Construction- Efficiency Report

Dear reader, As the World Bank has recently asked the Roads Ministry to develop new models to expedite projects, India’s Planning Commission envisages a fresh policy on EPC in road projects. Under the new EPC model, the contractor will accept the risk and responsibility for both the design and the construction of work. So while EPC projects have existed, the emphasis on them is freshly brewing. There is a crying need for more professional process in public procurement, better understanding of quality thresholds and technology among (especially) government and public sector developers.

The government will soon have a new law in procurement and may introduce a Department of Procurement. This should come as good news to everyone who is aspiring to reach international quality standards and new technology. Most industry experts believe our contract system—not procurement alone—needs major reform. International developers and investors are demanding better processes and adherence to health, safety, environment norms. As internationalization knocks on India’s doors, however, high attrition and lack of labour—especially skilled labour—persists.

Thanks to governments in traditionally underserved but overpopulated regions such as Bihar, Orissa and Bengal—from where labour typically migrates en masse to where the action is—developmental and infrastructure projects are coming up aggressively. The government-sponsored MGNREGA, which guarantees employment in rural areas, is another reason. Delays in our development projects are forcing more developers to go the EPC way. The new emphasis on EPC is also, sadly, because investments are looking south.

With a double-dip threat in the global economy, the worst industrial growth in eight quarters in India and projects down to a trickle, EPC is a stable option. But if the recent success of India’s largest-ever highway bid-out is any indication, some sectors are all set to change the trend—even as power projects remain suspect owing to poor health of the distribution companies. We’re proud to present a joint paper that outlines and analyses the trends in EPC, a\]flaO]k akkm]k$ Yf\ j][gee]f\k hgda[q [`Yf_]k Yf\ oYqk ^gjoYj\& Pratap Vijay Padode Editor-in-Chief, Infrastructure Today and Managing Director, ASAPP Media Information Group Ernst & Young Dear reader, India’s EPC market has come under the global scanner.

The sector has witnessed consistent changes over the past few years, with increasing project sizes, scale and market maturity. Riding on India’s af^jYkljm[lmj] j]imaj]e]flk gn]j l`] f]pl On] q]Yjk ]klaeYl]\ INR40. 9 trillion during the Twelfth Five Year Plan) the EPC sector is likely to make major advances. The order books of numerous players are bulging, and the sector is attracting the increased interest of global majors, and Indian conglomerates as well as infrastructure developers.

The sector has become more dependent on infrastructure investments than ever before. This trend is further illustrated by the fact that projects awarded by the Indian Government are gradually shifting toward the Private Public Partnership (PPP) model. Some sectors, such as highways and power, have reached a mature stage, whereas others such as the railways and urban infrastructure are yet to develop through the PPP model. Today, EPC contractors have a healthy mix of government and private sector clients, as compared to their heavy dependence on government clients until few years ago.

Therefore, companies have to adapt to such changing environments. Over the past three years, some large EPC companies have seen a ~20% growth in their j]n]fm]k Yf\ gj\]j Zggck& @go]n]j$ o] `Yn] gZk]jn]\ l`Yl l`ak _jgol` ak fgl j]O][l]\ af l`]aj Zgllge daf]$ Yf\ l`ak ak `a_`da_`l]\ Zq l`]aj mf\]jh]j^gjeYf[] af Af\aYIk OfYf[aYd eYjc]lk& L`ak kdgo\gof af hjgOlk eYq Z] YlljaZml]\ lg emdlahd] [Ymk]k E [gkl gn]jjmfk$ afOYlagfYjq hj]kkmj]k$ hjgb][l \]dYqk$ j]_mdYlgjq Zglld]f][ck$ Y__j]kkan] Za\\af_ gj resource constraints (including that of skilled labor).

In the present scenario, companies ^Y[] Yf af[j]Ykaf_ f]]\ lg j]Yda_f l`]aj kljYl]_a]k Yf\ ^g[mk gf hjgOlYZadalq Yk Y_Yafkl revenue growth. Companies have been constantly exploring and innovating means of overcoming the challenges mentioned above. This report discusses the latest trends and the market direction, as well as the strategies adopted by various players to adapt to the ever [`Yf_af_ f]]\k g^ l`] k][lgj& O] `gh] qgm ]fbgq j]Y\af_ l`ak j]hgjl Yf\ Of\ al insightful.

Sushi Shyamal Partner, Transaction Advisory Services Transportation Infrastructure and Construction Sector Leader, Ernst & Young India Heading 1 6 Engineering, Procurement and Construction (EPC)2 INR20 billion), mid (INR20 billion > revenue > INR10 billion) and small (revenue < INR10 billion). When their performance is studied through this categorization, a clear pattern emerges.

16 For our analysis we have included following construction companies: large sized — HCC Ltd, Gammon India Ltd, IVRCL Ltd, Larsen &Turbo, NCC Ltd, Simplex Infra, Patel Engineering , Era Infra; Mid-Consolidated Construction Consortium Lt, Jyoti Structures Ltd, Ahluwalia Contracts (India) Ltd, SPML Infra Ltd, ITD Cementation India Ltd, JMC Projects (India) Ltd, Sadbhav Engineering Ltd, Pratibha Industries Ltd; Small-KNR Constructions Ltd, J Kumar Infraprojects Ltd, Supreme Infrastructure India Ltd, Tantia Constructions and Welspun Projects. 30

Engineering, Procurement and Construction (EPC)2 gj ]pYehd]$ o`ad] eYjc]l capitalization (mcap) declined across all categories of companies, the mcap of large companies declined by 5% over FY05–11. Mid- and small-sized companies were not so lucky — the mcap of mid- sized companies declined by a staggering 20 % and those of small- sized companies by 27 % during the same period. Large companies: movement in valuation multiples 2. 5 60 2. 0 40 1. 5 1. 0 20 0. 5 0 FY05 FY06 EV/EBITDA Source: Company annual reports; BSE 0. 0 FY07 P/E FY08 FY09 FY10 FY11 Market Cap/Sales (secondary axis)

Things were much brighter for the industry between FY05- 08. Driven by economic growth and high infrastructure spending, construction companies registered high hjgOlYZadalq Yf\ kljgf_ nYdmYlagfk& DYj_] gj_YfarYlagfk kYo Yf Ydd%lae] `a_` af nYdmYlagfk trading at a P/E multiple of 29. 7 in FY07, while mid and small companies traded at multiples of 19. 1 and 12. 1, respectively. The track became slippery once the recession set in — while revenue growth was still strong due to order book positions (with revenue growth of 22%, 20% and 41% in large, ea\% Yf\ keYdd [gehYfa]k$ j]kh][lan]dq!

$ egkl j]hgjl]\ eml]\ hjgOlYZadalq d]Y\af_ lg reduced valuations. Large companies were trading at a P/E multiple of 6. 5 and mid and small companies at multiples of 4. 6 and 2. 7, respectively, in FY09. Engineering, Procurement and Construction (EPC)2 Q)) +&0 $ +&. Yf\ ,&) ^gj dYj_]$ ea\% Yf\ keYdd Ojek$ j]kh][lan]dq! Yf\ hjgOlk CAGR (+4%, +8% and -19%, respectively). C]q Of\af_k gn]j >Q(-C>Q))! 2 ? ? ? ? ? Revenue — ~20% growth over FY08-FY11 While this is not comparable to the growth over FY05–FY08, revenue performance over the past three years has been robust. =:AL