ICICI Securities: Indian Construction Sector: Growth at reasonable valuation…

Indian Construction Sector: Growth at reasonable valuation…
The government has lined up huge infrastructure spending in the XIth
and XIIth Plan due to infrastructure deficit and to sustain its long-term
GDP providing huge construction opportunities. These opportunities
have started trickling down to construction companies (order book to
bill ratio of 3.7x in FY10, one of highest in the last five years). With the
strong order book coupled with stable EBITDA margin and stable
interest outgo (as a percentage of sales), we project a CAGR of 21.2%
and 22.5% for revenues and earnings during FY10-12E, respectively.
Considering strong earnings growth and reasonable valuation (7x-12x
FY12 adjusted PE), we remain positive on the sector. Among leading
construction companies, our top picks are NCC and SIL as we like the
quality of their order book (well diversified and lesser exposure to AP
and other contentious orders), better working capital and comfortable
leverage position.
Large construction opportunity in XIth-XIIth Plans
The government is targeting infrastructure spending of US$514 billion
and over US$1 trillion (at an exchange rate of Rs 40/US$ considered in
Plan document) in the XIth and XIIth Plan, respectively. The construction
relevant spending is US$350 billion and US$697 billion (at an exchange
rate of Rs 45/US$)) in the XI-XIIth Plans, respectively. This could
potentially provide huge construction opportunities of US$161 billion in
the XIth Plan and US$322 billion in the XIIth plan.
Robust order book to drive revenues, earnings
The huge opportunities in the XIth and XIIth Plan are already trickling
down to the leading construction companies. The leading construction
companies are already witnessing order book to bill ratio of 3.7x (one of
the highest in the last five years). Going ahead, the strong order book
would ensure revenue CAGR of 21.2% during FY10-FY12E. With this
coupled with stable EBITDA margin and stable interest expenses (due to
improvement in WC cycle), we expect leading construction companies
earnings to grow at a CAGR of 22.5% during FY10-FY12E.
Value unlocking opportunities from new businesses
To diversify revenues, a majority of construction companies have forayed
into new business areas (power generation, real estate development,
mining, etc). Although it is in a nascent stage, these ventures provide
significant value unlocking opportunities for construction companies in
the future.
Risks exist
Key risks to our call include delays in award of contracts by the
government, cost overruns from implementation risks, execution delays
due to land acquisition and manpower shortages, continued delays in AP
projects, higher interest rates and slowing of economic growth.
Outlook & Recommendation
We remain positive on the sector as we believe revenues and earnings
growth are sustainable on a long-term basis with the increased
infrastructure spending. Our top picks among leading construction
companies are NCC and SIL as we like the quality of their order book
(well diversified and lesser exposure to AP and other contentious
orders), better working capital and a comfortable leverage position.