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India Industrials
Q3 FY11 earnings preview
E&C: Execution pickup should drive healthy earnings
growth; however, rising interest costs could play spoilsport
Capital Goods: We see strong execution, stable margins,
and robust earnings growth
Valuations, though, remain full for Capital Goods, while
underperformance by E&C stocks offers investment
opportunity; L&T, IRB, and NCC are our favourite plays
Engineering & Construction: We expect the companies to report improved top-line
growth for Q3 FY11: +26% for Larsen & Toubro and 18% for mid-cap E&C. While order
inflows reported by E&C companies during Q3 FY11 fell substantially, we believe the
market will focus more on execution, as book-to-bill remains at a cycle high of 3.0-3.5x.
We expect L&T to report slower earnings growth of 10% y-o-y, while mid-cap E&C
players should report healthy growth of 18% y-o-y. We believe that the market could react
negatively about L&T in the near term owing to weak earnings growth, while near-term
upside among mid-cap players could be limited owing to risk to earnings from rising
interest costs.
Capital Goods: We expect robust Q3 FY11 top-line growth of c17-57%, driven by strong
opening order books. We do not expect any deterioration in margins, which should help
companies report strong earnings growth of 20-50%. However, we do not expect this to be
a stock-moving event, as valuations already factor in the earnings growth, in our view.
E&C valuations attractive; near-term weakness could provide select opportunities:
The E&C segment ex-L&T sharply underperformed the market in CY2010, as slow
execution and a weak funding environment affected earnings growth. However, we
remain positive about long-term growth prospects, and any weakness in the stocks should
offer a good investment opportunity, in our opinion. L&T, IRB Infrastructure, and
Nagarjuna Construction remain our favourite plays.
Valuation in the Capital Goods group remains full, in our view. We do not expect
strong Q3 FY11 earnings to lead to earnings multiple expansion.
Company-specific comments
Engineering & Construction (E&C)
Larsen & Toubro: We expect L&T to report robust revenue growth of 26% y-o-y, as execution picks up
following the monsoon season along with new projects awarded during CY2010 reaching the revenue booking
stage. The company had an order book valued at INR1.15trn as at end H1 FY11, and we expect robust order
inflows of cINR120bn for 3QFY11 (L&T already announced INR110bn of new orders in Q3 FY11). While we
expect EBITDA margins to increase by c20bps for 3QFY11, a rise in debt to fund infrastructure assets and
equity in subsidiaries is likely to increase interest expenses – we expect interest cost-to-sales to increase from
1.6% in Q3 FY10 to 1.9% for Q3 FY11) and a normal tax rate of 34% for Q3 FY11; the latter was lower at
30% in Q3 FY10.
IRB Infrastructure: We expect IRB to experience 66% revenue growth, the highest in our coverage universe,
driven primarily by the construction segment, 67% y-o-y, and revenue growth in like-to-like toll assets of a
mere 2% y-o-y for Q3 FY11. We expect EBITDA margins of 41.5%, which has an upside risk, depending on
the construction margin (in-house business) being booked. We expect earnings growth of 29% y-o-y. IRB
appears likely to be a leading beneficiary of road projects valued at USD2.5-3bn that are expected to be
awarded by the National Highways Authority of India (NHAI) in 4QFY11.
Nagarjuna Construction: We expect NCC to report stable revenue growth of 16% y-o-y on expectations of a
pickup in execution on its diversified order book. And we expect the EBITDA margin to taper down by 10bps
y-o-y to 9.8% on an expectation of increased commodity costs. We do not anticipate any major impact on
working capital, and hence interest cost expense appears likely to remain stable. We expect NCC to deliver
c17% earnings growth. Status on the relocation of its 1,320MW power plant and data points on its operational
toll assets will be the key things to watch out for during Q3 FY11.
IVRCL Infrastructure: Revenue growth should remain stable at c18% for Q3FY11, driven primarily by an
improved funding position of IVRCL Assets (the subsidiary holding toll-road assets).We expect Andhra
Pradesh orders, which account for c19% of the order book outstanding, to continue to remain a drag on
execution; however, the impact should wane as new projects start contributing. We expect IVRCL to be hit by
rising leverage on its balance sheet. We estimate interest cost will grow from 3.1% of sales in Q3 FY10 to
3.5% in Q3 FY11, owing to a weakened working-capital position, thereby delivering earnings growth of a
mere 11% y-o-y for Q3 FY11.
Punj Lloyd: We expect Punj to continue to disappoint on execution, mainly on its non-moving Libya
orders, c35% of the order book. This appears likely to push revenues down by 15% y-o-y for Q3 FY11.
EBITDA margins are likely to fall by c250bps owing to a change in the order book mix in favour of lowmargin infrastructure orders. Additionally, increased interest costs are likely to impact profit growth
much harder, reflected in our weak earnings growth estimate of c46% for Q3 FY11.
Hindustan Construction: We expect HCC to report 18% revenue growth for Q3 FY11 on the back of a
pickup in execution following the monsoon season. HCC’s Q3 FY10 EBITDA margin was lower because
of a margin mix favouring transportation projects. This, in our view, will have changed during Q3 FY11
with the EBITDA margin retreating to 12.5%. However, increased funding costs – we expect interest
cost-to-sales to increase to 7.0% for Q3 FY11 from 5.6% in Q3 FY10 – should eat into profit margins,
thereby keeping our profit growth estimate at a mere 18.5% y-o-y for Q3 FY11.
Simplex Infrastructure: We expect Simplex to report c10% growth in revenues for Q3 FY11 on the
back of weak order inflows over the past 18 months. The company has said it has witnessed improved
momentum in order inflows, and we expect it to report INR18-20bn of new orders for Q3 FY11.
EBITDA margins should remain stable at 9.9%. The key issue to watch out for would be the workingcapital cycle, as the company already has high debt/equity of 1.3x. We expect interest cost-to-sales to
increase from 2.4% for Q3 FY11 to 2.9% in Q3 FY11, thereby restricting earnings growth at 22% y-o-y.
The earnings growth rate, which is higher than that for sales, owes to a very high tax rate during Q3 FY10
on the back of a tax rate realignment during FY10.
Capital Goods
BHEL: We expect BHEL to report robust earnings growth of 24% on the back of strong growth of 24%
in revenues. However, we expect a deceleration in the order book, which can pressure future earnings, as
well as margins. Investors should concentrate on the pace of execution during Q3, as well as the order
inflow outlook, as these have been the two areas of highest concern. Investors should also look at any
announcement by the company about new ventures or areas of business focus.
Thermax India: We expect the company to report robust earnings growth of c57%, much higher than its
peers, on the back of strong revenue growth of 48% y-o-y, aided by low base effect. Investors, in our
view, are likely focus on the company’s outlook for order inflows and margin sustainability.
ABB India: We expect ABB to report 17% earnings growth, driven by 20% top-line growth. We believe
that investors will monitor write-off of costs owing to discontinuation of REC business, which has
resulted in declines in margins over the past few quarters.
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