Macquarie Research: Jaiprakash Associates: Downgrade: Concerns on core businesses persist

Jaiprakash Associates
Concerns on core businesses persist
Event
􀂃 We revisit our investment thesis on JPA post its FY10 annual report. Leverage
has increased significantly as the company continues to invest in cement
capacity despite large oversupply. Visibility on construction business has
reduced as key projects are close to completion while new projects have been
stuck.
􀂃 We are reducing our target price to Rs105 and downgrade the stock to
Underperform. Revival in pricing power in cement and fund raising in power
would be key to make us revise our opinion on the stock.
Impact
􀂃 Margin compression in cement business to continue: We expect that key
cement markets of North and West India will remain oversupplied right into
FY13. The cement margins for JPA have corrected from Rs1,257/ton in
1QFY10 to Rs734/ton in 1QFY11. We expect it to fall further to Rs620/ton and
Rs553/ton in FY11 and FY12 respectively.
􀂃 Construction business to see significant slowdown going ahead: Two
key projects, Yamuna Expressway and Kharcham Wangtoo are close to
completion over next 18 months. The Sports City project and real estate
should add close to Rs20 of annual revenues but would not be able to
compensate for construction due to completion of larger projects. JPA would
need to start work on large hydropower project to grow E&C revenues.
􀂃 Balance sheet issue cropping up, incremental cost of debt is 11-12%:
Net debt for the parent entity has increased by Rs34.2bn mainly due to new
loans for cement plants and working capital for construction business. It’s
worth noting that the incremental cost of borrowing is 11.25-12.5%, which
would lead to a sharp increase in interest.
􀂃 Increased stake in JP Sports Private Limited to 90.6%: JPA increased its
stake in JP Sports Private Limited by 28.9% in FY10 for consideration of
Rs5bn. We are assigning little value to Sports City, as its business model for
F1 track and associated real estate is not clear.
Earnings and target price revision
􀂃 We are reducing our target price to Rs105 from Rs152 to factor in higher debt
in standalone entity, lower value for construction business.
Price catalyst
􀂃 12-month price target: Rs105.00 based on a Sum of Parts methodology.
􀂃 Catalyst: further fall in cement realisations and lack of new order inflows
Action and recommendation
􀂃 Earnings to be under pressure over next 18 months: Declining margins in
cement coupled with higher interest and depreciation cost will put standalone
earnings under pressure.
􀂃 Downgrade to Underperform from Outperform with price target of
Rs105: The reduction in price target is to factor in higher debt and reduced
revenues from construction business.