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Infrastructure
We expect the infrastructure sector to post decent numbers -
especially on the top-line front - for 3QFY2011 as the
construction activity picks up in the second half of the year.
On the earnings front the picture would be mixed as the sector
is still plagued by high interest cost owing to rising interest rates
and increasing working capital requirement leading to increase
in overall debt levels. We expect IVRCL Infra and Madhucon
Projects in our coverage universe to lag on the bottom-line
growth front for the quarter compared to its peers on account
of higher interest cost.
3QFY2011 expectations
Larsen and Toubro (L&T)
We expect L&T to record revenues of `10,202cr, a substantial
jump of 26.4% yoy. For FY2011, management has guided for
20% yoy growth in revenues, which implies growth of ~27% in
2HFY2011. On the EBITDA front, we expect margins to be flat
at 11.3% as against 11.8% in 3QFY2010. We project net profit
at `720cr, a modest increase of 3.4% yoy primarily due to higher
interest cost.
IVRCL Infra (IVRCL)
We project IVRCL Infra to clock revenue growth of ~17.8% yoy
for 3QFY2011 to `1,391cr as against management guidance
of `1,500-1,600cr, primarily on the back of the slow-moving
irrigation and road projects. Management has guided for a
minimum 18% yoy growth in revenues for FY2011, implying a
growth of ~40% in 2HFY2011, which exceeds our expectation
of reasonable growth of ~24%. We project marginal decline in
EBITDA margins at 9.2% and net profit de-growth of ~7.6%
for the quarter to `42.3cr mainly on account of higher interest
costs.
Nagarjuna Construction (NCC)
We project the company to post decent revenue growth of 22.3%
yoy for 3QFY2011 to `1,452cr. Management has guided for
revenue growth of ~20% for FY2011 (standalone), which implies
growth of >25% in 2HFY2011. We expect the company to
deliver as per management guidance given its diversified order
book and consistent performance over the past quarters. We
project stable EBITDA margins of 9.6% and net profit growth of
9.3% for the quarter to `52.3cr assuming a tax rate of 37.5%.
Hindustan Construction Company (HCC)
We project modest ~10.1% yoy growth in revenues for
3QFY2011 to `994.1cr impacted by the AP crisis and high
exposure to longer gestation period orders. We project stable
EBITDA margins at 12.6% and net profit growth of 19.2% to
`17.6cr for the quarter primarily due to the low base effect.
IRB Infra
We estimate consolidated revenue growth of ~78.9% yoy for
3QFY2011 on the back of the increase in construction and
EPC (C&EPC) revenues of `572cr for the quarter. However,
EBITDA margins are expected to decline given higher
contribution to top-line from the low-margin C&EPC segment
compared to the BOT revenues. Hence, EBITDA margins are
expected at 37.8%. We project net profit before tax and after
tax at `167.9cr and `134.4cr respectively, for 3QFY2011. PAT
is expected to increase 46.9% yoy assuming a tax rate of 20%
for the quarter.
Simplex Infra
We project a decent 17.4% yoy growth in revenues for
3QFY2011 to `1,250cr. We expect EBITDA margins to improve
by 106bp to 10.0%, which is in line with management guidance.
Net profit is expected to post a staggering ~51% jump to `34.8cr
for the quarter primarily due to the low base effect.
Key Developments
Road sector plagued by constant changes
Over the last few months, there has been a lull in the award
activity from NHAI primarily due to policy and capacity issues,
some of which are as below:
During the quarter, in its attempts to avoid a transport strike,
the government lowered the toll (base) rates slab for three-axle
commercial vehicles to `2.40/km from `3.45/km earlier. This
move is not expected to impact the road developers as the new
rate will be applicable to all future PPP projects and not affect
the already awarded projects. Thus, the new rates will not impact
the currently operational PPP projects. To that extent, it would
not impact our estimates and valuations for IRB and ITNL.
However, in the long run, we believe it could hit NHAI's financials
(which are already under pressure) in turn impacting the
awarding activity. We estimate that this road transport ministry's
agreement with the truckers could lead to a potential loss of
~`350cr annually for NHAI. Besides, we believe that it is a bad
precedent set by the government, as in the future in case of a
similar situation arising pertaining to rates, it is quite possible
that the government may once again be caught on the back
foot, which is fundamentally negative for the sector. Moreover,
new projects likely to be awarded under the new proposed toll
rate may find fewer bidders or the bidders may demand higher
viability gap funding (VGF) to make the projects viable.
Lack of a succession plan at the NHAI has impacted the
award of projects. Appointment of a successor to the outgoing
chairman, Brijeshwar Singh, is still pending. In the interim, the
ministry has asked Brijeshwar Singh, who retired on August 31,
2010, to continue for another one month after serving the three
month extension till such time a new chairman is appointed.
The finance ministry has put a cap on the yearly annuity
outgo at the total cess collected by NHAI. NHAI is expected to
receive `8,500cr as its share of road cess for the current fiscal
and its annuity payments are also expected to be in the same
range. However, the highway authority may find it difficult to
award further projects on annuity basis owing to the new cap
According to its roadmap, NHAI has to award projects worth
`40,000cr on annuity basis in the current and next fiscal.
However, the cess amount is expected to increase by mere 5.1%
a year. Under NHAI's work plan, 20% of the projects would be
awarded on BOT annuity, 65% on BOT toll and the rest on
engineering-procurement-contract basis. With this, NHAI's
annuity outgo is expected to increase to around `13,000cr. Thus
annuity cap may force NHAI to award majority of the new
projects on BOT toll basis with more VGF, so that the projects
are viable.
Lavasa under environment scanner
We have been maintaining that HCC is no longer a construction
play, as most of its value accretion is from its real estate
subsidiary - Lavasa - for which the company is seeking exorbitant
valuations and beyond our estimates. Further, as per our house
view, there are better plays in real estate, viz., HDIL and Anant
Raj, which are at very compelling valuations and at low/nil net
debt levels. Moreover, HCC/Lavasa is shrouded in controversy
- the CBI has sought details about money matters, it is facing
environment clearance issues coupled with some other alleged
irregularities. Consequently, we expect a delay in the listing of
Lavasa, which would be a negative for the stock performance
going ahead.
Thus, though our SOTP target price of `59 for HCC implies an
upside of ~20% from current levels, we recommend investors
to consider other stocks in the sector including IVRCL, NCC
and ITNL, which are also trading at attractive valuations.
Sensex v/s infrastructure stocks
The infrastructure sector stocks have taken a beating in recent
times (barring L&T) and underperformed the markets on account
of dismal 2QFY2011 performance on the earnings front.
Earnings for 2QFY2011 were disappointing, mainly for the
mid-size contractors. The slippage in the profit was due to the
lower-than-expected EBITDA margins and higher interest costs,
though top-line growth was broadly in line
The lull in execution, which we believe is temporary in nature,
was also partially responsible for the underperformance of the
sector. Nonetheless, post the lacklustre performance the infra
stocks are trading at attractive valuations, and we believe that
several stocks have limited downside from current levels.
Therefore, we remain overweight on infra and recommend
investors to seize the opportunity to increase exposure to the
sector.
Outlook
Robust medium to long-term growth prospects
The Eleventh Five-Year Plan missed its projections by ~20% in
the initial three years, and we believe that even if this
performance is maintained, it would lead to huge opportunities
for the infrastructure players. Going ahead, infrastructure
investment is projected to touch US $135bn p.a. in FY2011
and FY2012, which represents 145% growth over the last three
year's annual spend of US $55bn. Moreover, we expect the
power, road and water segments to witness maximum traction.
Favourable risk-reward ratio
The sector, after outperforming in the initial run-up from abysmal
levels, has underperformed over the last one year. As against a
17.4% return generated by the Sensex over the last one year,
most construction stocks have generated negative returns
(excluding L&T), leading to underperformance ranging from
18-50%.
Currently, the stocks are trading at attractive valuations -
available at 6-8x FY2012E earnings, excluding L&T. Also, we
expect the earnings momentum to pick up in 2HFY2011 on the
back of strong order book. From our universe, we prefer IVRCL
Infra, NCC and ITNL due to the relative comfort on the execution
front, healthy order book position and attractive valuations. We
have valued the construction companies on SOTP basis, wherein
for the core construction business we have assigned earnings
multiple of 10-14x (excluding L&T) based on certain quantitative
and qualitative factors. The listed (unlisted) subsidiaries of the
construction companies have been valued at 30% discount to
their CMP (1-1.5x book value).
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