The Hindu Business Line : Infrastructure: Build-up of expectations

Bharat Nirman, the Government’s four-year business plan (2005-2009) to improve rural infrastructure, has been the cornerstone for budget allocations to the infrastructure sector over the past few years. It follows that Bharat Nirman has been the key source of business for infrastructure companies in India, helping them post a compounded annual sales growth of about 30 per cent in the past three years (listed companies). We expect spending in power, irrigation and roa ds — in that order — to be the primary revenue drivers for the companies in 2008, on the back of robust budgetary allocation and Government spending.

A quick recap

Budget 2007 appeared to favour the water segment, which received a 54 per cent increased allocation — the highest among the various infrastructure segments. This benefited companies such as IVRCL Infrastructure & Projects, Nagarjuna Construction and a host of allied companies such as Jain Irrigation Systems.

Tax woes: On the flip side, many companies took a hit owing to the withdrawal of tax benefits under Section 80IA for projects that were in the nature of works contract and not investments. The withdrawal essentially meant that companies that were paying a Minimum Alternate Tax of 11.2 per cent for such unqualified projects had to pay a full tax rate of about 34 per cent with retrospective effect from April 2000. Companies did take a hit in their net worth as the reserves were used to provide for the same. A few, such as IVRCL, who are still contesting the reversal, continue to provide for taxes at a lower rate in their books. Overall the tax incidence, though it witnessed an increase for the nine months ended December 2007, did not increase drastically due to the above reason.

Order inflows: While the order book remains robust, at an average of 2-3 times the annual 2006-07 sales, there is lower contribution from segments such as roads due to a slowdown in order flows from the Government. The road segment almost saw a lull in order flows in 2007 due to the prolonged debate on the new Model Concession Agreement (MCA). With the clearance of the MCA towards the end of 2007, the NHAI has invited financial projects for Phase V (six-laning). Order book of infrastructure companies could therefore see a renewed tilt in favour of roads in 2008. However, the concern here is that the delay may well have resulted in project costs overshooting the initial NHAI estimates. Budget 2008 may require a higher allocation just to meet such an increase, to make the segment lucrative enough for private participants.

Raw material hikes: Increase in price of key raw materials such as cement and steel have increased costs for companies. Raw materials consumed as a percentage of sales has gone up from 39 per cent (for the nine months ended December 2006) to 44 per cent in the nine months of 2007-08 for the listed companies. The increase has however been kept under check by the price escalation clauses opted by a number of players. Operating profit margins (OPMs) for the comparable periods therefore remained at a steady 12.9 per cent. Any budget proposal for cement/steel that would result in a positive impact for the user industry can help operating profit margins.

No dearth of expectations

Reinstatement of tax benefits for contractors under Section 80IA appears to be the most voiced expectation from the industry.

Another proposal that could well provide some relief on the bottom line is the avoidance of multiple taxes on certain projects. For instance, a good number of companies participating in BOT projects do so through a Special Purpose Vehicle (SPV). The holding company receives income through dividends on such projects. Thus, while the dividend is taxed (as dividend distribution tax) at the SPV level, the same when received by the holding company is further subject to corporate tax. Infrastructure companies have sought exemption from DDT for SPVs similar to the exemption enjoyed by developers of SEZs.

Some sections of industry have also sought exemption of customs duty for inputs used in road projects. This is expected to facilitate procurement of better-quality imported equipment and deliver superior quality roads.

Infrastructure spending is likely to receive continued thrust in the upcoming budget. This is likely to drive volumes and therefore earnings for companies, irrespective of whether the other demands are accepted or not.

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