IRB INVIT TRUST- new game in the town!

[fabregas]

@Amit2saxena

Another worrisome point to note is that for one of the projects, INV IT has to provide a fixed premium to NHAI @ Rs 150 cr per year.
Till now this payment is deferred by INV IT and is added to cash flows and distributed to unitholders, which looks to be inflating the payouts.
But this cannot be continued forever, the trust will have to pay this amount added cumulatively sometime sooner to NHAI.

Just to give some background on this ‘premium deferment’ issue. Some of the BOT (Toll) projects (Not just IRB, but across developers) were under stress due to lower toll collections. Payment of premium was affecting servicing of debt. The loans, provided by banks, would have become NPAs had the developers continued to pay the premium. To prioritize servicing of debt and operating expenditure, NHAI allowed the SPVs to defer payment of premium until toll collections improve. This was in the year 2014. Here were the deferment terms:

1. NHAI will allow the developer to pay 25% of what they actually owe (i.e. 25% of the annual premium) NHAI during the first 3 years; thereafter, the amount will be raised to 50%.
2. The balance amount (i.e. deferred premium) will be treated as a ‘revenue shortfall loan’ and the interest will be payable to NHAI at 2% above the bank rate. The interest rate is around 10.75%
3. The SPV will not be allowed to pay any dividend to the parent until it pays all its dues (deferred premiums for the previous years) to NHAI.

My source for deferment terms is this article - NHAI shelves premium payment of nine road projects.

The terms for the ‘revenue shortfall loan’ are mentioned in the concession agreement, which is present on IRB InvIT’s website - link (Read page 75).

Here is an extract from a news article:

A project, once classified as stressed as per the Rangarajan formula, will be allowed to postpone premium payments to the following year under Article 28 of the Model Concession Agreement. The rescheduled amount will be treated as a revenue shortfall loan. Once toll collections pick up and the revenue shortfall is eliminated, the developer will have to pay the premium along with the deferred amounts and interest thereon. The discounting rate in order to ensure that the net present value of the premia doesn’t change is determined at 10.75%.
Source: IRB is first to sign up for road premium recast, takes 2 projects to NHAI

How much is the premium?

Starts with Rs 140.4 crores and increases by 5% every year. Source: Concession agreement from IRB InvIT’s website, link above.

The above news article also mentions that:

In the case of the Tumkur-Chitradurga project, the premium sought to be postponed is Rs 90 crore.

So IRB has not deferred the entire premium payment. And by now IRB must be paying almost 100% of the annual premium. The cashflows statement of IRB Tumkur Chitradurga Tollway Limited (source: Half year report September 2019. Link) confirm this:

The report says it paid a premium of Rs 139 crores in FY19.

@Amit2saxena Please correct me if I am wrong somewhere.

Appendix

1. NHAI shelves premium payment of nine road projects
2. IRB is first to sign up for road premium recast, takes 2 projects to NHAI
3. IRB Tumkur Chitradurg Concession Agreement
4. IRB InvIT Half Year Report Sep 2019

[pk89]

In short this will eat into divided payment and keep on increasing every year? Unless the revenue increases every year the dividend will reduce.

[Amit2saxena]

Thanks fabregas for initiating my interest to IRB INVIT after a long time. Your observations regarding deferred NHAI Premium for Tumkur Chitradurga is not correct . IRB InvIT is still deferring it and hence, the amount is reduced from net distributed cash flow. Check the FY 17-18 annual report and you will find exactly the same trend there also.

I have a questions that need answer:

IRB Profit and Loss Statement shows Profit of ~ 200 Cr during FY18 & FY19, however, Income tax deduction is miniscule (33 Lakh in FY18 and 1.5 Crore in FY19). Why?

@dd1474 Can you please help?

[fabregas]

@Amit2saxena

Your observations regarding deferred NHAI Premium for Tumkur Chitradurga is not correct . IRB InvIT is still deferring it and hence, the amount is reduced from net distributed cash flow.

I think you are partially right. The premiums are still being deferred but not to the tune of 100%.

I just checked the valuation report and for FY20 the projected interest paid on deferred premium is about Rs 13.7 crores. The valuation report also mentions that the interest rate on deferred premium is 7.65%, which implies the total accumulated deferred premium is about Rs 179 crores. So over the last 5 years they have accumulated about 179 crores of deferred premium.

The valuation report also says that about Rs 125 crores in premium and deferred premium (from previous years) would be paid in FY20 Oct 2019 to Mar 2020 (6 months) . This is actual cash outflow and not a notional/non-cash item.

However I am not quite sure about this. I will make it a point to ask this to the management during the next conference call.

[Amit2saxena]

The screen shot you have attached are all projected numbers of future years, not real cash flows.
Looking at these number, I understand the expectation is to pay premium, for example of 125 Cr in FY20. Also look at future years of premium payment projection (e.g. FY21 - 224 Cr, FY22- 205 Cr etc), basically meaning that expect to pay lot more premium in the future, given they have not paid it in the past.
Overall, I dont know how much it will impact the valuation, probably @dd1474 will be the best person to answer

[Amit2saxena]

Let us have a closer look:
If we look factually , two projects (Tumkur and Pathankot) have negative Net Distributable Cash Flow (explained below) and other two (Surat related) will vanish in 3 years.

So, we will be left with only 3 projects. Off course, this is a pessimistic scenario assuming that current projects do not improve in any substantial manner

Secondly, any addition of new project, cannot generate 20% returns (~Rs 10 yearly payout on current price of Rs 52) that is enjoyed by investors entering the stock now. Hence, new project will actually destroy value.

What can create value is buyback which looks far far off.

1. Tumkur – Chitradurga Project - a negative NDCF project , if we subtract pending NHAI Premium that are deferred (70 - 139 = -69 Cr)

2. Pathankot Project - This project is funded by external debt of 1600 Cr by the trust. Trust pays close to 160 Cr Interest on it on yearly basis. Now if you subtract this from 101 Cr of NDCF (101-160 = -59 Cr), this again has negative real NDCF.

[fabregas]

@Amit2saxena

Also look at future years of premium payment projection (e.g. FY21 - 224 Cr, FY22- 205 Cr etc), basically meaning that expect to pay lot more premium in the future, given they have not paid it in the past.

The premium increases by 5% every year. It started at Rs 140.4 crores, so by design it is an increasing expense. Also I have made a correction in the previous post - The amount Rs 125 crores is for 6 months Oct’19 to Oct 2020. For the entire year it will be around Rs 220 crores (95 crores paid during Apr-Sep 2019).

@Amit2saxena

The screen shot you have attached are all projected numbers of future years, not real cash flows.

Yes, but for FY 20 it will be closer to the real cashflows. See this line from the screenshot:

[Amit2saxena]

How did you know/ concluded that 95 cr was paid during the year (Apr-Sep 2019)

[fabregas]

See this screenshot from one of my previous posts. I have drawn a red rectangle around the line item.

@fabregas

The NDCF table has a negative entry of 9554.92 lakhs towards NHAI premium. I am assuming a negative entry in a cash flow statement implies actual cash outflow. Any non cash items like depreciation etc would be added back. Hence I concluded that around Rs 95 crores has been paid to NHAI in 6 months ending Sep 2019.

[fabregas]

I also want to share one new development from the Half Year Sep 2019 Report:

The InvIT gave a secured loan of Rs 143 crores to the sponsor (which is also the project manager since May 2019) IRB Infrastructure Developers Ltd. IRB repaid Rs 117 crores and about Rs 26 crores is due.

It looks like IRB was in urgent need of funds and borrowed from the trust. I have 2 questions about this?

1. The trust is obligated to pay atleast 90% of the NDCF. So where did this Rs 143 cr come from? From reserves and cash balances?
2. Is the InvIT not required to take unit holder approval for such a large loan to the sponsor? Even if it is not required to, I think they should have atleast informed the exchanges about this.

Rs 143 crores is almost 1 quarter worth of distribution (at Rs 2.5 per unit, 58.05 crore outstanding units).

[Amit2saxena]

This brings us to the point if investors can have trust on corporate governance of Sponsor (IRB Infrastructure). The Project Management expense in FY19 charged by sponsor have almost doubled from FY18 (67 Cr to 139 Cr)

Also if you look at balance sheet of IRB Infrastructure, debt is continuously piling up since last many years and currently stands at staggering 16000 Cr. No doubt why it trades at 3 times FY19 earnings:

[fabregas]

@Amit2saxena

The Project Management expense in FY19 charged by sponsor have almost doubled from FY18 (67 Cr to 139 Cr)

It is likely to double again this year. It has already paid about Rs 122 crores in project management fees in 6 months Apr-Sep 2019.

To be fair to the management they had mentioned that about 64 crores of additional major maintenance, over and above the usual project management fees, for the first 2 quarters of FY20. Also, the Sep 2019 valuation report mentions that about Rs 170 crores of major maintenance is scheduled for FY20.

Another point of concern is the FASTag implementation. All national highways will require payment via FASTag from 1st Dec 2019. This is likely to cause some uncertainty and volatility in toll revenues for Dec and Jan.

[deeps2884]

@Amit2saxena

Secondly, any addition of new project, cannot generate 20% returns (~Rs 10 yearly payout on current price of Rs 52) that is enjoyed by investors entering the stock now. Hence, new project will actually destroy value.

That’s a incorrect way of looking at it. Acquisition would be cash accretive if done via Debt - they would raise Debt @ ~9.0% and acquire projects with 14%-15% IRR which would add to the distributable cash flow available to Investors. Only if the acquisition is done 100% by raising fresh equity then it would lead to reduction of yield as current yield of 20%.

Further even the current yield of ~20% is incorrect representation as if you remove the 2 assets which would be ending there life in 2022. The income would fall to Rs.8 per unit giving IRB a ~16% Yield at Current Prices. I think more or less that’s the correct valuation of IRB.

IRB should ideally add 2 to 3 projects to ensure we increase the DPU and get the share price to move up. (but the management seems to be sleeping and has taken retail for a ride).

[AmitDGolchha]

My understanding on the three forms of payout to unitholders is that;

SPVs pay out Cash to trust in three forms and in turn trust pays out in the same form to unitholders -

1. Interest on loans given by trust to SPVs (this is in turn paid out as interest by trust to unit holders)

2. Repayment of loan to Trust by SPVs (this is in turn paid out as return of capital by trust to unitholders)

3. Since SPVs are repaying debt to trust, interest cost shud ideally gradually reduce, leading to SPVs making profits sometime in future. Payout out of profits from SPVs to trust will be dividend (this in turn will be paid out by trust to unitholders as dividend).

In terms of unitholders, the only difference between return of capital and dividend will be that dividend will be taxable at 10% in the hands of unitholders

[AmitDGolchha]

IRB INVIT in my sense could be beneficiary of mandatory FASTag implementation. While i am not sure of any initial 1-2 month teething issues impact, but FY21 onwards could get positively impacted. Toll collections are mostly in the form of cash and generally there are reasonable amount of leakages at various levels (toll collection local level, reporting level etc). Once FASTag is implemented, these leakages shud be plugged. So, this should lead to positive impact on cash flows.

Since IRB INVIT’s sponsor is IRB (a management not typically known for very good corporate governance), there is ought to be valuation discount to factor this. While, INVIT structure largely protects capital allocation and payouts, toll collection itself has the possibility of leakages. Post FASTag, the possibility of misgovernance with respect to Inflow (due to FASTag) and Outflow (due to INVIT Structure) both would be largely protected. This will remove uncertainty (and valuations discount) with respect to leakages and under-reporting/misgovernance possibilities in future.

This will be true only for IRB INVIT as of now and not for other road operators because they can still misgovern outflows (Capex etc).

IRB INVIT is AAA rated instrument with low debt. Next 2.5 year payout is likely to be Rs12/sh, post that the payout is likely to fall to anywhere between Rs5.5/sh (if no new projects r acquired) or Rs8.5/sh (if new projects r acquired taking debt equity to optimum levels). This i think is really good in low interest rate scenario when one is making hardly 4.5-5% post tax on FDs.

In the base case, FY23 yield is 10-11% which is likely to grow by 7-10% per annum w/o any Capex requirement except repairs.

Compared to this, for Indigrid INVIT to grow, it will require continous dilution because there is no revenue increase which can happen in the current projects. Infact, most of its projects hv been bid based on front loaded tariffs, so cash flows will reduce unless something new acquired every now and then.

Essentially Road INVITs are best in longer term because,
In transmission, there is no potential of cash flow growth in current set of projects
In REITs, for the current projects, only rental increase leads to cash flow growth
In Road INVITs, its volume + price both leads to cash flow increase (in long term, quantum will average out to somewhere around nominal GDP growth)

Only drawback in case of Road INVIT is its terminal value or essentially return of capital. However, IRR impact if no capital is returned is only 0.6-0.7% vs an instrument which returns capital at the end of life (assuming a life of 20-25 years). So return of capital in a long term instrument doesnt make much of an impact in IRRs.

Let me know if my thought process has any flows or miscalculations.

Disclosure:-
I have invested in IRB INVIT recently at Rs52-53. This is not a recommendation. Please do your own due diligence before taking any decision or consult SEBI registered advisor

[AmitDGolchha]

No, deferment is over. Its now paying current premium plus small part of Rs150cr odd premium deferred earlier. This is already accounted in current payouts

[deeps2884]

@AmitDGolchha

IRB INVIT is AAA rated instrument with low debt. Next 2.5 year payout is likely to be Rs12/sh, post that the payout is likely to fall to anywhere between Rs5.5/sh (if no new projects r acquired) or Rs8.5/sh (if new projects r acquired taking debt equity to optimum levels). This i think is really good in low interest rate scenario when one is making hardly 4.5-5% post tax on FDs.

The only flaw in your workings is Rs.5.5/ share for assets which would continue. As these assets mature they would start throwing better numbers and doesn’t factor growth during the next 2.5 years.

[AmitDGolchha]

While this is partly incorrect on part ot the management but i think to be fair, FY20 was projected to have repairs across projects and this seems to be advance against repairs. If u look at return of advance is essentially almost equal to total fees which has been paid to project managers. So probably it wasnt returned but adjusted against fees payable to IRBIDL.

[AmitDGolchha]

Thanks for ur feedback.

Yes, may be true. Thats why i hv mentioned base case or one may call it worst case. Later i will post my calculation of how i reach this number

[dd1474]

Excellent work by @fabregas and @Amit2saxena on this thread. Contratulation for bringing wonderful perspective.

I try to address my view on various points in previous few message on thread:

Income tax at InvIT:
There has been concern about lower income tax on InvIT. When I checked AR of FY19 for same, I got enclosed calculation on Page 89 of annual report for FY19

From above, I believe that the InvIT trust is exempted from income tax being Trust. Not 100% sure as could not get google link for IT Excemption under section 10 (23FC). If CA or other competent person help us, it would be great.

Premium Deferrment:
I also read whatever explanation given by Fabregas on the subject and independently checked the valuation report (Sep 2019) and results announced. I am in agreement with Fabregas that premium defered being deducted from Net cashflow available for distribution. Hence, there is no issue of upfronting of cashlfow and later on premium payment to NHAI reducing cash available to InvIT holder in future. In fact, the forecast cashflow in valuation also account for interest and along with deferment of premium.

Valuation report Sep 2019
I have concern about following assumptions used in valuation report:

1. Interest paid to NHAI on deferred payment assumed at around 7.25%, it appear very low when G-Sec for 10 year is around 6.5%. I feel interest paid to NHAI shall be same as borrowing cost of SPV else the valuation would be having benfit of 2% accruing from NHAI cashflow which increase EV in valuation in my opinion.
2. WPI at 5%. Whil valuer does indicate past 10 year WPI average at 5%, considering global siutation it may be lower than in next 10 years in my opinion.
3. Basis of 17.5% tax rate taken while calculating WACC for all project. No basis for this assumption I could get in valuation report.
4. Change in Valuer from Walker & Chandiok to Santosh N from September 2019

But for above observations, I did not see any issue. The projected traffic growth and major repair anyway depend on economy and weather condition and may undergo change over a concession period. That is the real risk along with management risk one take while investing in IRB InvIt in my view.

IRB InvIT Price and IndiGrid price comparision
On prices of InvIT, I continue to hold my position in IRB as well as Indigrid. The reduction in interest+ limited growth avenue (given the huge price difference between NAV and market price of unit) and agreement with GIC by IRB Infra could have attributated negative sentiment to stock. Having said that, I would not say market is wrong and probably perceive higher risk of business and management when consider IRB and IndiGrid. Transmission line along with change in control to KKR has resulted in increase in price of IndiGrid while toll road assets along with IRB managment has resulted in completely inverse movement (despite decline in interest rate during last 6 months) in case of IRB InvIT.

Discl: I continue to hold IRB and Indigrid InvIT. My view may be biased. I am neither SEBI registered investment advisor nor recommending investment in InvIT. Investor shall do his/her own due diligence. I reserve my divine right to be wrong in forecasting and reader shall take note of same.