>Demonstrated execution capabilities in EPC segment; diversification into external road and water projects

WEL forayed in the infrastructure segment in 2010 with the acquisition of MSK Projects Limited. The company has been developing and operating PPP projects in various sectors including roads, water supply, and urban infrastructure. WEL has successfully completed 6 BOT projects with a total length of over 500 kms and has established relationship with government authorities, namely, National Highways Authority of India (NHAI), Madhya Pradesh Road Development Corporation (MPRDC), Gujarat State Road Development Corporation (GSRDC) to name a few. The company continues to focus towards execution of projects under Hybrid Annuity Model (HAM) as well as BOT. The company has established its execution capabilities with successful completion of India's first project under HAM well ahead of the stipulated timelines and 4 others as per revised timelines (on account of Covid-19).
WEL continues to have a robust portfolio of 8 captive HAM projects, of which the India’s first HAM project i.e. Delhi Meerut Expressway (DME) was completed and has received 8 annuity payments till Q1FY23. Other 4 HAM projects received PCOD (‘Gagalheri-SaharapurYamunanagar’ (GSY), ‘Chutmalpur-Ganeshpur’ (CGRG), ‘Chikhali-Tarsod’ (CT)) and Amravati / Akola, MH (AM2). Of these 4 projects, 2 projects (GSY and CGRG) have received 3 timely annuity payments and Chikhali-Tarsod’ (CT) has received 1 timely annuity payment until Q1FY23, annuity in Amravati/ Akola is due and expected in 2 months. The balance 2 on-going HAM projects, ‘Aunta-Simaria’ and ‘Sattnapuram-Nagapattinam’ (rated ACUITE A/Stable) are under execution and are yet to achieve the PCOD. Besides executing HAM projects, WEL has 2 BOT projects – firstly, ‘Mukarba-Chowk’ which has received PCOD in March 2022 with present work execution at 85 percent of the stretch and secondly ‘Dewas Water’ project which is already operational. As a whole, it received 2 HAM PCODs ‘Chikhali-Tarsod’ (CT)) and Amravati/ Akola, MH (AM2) and in one BOT project‘Mukarba-Chowk’ in FY2022.
WEL’s order book as on Q1FY23 of ~Rs.11,900 Cr (excluding GST) manifest significant diversification on a positive note. The order book now consists of 54 percent of water segment orders and 46 percent from road segment vis-à-vis 70 percent in road and 30 percent in water as on Q1FY22. Notably, the diversification has come long way from deriving around 96 percent of revenue from HAM projects solely in FY2017 to now being present in multiple segments of civil construction industry.
To add, the order book no consists of 79 percent external projects and 21 percent captive HAM and BOT projects. To add, WEL has won 3 EPC contract for road and water treatment related work in Uttar Pradesh and Mumbai for EPC work of 1) Varanasi-Aurangabad (NH2’ project), 2) Design, Build, Operation and Maintenance of Dharavi Wastewater Treatment Facility and 3) second phase of road works for NH2 Varanasi (from earlier executor named - Soma Indus Varanasi Aurangabad Tollway Private Limited.
Acuité believes that WEL's demonstrated execution capabilities along with its diversification into water segment will support its business risk profile over the medium term.
 

>Healthy order book providing long-term revenue visibility

WEL, has a total unexecuted order book of Rs.11,900 Cr (excluding GST) as on June 30, 2022 vis-à-vis Rs.8,400 Cr as on March 31, 2022. The order book remains strong and is executable over the next 2-5 years; providing long-term revenue visibility. WEL’s portfolio consists of 8 executable projects as on June 30, 2022 (2 HAM, 1 BOT, 2 road EPC and 2 Water EPC project).
HAM projects i.e., Aunta Simaria HAM project (A-S Project) and Sattanathapuram to Nagapattinam, TN (SNRP) which are under implementation have achieved physical progress of ~ 41 percent and ~15 percent, respectively. These 2 projects are expected to achieve PCOD by Q3FY25 and Q2FY24. The project Aunta-Simaria and sattnapuram-Nagapattinam have been running behind schedule due to multiple reasons such as delay in receipt of ROW, change in scope of work, covid-19 related disruptions, extended monsoons amongst others. Under BOT Portfolio, Mukarba chowk project has achieved ~85 percent of its physical progress for which PCOD has been achieved; balance 15 percent work in being carried on and expected to complete by Q1FY24. Under the external order book portfolio, the Varanasi NH2 EPC – Package 1 & 2, are expected to be completed by Q2FY24 and Q3FY24, respectively. The UP water project and Mumbai STP (BMC) project is expected to be completed by Q1FY25 and Q1FY28, respectively.
Acuité believes that WEL’s project management capabilities will continue to support the timely execution of the aforesaid projects and result in achievement of revenue growth as envisaged over the medium term.

>Monetisation of completed road projects to strengthen balance sheet

As planned, WEL has declared divestment of its 6 completed road projects to Actis Highway Infra Limited (Actis) for an aggregate enterprise value of approximately Rs. 6,000 Cr. The Highway Portfolio comprises of 5 completed HAM assets (Welspun Delhi Meerut Expressway Private Limited, Welspun Road Infra Private Limited, MBL (CGRG) Road Limited, MBL (GSY) Road Limited, Chikhali Tarsod Highways Private Limited) and 1 operating BOT-Toll asset (Welspun Infrafacility Private Limited). EV excludes construction linked milestone/ grant payments of approximately Rs. 3,000 Cr received/receivable from National Highways Authority of India and Public Works Department of Government of Maharashtra, thus, valuing the highway portfolio being exited at approximately Rs. 9,000 Cr. These 6 projects have a cumulative debt outstanding of about Rs.3,465 Cr as on March 31, 2022 covered under corporate guarantee provided by WEL; these corporate guarantees shall be released post this transaction. Post this proposed exit, the WEL’s road asset portfolio would comprise of 2 under-construction HAM road projects (Sattanathapuram - Nagapattinam and Aunta – Simaria Road projects) which have a total project cost of ~Rs. 3,900 Cr.
The completion of the above transaction is subject to completion of customary and regulatory compliances and approvals from NHAI (incl. receipt of NOC post completion of 1 year (as per NHAI guidelines) from the date of completion), PWD, and lenders. Hence, the transaction is expected to be complete by FY2023 for all the projects; there might be a spill over to Q1FY24 given the PCOD for the BOT Project ‘Mukarba chowk’ was received in March 2022 and 15 percent of the work towards it is pending. As confirmed by the management, WEL has received NOCs from majority of the SPV lenders. The proceeds from the above transaction are expected to be utilized towards working capital purpose, reduction of debt and investments in newer SPVs/projects.

>Healthy financial profile albeit with slight moderation

WEL’s financial flexibility has moderated with marginal deterioration in Tangible outstanding liabilities to Tangible networth (TOL/TNW) ratio and debt protection metrics; gearing improved marginally given the reduction in overall debt. WEL reported gearing ratio of 0.27 times as on March 31, 2022 against 0.33 times as on previous year. The debt protection measures moderated with Interest Coverage Ratio (ICR) and Net cash accruals to total debt (NCATD) at 3.40 times and 0.21 times in FY2022 against 4.44 times and 0.20 times as on previous year end. The TOL/TNW ratio increased from 0.75 times as on March 31, 2021 to 0.84 times as on March 31, 2022. The adjusted TOL/TNW ratio (TNW – Investments in SPVs + Loans & advances to SPVs) stood at ~6-7 times as on March 31, 2022. These investments and loans & advances by WEL are towards its upfront equity commitments in SPVs or short term/temporary funding given to fill up the gap at SPV level. These investments (majorly short term) are expected to be released in the near term either through divestment of completed projects or debt draw down at SPV level.

The deterioration in gearing ratio in FY2021 and debt protection metrics was on account of issuance of NCDs and the interest outgo towards it, addition of fresh term loan of Rs.100.00 Cr from Axis Finance Limited and lower than Acuité’s estimated revenue and profitability. These borrowings have been in return used as investments in SPVs. Total debt increased from Rs.311.54 Cr as on March 31, 2020 to Rs.604.26 Cr as on March 31, 2021; reduced to Rs.507.54 Cr as on March 31, 2022. WEL prefers to infuse upfront equity in most of its SPV projects followed by debt draw down and government grants which leads to higher investments at initial levels.
Despite the moderation in FY2021 & FY2022, WEL’s financial risk profile remained less leveraged with healthy capital structure on account of asset- light model accompanied by comfortable debt protection measures. The gearing (including contingent liabilities in form of corporate guarantees extended to SPVs) has remained below 0.5 times over the last 3 years ending March 31, 2022. Moreover, WEL bids and sub-contracts majority of construction work to its sub- contractors which leads to minimal requirement of machinery or dependency on equipment loans or working capital limits. With no major debt-funded capex plans in place, optimal usage of working capital limits or commercial paper (CP), the gearing is expected to remain below 0.5 times over the medium term too. The improving revenue coupled with stable operating margins are expected to lead to better debt protection metrics over the medium term.
Acuité believes the financial risk profile to remain healthy over the medium term supported by no major debt funded capex plan, improving debt levels and higher profitability.
 

>Susceptibility of operating performance to timely receipt of orders and execution of projects in hand

WEL is focused on execution of HAM projects wherein 40 per cent of the project is funded on milestone basis by the counter party and the remaining 60 per cent is generally funded by the company by way of debt and equity. The project execution is dependent on timely debt tie up and timely receipt of milestone payments. Any delay in execution of projects due to factors such as delays in receipt of approvals is likely to impact the company's revenues and accruals during a given period. Besides timely execution, the company's revenue profile is also dependent on receipt of orders. The future flow of order is linked to level of government spending on infrastructure. While delays in budgetary allocations could lead to cashflow moderation for WEL. However, this risk is partially mitigated as the company has strong order book giving revenue visibility for about 2-3 years and given its established track record of majority of its projects achieving PCOD.
Acuité believes that timely execution and buildup of strong pipeline of projects will remain crucial for stable credit profile of WEL.

>High dependence on sub -contractors and working capital intensive nature of operations
WEL bids and sub-contracts majority of the construction work to its sub-contractors. High dependency on sub-contractors increases execution risk owing to the limited exposure of sub-contractorstowards executing such complex projects. Besides, higher dependency on the subcontractors also limits the operating margins as compared to players executing HAM projects on their own. Therefore, WEL remains exposed to the inherent risk associated with the execution of HAM/EPC projects. However, at the same time, there is trade-off to an extent with minimal investment in capex /machinery, execution of projects pan India and different types of projects with selection of sub-contractors depending on their expertise, location etc. However, with its vast project management experience in successfully completing large infrastructure projects, WEL is well equipped to get the required work done from sub- contractors with optimized time and cost manner.
Working capital requirement is inherently high in the construction industry, given the high dependence on state and central government authorities for timely receipt of payments. The working capital cycle is marked by high Gross Current Assets (GCA) days of 447 days as on March 31, 2022 against 335 days as on March 31, 2021. High GCA days are an outcome of moderate receivables of 88 days and increasing other current assets like security deposits, supplier advances and loans & advances to SPVs as on March 31, 2022; signifying high dependence on central and state governments and multipartite agencies for timely receipt of payments. Acuité believes that given the asset-light model approach followed by WEL, the dependence on sub - contracts will remain high over the medium term along with working capital intensity in the operations.

>Continued exposure towards non-core operations
WEL has invested in Oil & Gas business as it owns 4 relevant blocks through the 35 percent JV Company Adani Welspun Exploration Ltd (AWEL). The blocks are at advance stage of development/exploration. Consequently, no further large investments are expected in near term and beyond. Acuité believes that the exposure towards this segment as compared to its networth is modest. However, any further significant support towards this segment may impact the credit profile of WEL.