in commodity prices, along with increased competition, will have an adverse impact on industry profitability, with anticipated decline in operating profitability by 100-200 basis points in the current fiscal, the report said.
“Over the last five years, the order book of sample construction companies has increased at a CAGR of 12% remaining between 3x and 4x of billing, supported by increased capital outlay towards the infrastructure sector by the Central and state governments. Growth was much higher for some mid-sized entities, which scaled up significantly during this period as the relaxations in bidding criteria during Covid increased their ability to bag orders. Some larger companies were also able to expand their order book at a robust pace during this period. Supported by a strong order book pipeline, ICRA expects the industry’s revenue to grow 12-14% during FY2023e. Going forward, order inflows in the roadways, railways, and drinking water sectors are likely to be healthy, supported by increasing allocations from the government,” said Abhishek Gupta, sector head & assistant vice-president, corporate ratings, ICRA.
On the other hand, a sharp increase in commodity prices seen in FY2022, if sustained, can reduce players’ profitability by 100-200 basis points in FY2023. Notwithstanding some moderation in steel prices in the recent 6-8 weeks, the prices of steel were still higher by 40% (when compared to March 2021) which will continue to remain a drag on profitability.
Similarly, fuel prices, and bitumen prices have also seen a sharp increase in the last one year. The commodity price increase has been much sharper than the overall inflation rate and hence inflation-linked price escalation clauses (in some contracts) will not be able to absorb the commodity price increase.
ICRA adds that most industry participants’ working capital cycles have remained moderate, with an average receivable cycle of less than 90 days. Availability of advances from clients have reduced the overall reliance on working capital borrowings from the banking sector. Furthermore, Government relief measures (monthly billing frequency, lower BG requirements, etc.) have helped contractors’ cash flows, hence supporting working capital intensity. Most industry participants’ interest coverage indicators have stayed at a comfortable level (3-4 times). Despite cost pressures, ICRA expects industry participants to remain resilient in the backdrop of stable working capital cycle, limited capex requirement, healthy accruals and moderate leverage. Further, if the recent easing in the commodity prices continues, it would ease profitability pressure from construction companies to an extent.
“ICRA forecasts operating profitability to moderate in the near term due to input cost pressure and strong competition, however, advantages from improved execution will offset the negative impact to some extent. An increase in interest rates, combined with expected moderation in operating margins, may result in some moderation in debt coverage indicators in FY2023. However, most construction entities are expected to be resilient and are expected to maintain their credit profile,” Gupta added.
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