ROAD INVITs – All you need to know before investing

Puspendu

Interest rates have remained low for a considerable period of time and investors all around are justifiably dissatisfied with low returns in their fixed income portfolios. REITs and INVITs become relevant in this context, given their ability to provide regular cash flows and capital appreciation at the same time. In this note, we will try to understand the risks associated with INVITs that invest in road assets, the expected return in available securities, the characteristics of the underlying assets and their ownership. We will take the example of IRB INVIT to help you understand this, as this is the only available road INVIT that is publicly traded. 

The closing price of IRB INVIT (ISIN: INE183W23014) on 6th September, 2021 was 56.54. The distributions made in the Q1 FY22 and Q4 FY21 were Rs. 1.8/- and Rs. 2.5/- per unit, respectively. So the expected yield at current prices is anywhere around 12% to 17%. The company, in the analyst call for Q1, also gave a guidance of distributions to the tune of Rs.8 – Rs.8.5/- per unit, for FY22. While this is at a significant premium in comparison to the prevailing interest rates, it is also an indicator of the risks associated with the predictability of returns, and factors that can significantly alter the outcome in comparison to the expectations. 

The first step is to understand the nature of ownership here. The roads that constitute the portfolio are not owned by the INVIT (unlike a REIT which has actual ownership). Instead, they enjoy ownership rights for a specific period as outlined in what is called a “concession agreement”. A concession agreement is a contract that gives a company the right to operate a specific business within a government’s jurisdiction or on another firm’s property, subject to particular terms. The INVIT, in this case, has the right to operate, maintain and collect toll charges on the road assets as per the terms of the “concession agreement”. The tenure of the contract is subject to reduction/extension, based on achievement of the targeted net present value as per the agreement. However, these contracts are generally long term in nature. As an investor, one needs to be aware of the residual period of the concession agreement for individual assets and their contribution to the overall operating income. We will use the IRB INVIT portfolio as an example here;

As you can see in the above table, more than 50% of the operating income (EBIDTA) is being generated from 2 assets in Gujarat(IDAA & IRBSD). Both agreements are also scheduled to end in 2022, with possible extensions on account of second wave of COVID 19. This affects the visibility of cash follows in the medium term, and return expectations thereon, will be based on the nature of new assets that the INVIT is able to acquire as replacement for these assets. Also note that the EBIDTA contribution of the IRB Pathankot Amritsar Toll Road is just 2%. Due to the ongoing farmers’ protest tolling for the project has been halted since the beginning of October, 2020. NHAI has come out with a circular covering farmers’ protest under force majeure clause of the concession agreement, whereby they will be paying 50% of the O&M and the interest cost as reimbursement in cash and an extension in the concession agreement to compensate for the revenue loss during the toll suspension period. The expected cash compensation will help to improve pay-out to the unit holders to some extent.

So, in order to evaluate if the additional returns are in line with the specific risk factors, one needs to be mindful of the following;

  • The asset mix and concentration of cash flows from individual assets in the portfolio
  • Residual period of concession agreements
  • The revenue model(asset specific) : Toll asset Vs. HAM(Hybrid annuity model) asset
  • Traffic movement and factors affecting the same
  • Event risks in the form of protests/blockades/disruption on highways.

In conclusion, the investor should expect lesser stability in distributions as compared to POWER INVITS and REITS managing commercial real estate. Therefore, the expected return in case of road INVITS need to be higher, in order to compensate for the relatively higher risk profile.

Hope the above information puts you in a better position to take an informed decision.

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