CRISIL Research: Strong Infrastructure-led Growth to Boost Construction Revenues, Margins to be Under Pressure

Mumbai, July 17, 2006.

Buoyant growths in urban infrastructure following the commencement and progress in several government road projects as well as industrial sector expansions by turnkey consultants are expected to result in a significant growth in India's construction industry.

According to Sudhir Nair, Head, CRISIL Research, "India has the second largest road system in the world of 3.3 million kms. With the government's added impetus, the transportation segment is expected to witness huge investments over the next few years. By financial year 2007-08, the overall construction investments in the infrastructure sector will increase at a compounded rate of 8%. The transportation segment (which is the largest segment amongst the various infrastructure sectors and accounts for about 35% of the total investments), will witness the fastest growth at about 17%.

He further adds, that, "CRISIL Research has adopted a new segmental classification based on the gestation period involved in the execution and completion of projects in order to aid transparency and consistency of data in this sector. Resulting from this is our view that investments in the transportation segment - specifically roads, bridges & flyovers - will result in a turnover growth of industry players at a compounded rate of 20% over the next two years. Given this momentum, the order backlog of the players is also expected to soar to Rs. 1369 billion by 2007-08 from Rs. 837 billion in 2005-06. With the mix in revenue profile skewing towards the low-margin transportation projects segment, overall margins in the construction sector would be under pressure."

In its latest review of the construction sector, CRISIL Research estimates that the strong growth in the sector will result in the order book growing at a compounded rate of 28%. Key beneficiaries of the order book back-log will be the largest players in the industry - Larsen & Toubro [L&T]; HCC, Gammon India, Jaiprakash Associates - among the large players; IVRCL and NCC - in the mid-size segment; and Madhucon Projects - in the smaller player segment.

Order backlog to touch unexplored levels from the current levels of Rs. 837 billion
The order backlog of the 12 dominant construction companies has increased by 100 percent in the past two years. As per CRISIL Research, the increase in the next two years would be close to 65 percent, with companies bagging major orders from the infrastructure segment and industrial segment, benefiting few players.

Transportation segment flavour of the season
CRISIL Research opines that the transportation segment is now truly the flavour of the season. The increased proportion of this segment in 2005-06 is on account of the awarding of projects by the NHAI for the NSEW Phase II in 2005. This segment now accounts for 26 percent of the order backlog, surpassing the previous year numero uno - the power segment.

Performances - Good to better but margins to decline
Player margins are mainly determined by the project mix, which in turn is determined by the level of competition, capital intensity of a project and the direction of costs; while the turnover will depend on the gestation period and other caveats to the project implementation.

Going forward, with increasing focus on transportation projects, turnover growth is expected to increase at a compounded rate of 20 per cent over the next two years. However, if L&T, which accounts for around 47 per cent of the turnover, is excluded from the players' sample set, then the turnover growth for the other 11 companies is expected to be around 24 per cent for the next 2 years.

With the mix in revenue profile skewing towards the low-margin transportation projects segment, overall margins in the construction sector would be under pressure as well. Increasing trends in raw material costs and high labour costs would further impact margins.

Net margins are also expected to witness downward pressure; with the increase in capex plans of the construction players, in order to meet the huge order backlog, depreciation costs will also be significantly higher.

Concluded.

---