Nation-wide lockdown to reduce rating headroom for construction companies: Ind-Ra

Nation-wide lockdown to reduce rating headroom for construction companies: Ind-Ra

India Ratings and Research believes that the slowdown in construction activity owing to the 21-day nation-wide lockdown would significantly weaken the liquidity profile of its rated engineering, procurement and construction (EPC) companies. This could result in rating transitions, in case the COVID-19 outbreak and the associated fallout persist beyond April 2020.

As articulated in Ind-Ra’s revised base case scenario, the agency does not expect a sharp recovery in the business activity post the lockdown. Similar to the progress in China, the economic activity most likely will resume gradually. In Ind-Ra’s opinion, it could take a few weeks for EPC players to mobilise resources back at the sites, post the lockdown is lifted, and as such, operations can stabilise within a couple of weeks. However, the collection risk could still continue, and will depend on the counterparties’ ability to clear dues post the lockdown.

Portfolio Vulnerability Assessment: India Ratings and Research has rated 16 EPC players ‘IND A-’ or higher in the last one year. An assessment of this portfolio indicates that the disruption emanating from the COVID-19 outbreak would render eight entities highly vulnerable to a negative rating action. Another two entities are likely to be at a risk of downgrade in case the outbreak remains uncontained beyond May 2020.

Although, prima facie, the available liquidity cover for most highly rated entities stands in excess of three months, yet this does not eliminate the risk of liquidity mismatches in the interim. The assessment of liquidity cover does not reflect other fixed costs such as operating lease rentals or capital commitments such as equity contributions for special purpose vehicles. In cases where principal repayment is front loaded in 1QFY21 (contrary to working assumption of even debt repayment through the year), the actual liquidity available could be significantly lower. India Ratings and Research continues to monitor all rated entities closely and will continue to track their liquidity profile over the coming weeks.

Regulatory Moratorium Could Ease Immediate Liquidity Pressures: India Ratings and Research believes that the regulatory dispensation with regard to providing relief from debt servicing in the next three months will significantly ease the liquidity requirements for these entities in the near term. However, this will be contingent on the lenders being willing and able to provide such a moratorium to the borrowers. This could increase the liquidity cover by up to 90 days for all Ind-Ra rated issuers and significantly mitigate the risk of sharp rating transitions in its portfolio.

Given that majority of the EPC companies’ borrowings are in the form of working capital loans, even in cases where such a dispensation is availed, the interest could be required to be serviced in the subsequent months. Therefore, the aforementioned moratorium does not affect the agency’s estimates of the FY21 liquidity scores of the rated borrowers.

Funding Risks Could be Elevated: The EPC players’ business models have historically been working capital intensive. Consequently, even in cases where substantial liquid assets are available, unutilised bank lines have been an important source of liquidity. Additionally, the majority of the capital expenditure, mainly towards purchase of construction equipment, is financed using equipment financing loans (CE Financing). Even prior to the COVID-19 outbreak, risk aversion in the system continued to proliferate. Banking system’s liquidity remains high while credit continues to be rationed towards highly rated large borrowers. Ind-Ra believes that the pandemic would lead to further risk aversion in the system, with lenders tightening their underwriting standards and the financial flexibility of borrowers across the board getting affected. With majority EPC players rated in the ‘IND A’ and ‘IND BBB’ categories, funding risks are likely to be higher for the sector at large.

The ability to secure timely CE Financing sanctions coupled with the non-availability of working capital lines could severely impinge the liquidity profiles of the rated entities. Even in cases wherein rated issuers cut back on their capital expenditure plans due to the non-availability of bank financing, operating cash flows could still fall short of Ind-Ra’s projections as the execution capability could be further affected.

Imminent Pressure on Receivables: Most India Ratings and Research rated EPC players cater to various state governments, central government departments and public sector enterprises. Thus, the receivable collection cycle is closely linked to the liquidity of these counterparties, which bears a strong correlation with the fiscal headroom available at both the state and central government levels. The counterparty experience in Ind-Ra’s rated portfolio indicates that the last fortnight of March and the first fortnight in April would witness a surge in receivable collections.

However, in light of the COVID-19 outbreak, most state governments and the central government have been required to undertake a massive reprioritisation of fiscal goals and objectives. This, invariably, is likely to prioritise timely payment towards healthcare and other essential services. At the same time, the slump in economic activity coupled with the already ongoing slowdown is likely to keep the fiscal position stretched at both the central and state government levels. Ind-Ra expects this to translate into a rise in receivable collection period and further strain the cash flows of the rated EPC players. In such a scenario, the ability of the EPC players to manage their payable cycle in commensuration with the fall in debtor turnover will be a key credit driver.

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