Input, interest costs remain a concern for cos: IRB Infra

Infrastructure stocks have been under a lot of pressure over the last few weeks. They have been underperforming on fears that rising interest rates, interest cost and raw material costs will peg earnings down.

The government is also more than likely to miss its target of constructing 20 kilometres of road per day in this fiscal. Last year, Roads and Highways Minister Kamal Nath had projected that the country would build close to 3,000 km in FY11.

Difficulties in toll tax collection and problems arising due to land acquisition and environmental concerns has also led to foreign investors shying away from the road infrastructure sector despite the government allowing 100% FDI in infrastructure.

In an interview with CNBC-TV18, VD Mhaiskar, Chairman and Managing Director of IRB Infrastructure and Parag Parekh, CFO of Gammon Infrastructure discussed the road ahead for infrastructure and what material impact it would have for the infrastructure players operating in the BOT space.

Below is a verbatim transcript. Also watch the accompanying video.

Q: How material is the threat to earnings from rising interest cost because rates are going up and most of the BOT players do have access to a lot of debt capital?

Mhaiskar: The concern at this point surely would be raw materials. It will all depend on the fact how well escalation has been factored into the pricing when financial closure was achieved.

In the case of IRB, we are well hedged at this point where the escalation has been factored for and we are quite confident of retaining margins going forward. But for the newer projects, it is going to be a concern because if we bid at these high escalation levels, the project viability also can be at stake.

Q: Have you seen any kind of slowdown or sluggishness creeping in in the last month or two when rates have gone up in terms of closing projects at all or is execution getting hit at all?

Mhaiskar: On the contrary I would say that execution is improving as of now with the projects that we closed the financial year over the last two quarters. They are now getting into execution mode. So execution we believe will now pick up considerably but the major concern at this point is the slowdown in the bidding that has happened over last two quarters and rising interest cost.

Q: What has the experience been for Gammon particularly by way of what you are booking in terms of new projects and executability?

Parekh: I think as rightly pointed out, there is clearly a concern on rising interest cost. Invariably in most of the projects we have a hybrid interest rate structure where we lock in our interest rates for a period of 3-5 years and to that extent, the sudden leaps if it is falling within that cycle of 3-5 years, it to that extent does not affect us. There is clearly a concern when it comes to bidding for newer projects invariably you tend to factor those newer higher interest rate costs when it comes to newer projects.

The challenge is to ensure that what you have assumed as these higher costs continue to sustain for a period of about 6 months which is why then you conclude your financial closure. In respect of the pressure on costs invariably we try and tie up with a fixed price EPC contracts and to that extent as long as these are being mitigated through this mechanism, it does not impact the project SPVs and in turn Gammon Infrastructure.

Q: I just want to pick up on one of the points that you raised which is that you have seen a slowdown in bidding, we as well are hearing that projects from NHAI has slowed down, is that something you expect to see for the rest of the year because the expectation this year is public spend in investment is going to be very high?

Mhaiskar: Yes, what we have seen is over last six-nine months, there has been a considerable amount of bids which were announced and where prequalification documents have been submitted but we are not seeing any confirm dates on putting up the financial bids and that is where the concern is because although we would get qualified on those projects, we are not certain whether the bidding on those will happen in this financial year or it will get further shifted down. So primarily that is the concern at this point. We have seen a considerable slowdown in terms of awards in NHAI this year.

Q: Is environmental clearance becoming an issue for some of you as well because that is another thing that the market or your investors worry about in the current environment that there are so many niggling issues with clearances coming up, could it affect execution going forward?

Parekh: Yes, clearly MoEF and environmental clearance has become a challenge but more often than not that we have seen as our experience, it has been more an issue of land acquisition, which sometimes tend to push the time cycles of execution of our projects.

Having said that, as a growing process NHAI and some of the other authorities do take up these responsibilities with higher stakes. For example land acquisition earlier was at 20%, and it has gradually moved to 50% and now the responsibility is to ensure 80% of land acquisition being done by them upfront.

And to that extent, once that is being done, the other challenges including clearances, approvals of environment and forest, in its own manner depending on where your locations are do tend to come into the way. But we have not seen great challenges in respect of our projects.

Q: Your investors would worry because in past rising interest rate cycles, they have some time seen margins coming under pressure for the infrastructure executors, are you confident that this time you can mitigate it with the kind of contracts you have or would you need to sacrifice some kind of profitability the way rates and raw material costs are positioned now?

Mhaiskar: Most of the projects, which we have on hand at the moment, we have already locked in the interest rates like Mumbai-Pune we have a fixed interest rate for the balance 8 year term on the newly concluded financial closures on projects which we bag. We have a three year interest rate reset.

So most of the projects that we have in hand, we have an interest rate hedge at this point in time and that is why I said that we are confident of delivering better margins going forward.

Q: Would you say though that is the norm for your industry because that was the problem, the last time around your industry went through this cycle, numbers became so lumpy, projects started stalling half way through?

Mhaiskar: None of our projects have been stalled midway. All the projects are going on in terms of execution quite well and in terms of interest rates as I said, we have most of the projects have been locked in for 3-5 years interest rate reset, Bombay-Pune is for eight years and the newer projects for 3-4 years.

So I don