Edelweiss: Construction - Is the underperformance a buying opportunity?

While broader markets have performed excellently recently, infra contractors like IVRCL Infra (IVRCL), Nagarjuna Construction (NCC), and Patel Engineering (PEC) have missed the bus; in fact, they are trading ~20% lower than their individual peaks over the past 15 months. We analyse the reasons for the same, the likely way forward, and also try to gauge if the stock correction is a buying opportunity.

n  Is there a systemic risk across companies resulting in the correction?

We believe there is no systemic risk in the sector; reasons for correction are myriad and vary from company to company. While order booking for IVRCL has been robust, the company has disappointed on the execution front. For NCC, the sluggish order intake and negative news flow in the power and realty businesses has created problems. In case of PEC, Andhra irrigation projects still corner a significant share of the order book; the stretched working capital cycle and delay in financial closure for the power plant have further arrested the stock price..

n  Are concerns going away in the short term (next quarter)?

We believe that Q2FY11 results are likely to be weak due to heavy rains, extension in working capital cycle, and rise in short term interest rates. The value unlocking from the power and realty businesses is likely to take some more time for PEC; similarly, disappointments in these businesses for NCC are unlikely to be over soon. NHAI project award is expected to pick up only in Q4FY11.

n  Are things going to improve post Q2FY11?

We expect execution to pick up for IVRCL post Q2FY11 since there is no common theme in the reasons for past disappointments on the revenue growth front and the same were beyond the company’s control. In case of NCC, the exact quantum of the likely losses on the power plant and any cancellations in the Dubai realty project will be clear post the quarter, thus eliminating uncertainty on the same. Diversified segmental presence of NCC means that orders will flow, sooner or later. With execution on PEC’s realty projects picking up, profitability will improve considering that the projects have much inherent embedded value; we expect tangible action on the power plant by Q4FY11. 

n  Is there a valuation comfort? Is it time to buy?

Infra contractors are currently trading at a 30-40% discount to their long term trading multiples. We believe the situation will improve over the next couple of quarters and the de-rating which has happened over the past year will reverse. We believe it is an opportune time to buy these stocks with 6 months- 1 year perspective.