Expect toll collection from road projects to rise 12-14% in 2021-22 despite second wave: ICRA's Rajeshwar Burla

ICRA expects toll collection from road projects to rise 12-14 percent in 2021-22, though collections have fallen in May and June as toll rates rose 3-4 percent. ICRA expects traffic on Indian roads to rise by August, Rajeshwar Burla, Vice President and Co-Group Head, Corporate Ratings, ICRA, said.

In an interview with Moneycontrol, he said average road construction in April and May dipped, when compared to March. However, the cumulative road construction in April and May rose 74 percent to 1,470 km this year from 847 km last year.

ICRA also expects road construction to surpass the average target of 40 km per day for 2021-22. However, the rating agency is wary that rising competition may lead to lower profit margins.

The FASTag collection has fallen from around Rs 3,000 crore in March to close to Rs 2,000 crore in May. How do you see FASTag and overall toll collection panning out in the coming months?

We have done one study for about 30-odd projects across 11 states. What we have noticed is in line with the data you have mentioned. We have seen a 10 percent decrease in April on a month-on-month basis, and 25-30 percent decrease in May over April 2021.

There are a couple of things here when compared to the first wave of COVID. During this second wave, restrictions on construction and manufacturing activities are relatively lower. In fact, almost very minimal I would say, when compared to the situation last financial year. Because of this, once unlocking started, we also saw a gradual pickup in collections.

As some states have announced partial or full unlocking, we have noticed that the ramp-up has started from the third week of June. By the end of June, I think the rebound should be much faster.

So, do you expect traffic to be back to earlier levels by the end of June?

Not fully. As I was mentioning earlier, the unlocking started happening, perhaps, from the second or third week of June.

So it will take some time to stabilise. But overall, I think by the end of July or the first week of August, things should be largely back to the earlier levels of February and March.

For this financial year as a whole, we expect toll collections to be 12-14 percent higher, compared to the last financial year on the back of a low base and increase in toll rates.

The expected rise in toll collection is not just because of the implementation of FASTag. The impact of FASTag implementation is visible in the case of public-funded (tolls) and the ones which are operated by the NHAI through various contractors.

But if you look at other assets, which are currently with large developers, we have not seen any drastic change or improvement in terms of total collections, which can be directly linked to the implementation of FASTag.

There could be a few basis-point improvement here and there, 0.5 to 1 percent changes. Otherwise, largely, they have been operating these plazas efficiently in the past as well.

This increase has more to do with the fundamental increase in traffic as well as the increase in toll rates. The latter would be in the range of 3.5-4 percent for projects which are aligned with the new toll rate revision regime.

For older projects, the increase would be upwards of 7 percent since WPI in March was quite high.

The NHAI has delayed its InvIT issue twice already. Do you think the second wave of COVID-19 has hit investors' interest in the government's road monetisation plans?

This is a temporary setback due to the outbreak of the second wave of COVID-19. The ramp-up in toll collections is, anyway, currently under way, and they should be back to the earlier levels, latest by August, right? So I don't think this will have a huge impact.

On an overall basis, if you consider around four months last year and two months this year, road construction was limited because of lockdowns. Do you think this will have an effect on the government's plans to monetise 6,000 km of road assets and raise Rs 85,000 crore by FY25?

I don't think so. Anyway, asset monetisation happens on future cash flows, discounting of future cash flows, and we have already passed that phase of the first wave and are nearing the end of the second wave.

What has come across very clearly during both first and the second wave is perhaps the road sector, and toll-road projects, more specifically, are one of the few infrastructure asset classes which have remained resilient and bounced back quite strongly from the adverse impact of COVID.

Investors may want stability in cash flows, however, the long operating history of these assets, with a well-established traffic base and some fundamentals, and the long-term growth prospects are also quite healthy for the sector. These should work in favour of NHAI.

There has been a lot of talk about a third wave hitting the country. What effect would you think it will have on labour availability, construction of roads as well as toll collections?

Labour availability, even during the second wave, was not impacted much. It was not affected as much during the first wave.

During the second wave, contractors ensured that adequate measures are taken. They complied with the Covid safety guidelines, but made sure execution does not suffer much.

Most of the labour was retained at project sites this time, because of which we did not see much migration happening, compared to the first wave. In fact, it has almost been negligible.

I am talking specifically about the road sector. The labour which usually gets employed in various other segments, perhaps because of lack of opportunities there, some of them would have returned. Since most road-related projects are in remote areas, there hasn’t been much migration.

Contractors have also made certain provisions and created ample facilities to avoid migration. Contractors have started conducting vaccination drives in camps to instil confidence among the workforce.

So, I don't think there should be much of an impact. Definitely, the learnings, which the contractors had during the first wave are helping them.

As far as toll projects are concerned, after the first wave, perhaps, it took five to six months to reach the pre-COVID levels. As far as the second wave is concerned, perhaps, by August, things should be back to the February-March level.

If the intensity of the third wave is not very severe given the pace of mass vaccination which is currently underway. Then I think it shouldn't be a problem, both for toll-road projects as well as for road construction.

What would be the pace of average road construction in the country, as of May- end, and how has it been in June?

I'll just tell you what happened in April and May. In April, road construction stood at 853 km, against 210 km in April 2020. Of course, 210 km is not a directly comparable figure because of the lockdown at that point of time.

This was followed by the construction of about 617 km in May 2021, as compared to 637 km in May 2020. That would be approximately 20-21 km per day. It may not be as high as 2019, but quite decent. Project execution in April-June, historically, tends to be quite high.

On a cumulative basis, 1,470 km have been constructed in April and May as against 847 km in the same period last year, which is a 74 percent jump. Even if we adjust for the first 20 days of April 2020, I still think it is a decent increase.

Now, as I was mentioning earlier, labour and raw material availability issues were not there this time. That is the reason why we don’t foresee any significant disruption in overall construction activity on account of the second wave.

The performance of medium- and large-sized companies should not get materially impacted due to this. As a result, we expect that, for the full financial year 2021-22, highway construction is likely to surpass 40 km per day, because of the strong project pipeline of under-construction projects, along with the limited impact of second wave on the overall construction activity.

Given that the next few months are the start of the monsoon season and road construction is historically low during the monsoon months, coupled with the expectations of a third wave, do you expect any impact on the financial health of road construction companies and operators?

Every year, 2-3 months get affected due to monsoon. So, when we are comparing on a like-to-like basis, definitely, when compared to last year, this year should be much better.

As far as financial strain is concerned, perhaps road and railway contractors were least affected as far as payments are concerned.

The Ministry of Road Transportation and Highways has taken up several measures on a proactive basis. What they have done is that they have shifted from a milestone-based billing system to a monthly billing system, because of which the overall working capital cycle or the cash conversion cycle got compressed.

At the same time, they have also started releasing retention money and performance security in proportion to the work already done. Now, these initiatives have helped in the overall cash conversion cycle and performance guarantee requirements getting reduced. Because of these, the associated margin money is also released.

The combination of all these has resulted in a significant improvement in the overall working capital cycle for road contractors. Hence, they were not much impacted in the last financial year as well.

In fact, they have even made special arrangements to facilitate the return of labour at some project sites.

Do you think competition in the road sector will rise in the coming months as the government comes out with more projects to make up for lost time due to COVID-19?

Yeah, definitely. In fact, competition has already started heating up quite a lot. There are a couple of reasons. One is in terms of criteria relaxation, both technical as well as financial.

They have allowed the entry of players from other sectors into the road sector. For instance, players or contractors who were earlier working on stadiums, hospitals, smart cities, warehouses, oil, and gas are now allowed. They were not permitted earlier. In addition, there has been some relaxations on the bidding eligibility criteria, based on financial metrics.

Secondly, if you look at capital expenditure, state finances got affected. They are facing certain challenges because of which fresh project awards from States is subdued.

On top of that, private sector opportunities are quite muted. Most contractors are being pushed towards the road sector or segments where funding is not a challenge.

Roads and railways are two segments where we see increased competition because of the relaxations.

If you look at some of the bids between January-May 2021, many bidders are quoting at a discount of as high as 30-35 percent to NHAI’s base price.

In terms of the number of bidders, the number has surpassed 40 in some EPC project, when compared to a maximum of 18-20 earlier. That’s a huge number. In hybrid annuity model projects, we have seen participants increasing to 10-15, when compared to 5-10 earlier.

Do you think rising competition will lead to delays in road completion or a fall in the quality of roads or, in some cases, even a rise in NPAs?

NPAs, I don't think so. That is a far-fetched conclusion, perhaps at this juncture, we'll have to see.

But delays. See, it depends on the learning curve. How quickly these guys (new entrants in the roads sector) are able to learn the nuances of the sector and then start delivering.

It's not that entry of other players is bad. Some of them are very well-entrenched and large in their own segments. Perhaps there are some good players with strong financial capabilities also.

The challenging part is the discounted bids. That is more worrisome because what is happening is these discounted bids to NHAI’s base prices are coinciding with the period of high commodity prices. Steel and cement prices are at high levels right now.

If bidding discipline is not ensured, this would have an adverse impact on the overall profit margins, and there could be some build-up of stress on the working capital cycle.