CONSTRUCTION Execution to pick up, but concerns on profitability persist: Q3FY11 Result Preview: Edelweiss

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CONSTRUCTION
Execution to pick up, but concerns on profitability persist: Q3FY11 Result Preview: Edelweiss


􀂄 Key highlights of the sector during the quarter
After a subdued monsoon quarter, revenue growth is likely to return in Q3FY11.
Order award activity in NHAI road BOT projects showed signs of pick up towards
the end of the quarter after a six months’ lull. We expect activity to pick up by
Q4FY11 end with a large number of projects entering the bidding process.
Orders from the industrial capex space are picking up. However, uncertainty
regarding Andhra irrigation projects continues; most companies have adopted a
‘wait-and-watch’ attitude towards these projects with some slowing/stopping
execution. Interest rates have also started inching up, albeit slowly.

􀂄 Result expectations for the sector and stocks under coverage
After a disappointing performance by construction companies in Q2FY11 on the
top line front, Q3FY11 is likely to be better as execution is expected to pick up
post the monsoon. In our coverage universe, we expect top line to grow 20% Yo-
Y and 27% Q-o-Q (ex JPA). Execution on Andhra irrigation projects will be a
key moniterable for HCC, IVRCL, and Patel Engineering.
We expect EBITDA margins (ex IRB) to improve by 40bps Q-o-Q to 12.9%.
Rising interest rates and extension in working capital cycle across many
companies implies that overall interest charges are likely to jump sharply. As a
result, PAT margins (ex IRB) are likely to dip 30bps compared to Q3FY10.
􀂄 Outlook over the next 12 months
Outlook for the construction sector is positive over the next year. We expect
order inflows to remain strong with the government’s emphasis on
infrastructure development. We expect traction in the roads space to build up
with a large number of projects slated to be awarded by NHAI. Irrigation, urban
infra, and power sectors are also expected to corner a fair share of government
focus. The increase in interest rates may hurt the realty space in FY12; as a
result, order award in the building contracting space may be impacted to some
extent. After a benign FY10 and 9mFY11, we expect both commodity prices and
interest rates to increase. However, the impact on construction companies is
expected to be minimal as the changes are more or less expected and are
unlikely to catch companies by surprise. Fund availability is not expected to be a
concern; this is likely to aid the funding-intensive construction sector, both in
the form of working capital availability and long-term funds for BOT projects. A
spate of BOT project wins as well as entry by many companies into the power
development space implies that we are likely to see a significant fund raising
exercise.
􀂄 Recommendations
Top picks: IRB Infra.