Indiabulls research: Construction 2Q results preview: Waiting for pick-up

FY11 kicked-off on a rather slow note with execution disappointments across construction companies in 1QFY11. 2Q, being the ‘monsoon’ quarter, the situation is unlikely to be materially different. However, we will watch out for signs of improvement in execution as well as order flows from the results and management calls. We expect some companies (L&T, NCC, and Simplex) to deliver higher than the rather suppressed expectations. We expect the steady performance from the road developers (IRB and ITNL) to continue. NCC, Simplex and ITNL are our top picks in the sector.
Expectations are low, but look for signs of improvement
We expect the execution pace / revenue booking in 2QFY11 to remain tepid, partially led by the seasonal factor (2Q typically the worst quarter for most companies as monsoon hampers execution) and partially because of the general slowdown in execution seen in the past few quarters due to various issues such as back-ended order flows, funding, etc. However, we would closely watch out for signs of improvement and indications on possible pick-up in execution from 3Q onwards.
Result expectations in a nutshell:
1) After a sharp QoQ drop in revenues in 1QFY11, we expect L&T’s execution to pick up in 2Q and expect revenue and APAT to grow by 12.6% and 16.8% YoY.
2) Among the mid-caps, we expect NCC and Simplex to report a relatively stronger performance thanks to their diversified order-book profile, while IVRCL and HCC may disappoint
3) We expect road developers, viz., IRB and ITNL to continue on their steady growth trajectory and report strong numbers.
Valuation attractive for mid-caps: NCC, Simplex & ITNL are our top picks
Post the disappointing 1QFY11, the mid-cap construction stocks have significantly underperformed in the last few months and are trading at a significant discount to L&T (over 55%). As we move into the seasonally strong half (2H), we believe that the execution will pick up sharply from 3QFY11, backed by a strong order backlog. NCC and Simplex are our top picks due to: (1) well diversified and better quality order-book profile, (2) strong near-term earnings drivers with potential surprises on the upside, (3) relatively stronger working capital management, and (4) attractive valuations. On the road developers, we prefer ITNL due to (1) well-diversified portfolio, 2) ability for faster accretion of projects thanks to its business model, and 3) valuation comfort.