Infrastructure construction: Leverage from high backlog

The North-South Expressway project

Infrastructure development funding

Vietnam's government has increased public investment to sustain economic development in the face of low private investment and FDI inflows from the beginning of 2023. According to GSO, implemented state capital (public investment) increased 16.4% year on year to VND39.3 trillion in April 2023 (up from 18.6% year on year in Mar 2023). The implemented state capital increased 17.9% year on year to VND131.2 trillion in 4M23, above the 10.8% year on year growth rate in 4M22.

However, public investment capital execution in 4M23 only reached roughly 19% of the entire year 2023 plan (vs. 18.5% of the entire year 2022 plan in 4M22). As a result, the government must continue to encourage public investment in the coming months in order to meet the target of disbursing more than VND700 trillion in public investment capital by 2023. According to Mr. Tran Ba Trung, analyst at VNDirect, there will be various supportive elements this year to further accelerate public investment projects, including:

First, Vietnam has successfully reduced its public debt ratio in recent years: thanks to solid GDP growth from 2016 to 2022 and tight spending controls, Vietnam's public debt has fallen rapidly over the years, from 51% at the end of 2016 to 40% by the end of 2022 (IMF estimate), which is significantly lower than Vietnam's public debt ceiling of 60% of GDP. Low public debt allows for more leeway in fiscal policy to help the economy recover.

Second, since the beginning of 2023, the rates on Vietnam's government bonds have fallen dramatically: In the primary market as of 10 May, 10-year and 15-year G-bond rates have fallen 167 and 170 basis points year to date, to 3.0% and 3.1%, respectively. On the secondary market, Vietnam's 5-year and 10-year Gbond rates fell 242 and 189 basis points year on year, to 2.6% and 3.2%, respectively.

Third, domestic inflation has slowed in recent months: Vietnam's headline inflation fell to 2.8% year on year in April 23 from 4.2% year on year in 1Q23. As inflationary pressures subside, the government may reconsider relaxing fiscal policy further to aid economic recovery.

Fourth, Prime Minister Pham Minh Chinh has urged the Ministry of Transportation to complete preparations for the start of construction of three expressways, Chau Doc-Can Tho-Soc Trang, Bien Hoa-Vung Tau, Khanh Hoa-Buon Ma Thuot, and two ring roads, including the 4th belt of Hanoi and the 3rd belt of Ho Chi Minh City, before June 30. These initiatives must begin before June 30 of this year.

Taking advantage of large backlog value

Leading infrastructure construction firms have dramatically boosted their backlog values after being selected contractors on various component projects at the NorthSouth Expressway phase 2 (early 2023). Notably, HHV's backlog value at the end of 1Q23 was VND3,135bn, which is comparable to 6 times the company's construction segment's average revenue in FY21-22.

With transportation infrastructure projects typically taking 2-2.5 years to complete, infra construction companies have the ability to quadruple their income in FY23-25 compared to FY21-22.

Mr. Tran Ba Trung observes that these enterprises are constantly gaining new building contracts and profiting directly from the government's desire to disperse public money. As a result, he expects that the revenue size of these prominent infrastructure building firms will increase in the next years.

Long Thanh International Airport (LTIA) megaproject would also attract numerous contractors, with a construction value of VND56,000bn (phase 1). However, the contractor selection progress in package 5.10 - the largest package - for the building of the LTIA passenger terminal has been repeatedly postponed due to the unappealing bidding price and the need for a quick construction time.

“We expect LTIA to be a growth engine for domestic contractors when it is permitted to resolve these two bottlenecks in the future months. Construction company executives also said that investors' first reciprocating funding for contractors in airport projects is often 30-50% of the package value, which is larger than in road projects (10-20%)”, said Mr. Tran Ba Trung.

High backlog value of leading infra construction companies at the end of March 2023

Mr. Tran Ba Trung believes that due to the specialized technical and mechanical requirements, only a few domestic contractors will be able to participate in the LTIA construction. He prefers C4G and VCG for this topic since they have been involved in the development of several airports in Vietnam. However, due to the massive magnitude of the LTIA bidding package, these firms must form a joint venture with other enterprises to assure the project's success.

Profitability of infra construction companies

Seven of the eight listed businesses that have been designated contractors (early 2023) on the North-South highway phase 2 project reported an increase in 1Q23 client prepayment compared to the beginning of the year. As a result, the 1Q23 revenue/average prepayment by customs ratio of infrastructure building firms fell to 2.4x from 2.7x in 2022. This rise is mostly attributable to attempts to speed the disbursement of public investment, as investors have aggressively allocated counterpart funds to contractors for project completion.

As a consequence, infrastructure construction firms lowered their working capital strain, strengthening their net debt/equity ratio at the end of 1Q23.

At the end of 1Q23, the average net debt/equity ratio of infrastructure construction firms was 1.1x, with LCG having essentially no net debt. Because of the consolidation of BOT projects (huge debt and payments throughout the life of the project - spanning 10- 20 years), HHV and C4G had higher net debt/equity ratios than the industry average, reaching 2.4x and 1.3x, respectively, at the end of 1Q23. However, we believe C4G is in good financial condition because to the Nam Ben Thuy 2 BOT project, which generates yearly net cash flow. As a result, removing the debt in this BOT project, C4G's net debt/equity ratio at the end of 1Q23 was just 0.5x.

"We also note that C4G successfully raised VND1,123bn from existing shareholders in April 2023, increasing the company's owner equity by 44% compared to the end of 1Q23," Mr. Tran Ba Trung remarked.

Mr. Tran Ba Trung believes that only construction companies with strong construction capacity, reasonable machinery mobilization, and ample working capital can ensure profitability on the North-South Expressway project because (1) it has a short construction period and (2) the government assigns a fixed profit margin based on the bid price.

"We believe that infrastructure construction firms will benefit from the government's trend of increasing public investment disbursement in FY23-25F." We choose enterprises that meet the following criteria: (1) good construction capacity, (2) high backlog value/revenue ratio, and (3) strong financial health. As a result, we anticipate C4G and LCG would benefit the most from this trend," said Mr. Tran Ba Trung.