BNP Paribas: Construction: 2QFY11 Preview

Construction: 2QFY11 Preview
Revenue growth to remain muted, interest to dent bottomline
We expect muted revenue growth during 2QFY11 for the construction companies
under our coverage (Exhibit 1). Typically, 2Q is weaker relative to the other
quarters. During 2QFY11, construction activity was muted across companies and
regions on account of better-than-expected monsoons. Based on 1QFY11
performance, we estimate the companies under our coverage will have to expand
their revenues between 25% and 30% during 2HFY11 (Exhibit 2) to achieve our
full-year estimates (which are in-line with their annual guidance). Higher debt
levels should result in a 6-37% y-y increase in interest cost, while depreciation is
likely to increase by 14-25% y-y. As a result, PAT growth is likely to lag EBITDA
growth.
Stocks U/p due to slower order book conversion in 1QFY11
The companies under our coverage have underperformed the Sensex during the
last month on execution concerns (Exhibit 7). Several reasons could be attributed
to this performance. Fundamentally, topline growth during 1QFY11 was muted as
companies reported less than 10% topline growth, on average (Exhibit 3). Specific
project related delays were cited by companies for the revenue shortfall.
However, most companies have maintained their full-year guidance implying a
stronger 2HFY11 or uneven growth during the year.
BUY for 2HFY11 performance
We reiterate our BUY recommendation on IVRCL, NJCC, and HCC. We believe
the 3Q performance will be an important catalyst for these companies. Given the
strong visibility in the form of large order books (2x-3x FY11E revenue) and based
on our proprietary analysis of the orders, we think these companies are likely to
report stronger 2H. Additionally, raw material prices have been favorable, which
should help them sustain EBITDA margin. Interest costs, however, are likely to
increase due to higher debt that was used to fund working capital. Fund raising at
subsidiary (IVRCL), order wins and listing o subsidiary (HCC) will be key catalysts
for these stocks.
Valuation
The sector is trading at 22.4x or within one standard deviation from its historical
mean (16x 1-yr forward). L&T (at 27.2x FY12E) is trading above the sector mean
plus one standard deviation. However, our basket of construction names (IVRC,
NJCC, PEC and SINF) are trading below the historical mean of 16.0x 1-year
forward.