Strong order books and improved project execution, supported by the central government’s thrust on infrastructure spending will help large and diversified engineering, procurement and construction (EPC) companies rebound with a revenue growth of over 20% this fiscal.

While operating margins may moderate slightly due to higher cost of inputs, particularly steel, an improvement in the working capital position and strong balance sheets should support credit profiles, shows a CRISIL Ratings study of eight large and diversified EPC companies. These are into civil infrastructure, transportation, power, and oil and gas, among others, with aggregate revenue of Rs 1.5 lakh crore¹, and well-represent infrastructure activity in the country.

These companies have logged aggregate revenue declines of 4% and 6% in fiscals 2020 and 2021, because of weak economic growth and the Covid-19 pandemic, respectively.

Says Manish Gupta, Senior Director, CRISIL Ratings, “Project execution in the second wave of the pandemic was impacted, but not as much as the first wave because of less-stringent restrictions. Also, this time around, companies were better prepared to manage labour and supply chains. With lockdowns progressively easing, execution has picked up from the second quarter. That will strengthen through this fiscal, the way it did in the last fiscal. We expect this to boost revenue by 20% this fiscal, to well over the fiscal 2019 level.”

Another good augury for the medium term is that order books are already at a multi-year high of 3.5x revenue, and the flow of orders will continue to be strong because of government thrust to infrastructure. Notably, the National Infrastructure Pipeline will provide EPC players an estimated Rs 80 lakh crore opportunity through fiscal 2025 across sectors such as transport, water and sanitation, social infrastructure and power.

Says Naveen Vaidyanathan, Associate Director, CRISIL Ratings, “Amid strong revenue growth, operating margins may moderate by 20-40 basis points to 9.3-9.5% this fiscal as over 85% of the costs of EPC companies are variable in nature, and prices of key inputs such as steel are likely to increase 23-25% on-year². This will have to be absorbed in the case of fixed-price contracts, which account for a fourth of all contracts, while for the remaining, it will be passed on with a lag.”

The conversion of operating profits to cash flows is critical for the sector given its high working capital requirement. Additionally, rising share of orders from the public sector, has increased the working capital intensity of EPC companies. The gross cash conversion cycle (CCC), or the time taken to convert inventory and debtors to cash, was 300 days on average over fiscals 2016-2019. That duration has increased progressively and stood at over 360 days last fiscal (see annexure). This fiscal, we expect the CCC to moderate to about 320 days because of better collection efficiency stemming from the continued impact of liquidity support announced by the government³, and strong revenue growth.

Moreover, healthy capital structure in the form of total outside liabilities to net worth ratio of 1.8x, and interest coverage of over 5x will support stable credit profiles.

Any further waves of the pandemic, especially an intense third one, could jeopardise execution. That will, therefore, bear watching.

¹ Larsen and Toubro Ltd, L&T Hydrocarbon, Tata Projects, Afcons Infra, NCC Ltd, JKumar Infra, KEC International, Kalpataru Power and Transmission (including JMC Projects)
² Long steel prices used in the construction sector
³ Government measures were monthly release of payments against earlier milestone linked disbursements and reduction in performance guarantee from 5-10% to 3% for existing and new projects till December 2021