Companies in the construction sector continued to witness negative cash flows from operations (CFO) in FY16, which is likely to improve gradually to near zero levels in FY17, as more orders procured during the last two years are executed, says India Ratings and Research (Ind-Ra). Competitive intensity had reduced for new orders over the last two years and hence margins on such orders are expected to be higher.
Order inflow in the construction sector is likely to grow, as the government has increased outlay for highways and railways in the Union Budget 2016-17. The government increased allocation for highways by 28% and has targets to award 10,000 km of highways in FY17.
The government has also laid out ambitious targets for spending on other infrastructure sectors and irrigation, drinking water supply, housing and power supply, which would entail significant opportunities for the sector over the medium term.
Ind-Ra believes that prudent accumulation of orders with close correlation between capacity to execute and order book size will be crucial to improvement in the cash flows and credit metrics of individual companies.
Hence, Ind-Ra expects companies to focus on margins and funding while bidding for new projects and to limit their order books near the current level as a multiple of revenue, which will provide for a moderate growth in revenue along with improvement in cash flow margins.
Ind-Ra believes that the negative CFOs are a legacy of the aggressive bidding seen during FY10-FY12, when companies focused on building their order books. In such orders, EBITDA margins were very close or even lower than retention money margins in some cases, leading to negative operational cash flows. Also, the companies did not focus on funding by the customer, resulting in long receivables and inventory holding periods. The construction sector’s receivable days have widened by 33% to 141days and inventory holding period has risen by close to 9% to 124 days in the last five years.
As highlighted in the report “Construction Sector to See Gradual Improvement in FY17”, liquidity remains weak as indicated by negative CFO. Difficult borrowing conditions, due to weak balance sheets, is also affecting liquidity. Companies with strong liquidity, however, will continue to have a significant advantage over their peers.