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Infrastructure and E&C
Sector Outlook
FY12 outlook for the sector remains bright. Revenue growth is expected to pickup in FY12,
order inflow would improve on revival in industrial capex and improved ordering activity in
road sector.
Revival in execution to drive revenue growth: We expect execution-related challenges
like clearances and land acquisition will subside in FY12 for projects, which have been
awarded some time back. Government focus is also likely to increase after lull in activity for
the last 12 months or so.
Infrastructure orders to pickup pace from low base: We expect the government to
speedup the awards in road sector to meet its ambitious target of 20km/day in some
degree. While, government’s ambition of ordering out 15,000km may be ambitious, even
40% ordering would mean US$13bn worth orders. Similarly, Powergrid (PWGR IN,
Neutral, TP: Rs91, Covered by Jeff Evans) would start ordering out for its US$20bn
investment outlay for XIIth plan following its recent fund raising by FPO.
Rising interest rates weighs on corporate capex: Capex cycle has been anticipated to
pick up in 2HFY11 as GDP growth remains strong and no major capex over last three
years. However, high inflation and spectre of rising interest rates continue to weigh down.
We believe demand strength would outweigh concerns around interest rates impacting
capex plans of companies.
Operating margins to remain largely stable, rising interest rate to hurt midcap
companies: We do not expect prices of key commodities – steel and cement – to go up
sharply from current levels. This would ensure that the operating margins for the
construction companies would remain at current levels +/-50bps. Midcap companies have
a net debt: equity of 1:1 and hence, are more susceptible to rising interest costs than larger
players like L&T, BHEL and other capital goods.
All eyes on XIIth plan outlay: The government has already kicked off the process of
finalising XIIth plan outlay. Clarity on US$1tn expenditure would be a major event to watch
out for in FY12.
Sector Top Picks
Top Buy Recommendations
Larsen & Toubro (Outperform; TP: Rs2,260; Upside: 29%)
Revenue growth to surprise: We expect revenue growth momentum for L&T to continue
well into FY12. 1HFY11 results have shown that L&T is well on target to achieve 20%
revenue growth guidance in FY11. Order book coverage at 3.5x and further pick up in
execution would set pace for 25-30% revenue growth in FY12-13.
Order inflow to pickup further: With pickup in industrial capex and stabilisation of Middle
East, order inflow for L&T is expected to pickup further in FY12.
Margins to remain stable: We expect the margins in core E&C business to remain stable
at current levels of 12.5-13% in FY12. Stabilisation of revenues in Middle East would aid
margin pickup in MIP and E&E segments.
Key Near-Term Catalyst
Listing of financial subsidiaries in 1QCY11 should enable L&T to unlock huge value and
also stop financial support from parent into these subsidiaries.
Top Buy Recommendations
Crompton Greaves (Outperform; TP: Rs361; Upside: 24%)
Rationale
Revenue growth momentum to continue: Domestic business on track to deliver 15-18%
revenue growth, international business to show growth following stabilisation in Europe.
Consumer business will continue growth at 25-30%. Industrial segment to deliver 20%
revenue in FY12 following revival in industrial capex.
Scope to improve margins further: We believe CRG will continue to surprise the street
with margin improvement. Street is being too bearish on margins by building in a margin
decline in FY12 by 80bps.
Key Near-Term Catalyst
Big size order wins from Powergrid: Powergrid (has a capex outlay of US$20bn for XIIth
plan (FY13-17). Post its recent fundraising by a FPO, Powergrid is expected to speedup
project awards, which would benefit Crompton Greaves.
Top Sell Recommendations
Punj Lloyd (Underperform; TP: Rs84; Downside: -18%)
Revenue growth in FY12 at risk: Slow movement on Libyan orders (28% of US$2.3bn
order book) has led to a revenue decline in FY11. Land acquisition issues may delay the
project further.
Order inflow has dried up: In 9MFY11, the company has witnessed slack order inflows.
Further delay in order wins would create further stress on revenue growth in FY12.
Consensus numbers are unrealistic: Consensus numbers are at significant risk.
Consensus is still building 4% top-line growth in FY11 while it has reported 39% decline in
1HFY11.Consensus forecasts of 19% top-line and 67% bottom-line growth in FY12 on
poor FY11 results are bound to be disappointed.
Key Near-Term Catalyst
Risk of contractual liabilities: PUNJ might have to provide for another Rs4.9bn of
potential costs related to ONGC platform project, Ensus project and disputes with subcontractors
Suzlon (Underperform; TP: Rs42; Downside: -21%)
Gloomy wind market conditions persist in Europe and US: Vestas and Hansen in their
earnings release point to a bad state of European wind industry. Fierce competition and
delivery postponement by clients create significant uncertainty. This has created pricing
pressure continues as competition has intensified immensely. Realisation/MW in Vestas’
contracts signed in CY10 has dropped to €0.91mn (down 10% from CY09 level).
Competition from Chinese players to intensify further both in India and abroad:
Chinese players are suffering from oversupply in their domestic market (China) and, are
entering markets worldwide at prices significantly lower than the other players in those
markets.
Breakeven still sometime away: Suzlon needs sales of 2,000MW to breakeven. We
believe this is still a year away as current order inflow does not create visibility for such
high sales in FY12. Orders of c1,000MW in 9MFY11 have come mainly from India as
overseas markets remain frozen.
Key Near-Term Catalyst
Further slowdown in order inflow: Suzlon needs order inflow of 2,000MW to secure
revenue visibility for breaking even. Orders from overseas markets have dried up
completely in CY10. Any slowdown in Indian orders would bring bad news for the
company.
Switch from BHEL to L&T
Margins for BHEL to decline following huge competition: L&T has been facing
competition in most businesses for many years. Its market share in key segments like
roads, construction is in single digits, so competitive intensity may not worsen much. On
the other hand, BHEL is losing its monopoly-like status in BTG (boiler turbine generators),
which is fast turning into a four-player market. The complete impact especially on margins
is still not clear, as some new players are yet to win orders.
Order inflow for BHEL has peaked out unlike L&T: Order inflow growth remains a lead
indicator for E&C companies for future growth. We estimate BHEL order inflows in FY11
would be the same as FY09 levels, while for L&T it would be ~78% higher than FY09.
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