Nomura sees cash flow challenges for road EPC players, but prefers PNC Infra over KNR Constructions

Road projects have witnessed significant cost inflation largely due to a sharp rise in cost of land acquisition.

A potential slowdown in orders prior to elections, lack of pace of execution, and increase in debt levels for road engineering, procurement, and construction (EPC) companies could lead to cash flow challenges, which has pushed Nomura to remain negative on the sector.

Within the road EPC sector, Nomura prefers PNC Infratech over KNR Constructions, because the former has a larger order book which provides higher revenue visibility, and has comparatively lower valuations.

Year to date, KNR Constructions stock is down 5 percent whereas shares of PNC Infratech are up 10 percent during the same time.

Nomura highlighted ordering of roads and highways had lost pace ahead of parliamentary elections in FY09, FY14 and FY19. Nomura is of the view that FY24 is also likely to witness a similar trend. It believes that ahead of the general elections, policy focus may shift to social welfare measures.

It highlighted that elevated debt levels for National Highways Authority of India (NHAI) along with rising project cost are likely to cause a slowdown in project awards in FY24.

NHAI’s total debt level by the end of FY23 came in at Rs 343 crore, marginally lower as compared with Rs 349 crore by the end of FY22. Meanwhile, road projects have witnessed significant cost inflation largely due to a sharp rise in cost of land acquisition. Plus, cost of construction has also witnessed a sharp rise from pre-COVID levels as the cost of all key raw materials is elevated as compared to pre-COVID levels, the brokerage firm explained.

According to the brokerage firm, debt levels of road EPC companies might remain elevated amid the likelihood of a slowdown in ordering which can restrict the rise in earnings.

Most key road EPC companies have witnessed a decline in operating cash flow except for HG Infra, Nomura noted. A rise in PNC Infratech’s working capital levels led to operating cash flow outflow of Rs 150 crore in FY23, from being operating cash flow-positive over FY18-FY22, it highlighted.

The foreign financial services company pointed out that net debt has increased for most of the companies in the road EPC space except for KNR Constructions, with proceeds from the divestment of its projects helping to increase its net cash position.