The escalation of Covid-19 pandemic is expected to impact the Indian economy severely in the short to medium term. One of the key sectors likely to be affected is infrastructure, given its importance in supporting the overall growth and development of India’s economy.
As we speculate on the future, the immediate impact on valuation is observable through the public market benchmark. The S&P BSE India Infrastructure Index has lost nearly 35% value between January-end and March-end.
Given the above volatility, in this article, we consider some of the key factors that investors should consider for their investing decisions and for fair value reporting purposes.
Macroeconomic factors to consider
The macro challenges are arising from the fact that even though infrastructure assets are considered defensive assets, there will be substantial non-systemic risks originating due to Covid-19 as noted below:
- Demand risk: Early indicators show some sub-sectors linked to transport (air, sea and surface) have seen substantial demand cut. Going by the directions of the ministry of road transport and Highways and National Highways Authority of India (NHAI), operations at all toll plazas of project SPVs (special purpose vehicles) of companies have been closed. Also, no toll collection is allowed till 15 April 2020.
- For power assets, since almost 50% of the demand is from the industrial/commercial segment, a sustained lockdown will have adverse impact on revenues; even after lockdown, a ramp-up will take some time. Given there is no clarity whether the recovery would be U, V or L-shaped, demand risk should be monitored closely.
- Supply-side risk: The impact of recent labour migration due to Covid-19 will amplify the stress on the infrastructure sector. The availability of human capital is critical for both operational assets and under-construction assets and there is no precedence to estimate the economic impact of human crisis. The volatility in pricing could also bring in challenges for this sector. However, at present, key commodities have shown a significant decline due to a lack of demand.
- Liquidity risk: Liquidity will be key to prevent any payment defaults or debt restructurings. Given the assets are significantly leveraged (operational and under-construction), the optimality of capital structures will be reassessed due to the sudden and significant impact on the revenue side.
- Counterparty credit risk: As Indian infrastructure assets are attracting a lot of foreign funds, stress on the ratings and possible downgrades could test the ability of domestic institutions to attract new investments in the short and medium term.
We have seen the initial reactions from the service providers, and they are noted below.
As per exchange announcements by two of the leading service providers Ashoka Buildcon and IRB, the prevailing conditions may be treated as force majeure as per their concession agreement and therefore the respective project SPVs are entitled for relief as per the terms of the concession agreement.
They would also seek a moratorium on loan repayment to banks and extension of the financial year closure timelines by at least three months to tide over the crisis.
The reactions highlight how the service providers have started calibrating their responses to this unprecedented challenge. Policy-related reactions from the government are still awaited.
It should be noted that given the sheer complexity of the Covid-19 impact, scope and scale of the economic support and policy responses will be a major ask for even the most seasoned of policymakers.
However, the Reserve Bank of India provided some general relief to Indian businesses, which includes debt moratorium for three months and working capital support through margin reductions and recalibration of working capital cycle.
The valuation challenges for investors have started to show as well. Public market reactions are the first indicators for the same. The factors affecting valuation are arising from macroeconomic challenges, as highlighted before. Also, certain asset-specific impacts could arise from Covid-19 disruption, which are highlighted below:
- Management of liquidity: The priority is to ensure sources of liquidity to cope with any operational, capex and debt-related payment;
- Preservation of yield: The investor group for this sector is mostly yield-focused and the challenge arising from maintaining covenant ratios could affect distributions in the short term.
- Optimisation of the capital structure: An environment of lower cost of capital and cash flow challenges can lead to a new capital structure optimality for infrastructure assets.
The other valuation challenge would arise from the market observable inputs derived from recent and ongoing transactions, which didn’t consider any Covid-19 impact. The valuation assessment would also be impacted by any government policy to support this sector.
For investors in Indian infrastructure assets, though the long-term story remains intact, the valuation assessment in the short term should be calibrated to short-term challenges.
Pratik Sengupta is director of alternative assets advisory at financial services firm Duff & Phelps. Views are his own.