Indian Highways Sector

Investment Research
INITIATION REPORT

Secular Growth Despite Bumps

16th May 2011

After a lull in awarding road projects in the past, FY12 is expected to be better with the NHAI expected to award projects totalling 7,300km compared to ~5,000km in FY11 (we have factored in 6,100km in FY12E and 7,300km in FY13). Though issues like land acquisition and environment clearances do exist, one of the emerging risks for the sector is the increasing competitive intensity which could impact projects IRRs. We are positive on the sector given the near-term opportunity of US$37bn and steps taken by the government to ease execution risk. We prefer companies that have an established record in the sector, strong financial position, experienced project evaluation team and good execution track record. We initiate coverage with a Buy rating on Sadbhav Engineering and IL&FS Transportations Network (ITNL) and Hold rating on IRB Infra. Sadbhav presents a better risk-reward trade-off than ITNL. After the recent correction, IRB Infra also presents decent risk-reward. But we rate it a Hold as the upside triggers seems limited. NHAI award activity to gain momentum: We expect the NHAI to award 6,100km in FY12E and 7,300km in FY13E. The NHAI has eased norms from the earlier projectspecific qualification to annual pre-qualification. This move would enable faster project awards by 2-3 months. US$37bn opportunity: Indian road sector presents a US$37bn opportunity for private players in the next 3-4 years. 79% of projects undertaken in the National Highway Development Project (NHDP) are on a Public Private Partnership (PPP) basis. National and state highways would contribute US$27bn and US$10bn, respectively. Increasing competitive intensity dilutes optimism to some extent: Aggressive project bidding has been observed in recent project awards by NHAI. This, coupled with already existing land acquisition, environmental clearances and other regulatory complications, could impact execution and project returns. Steps to mitigate execution issues gaining shape: Moves like accepting the recommendation of BK Chaturvedi report and implementing State Support Agreement (SSA) for smooth execution would mitigate execution risks. Further, robust CV growth would ensure traffic for toll-based stretches, comforting traffic volume estimates. Four parameters to judge road players: We have analysed road developers on four aspects (1) Established track record; (2) robust financial position; (3) strong project evaluation team; and (4) internal EPC capability. These aspects are important to judge the companys capability in executing project and generating returns. Positive view on sector; Initiate with a Buy on Sadbhav and ITNL, Hold on IRB Infra: We initiate coverage on the highway sector with a positive view. We initiate with a Buy on Sadbhav and ITNL and Hold on IRB Infra. Our Contact Details: For more information or clarification, please contact us at research@edencapital.in

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