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IRB Infrastructure (IRB IN, INR 227, Buy)
Key investor concern on IRB Infrastructure (IRB) has been regarding the valuation assigned to its EPC business, given: 1) Predominantly in-house road projects; and 2) significantly higher EBIDTA margin, at ~20% against 10% for other construction companies. We attempt to incorporate these concerns in our valuation through various scenarios, as below, and conclude that even our worst case SOTP value of INR 236/share offers 5% upside on the current market price.
n Scenario–I: EPC business earns normalized margins / nil profits
Here, we assume EPC business earns EBIDTA margin of 10% instead of 20% and pass on this benefit to BOT projects through lower project cost. We use target P/E of 11x FY12 for valuing EPC business. This is higher than base case target multiple, but is still at 10-15% discount to the target multiple used to value other construction companies. In this case, EPC value nearly halves to INR 44/share, but value of BOT projects goes up 8% as project costs reduce to the extent of lower profits earned by EPC business. Our SOTP value in this case comes to INR 264/share. Further, if we assume that EPC does not earn any profits and pass on the entire benefit to BOT projects, we arrive at SOTP of INR 239 /share (with zero value for EPC).
n Scenario–II: No new project win; EPC executes only current order book
Here, we assume that the EPC executes only current order book of INR 95 bn by FY14 and then shuts down. We use DCF for valuing EPC business in this case and arrive at a value of INR 30/share (versus INR 86/share in our base case). Value for BOT projects remains unchanged and our SOTP value comes to INR 236/share.
n Outlook and valuations: Top construction pick; maintain ‘BUY’
We expect award of road projects to pick up pace in Q4FY11 and believe IRB is well-positioned to win a few. Also, we expect Q3FY11 to be a strong quarter for construction as contribution from new road projects will start to kick-in. We maintain ‘BUY’ on the stock with target price of INR 292 and rate it ‘Sector Outperformer’ on relative returns
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