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Sintex (SINT)
Others
Concerns remain. Sintex reported 3QFY11 consolidated EBITDA at Rs1.96 bn versus our
estimates at Rs1.77bn. The outperformance has come on the back of higher execution (Rs11.86
bn vs our estimates at Rs10.69 bn) against our estimates. The EBITDA margins in 3QFY11 at
16.6% are exactly in line with our estimates. We see incremental risks and any rally on the back
of good news/results should be used to pare down exposure. Retain REDUCE rating with target
price of Rs180 based on 13X FY2012E fully diluted EPS (Rs210 previously).
Beats estimates on higher execution – EBITDA margins in line
The outperformance on the execution front has come primarily from the standalone pre-fab and
custom molding segment. In the pre-fab segment, the 3QFY11 revenues came at Rs1,770 mn
versus our estimates at Rs1,150 mn; standalone custom molding revenues came at Rs1,070 mn
versus our estimates at Rs800 mn. The EBITDA margins reported by the company are exactly in line
with our estimates at 16.6%.
Concerned on the future direction of the business
We have highlighted the rising working capital requirements of the business in our earlier notes
(refer our note dated Oct 11, 2010) which is making us uneasy. Also, we had mentioned our
dismay on the unrelated diversifications being pursued by the company in oil and gas exploration
and power business. Those concerns still remain. Our other concern is:
We see limited prospects in the monolithic business: On account of: (1) Very low entry barriers
in the business which could lead to margin dilution in the future; possibility which is not factored
in by the market. We are assuming declining margins (100 bps decline in FY2012E and FY2013E
from 18% in FY2011E) in this business. Actual decline could be more considering that the
competing construction companies don’t make more than 10-12% EBITDA margins in their core
construction business, and (2) high working capital requirements. In our opinion, a business which
is so working capital intensive has limited potential to generate significant value for investors.
Retain our REDUCE rating with target price of Rs180 (Rs210 previously)
We retain our REDUCE rating with a target price of Rs180 based on fully diluted 13X FY2012E EPS.
We have reduced our earning multiple to bring it in line with the average 1 year-fwd P/E multiple
from FY2005 onwards and also to bring it in line with the average multiples similar sectors like
construction and auto ancillaries are valued at.
We are not positive on prospects for the monolithic business
Our concerns are the following.
Very low entry barriers. Monolithic construction as a technology is used by every
construction (big or small) company in India. The entry barriers in the business by way of
prequalification requirement are very low. Also there is a large gap in the EBITDA margins
(18% versus 10-12%) generated by Sintex and other construction companies. We expect
incremental competition to dilute the current EBITDA margins being enjoyed by Sintex – a
fact which is overlooked by the market. We see some moves in the market on that front:
Nagarjuna Constructions in partnership (26:74 JV) with Paschal Formwork of Germany
has inaugurated (in April ’10) a facility in Vishakhapatnam to manufacture aluminum
formwork with a capacity to manufacture 0.2 mn sq mt of formwork.
Companies like L&T, Ahluwalia Contracts, Billimoria, and Monitor have already started
importing aluminum formwork and executing construction contracts based on the same.
Working capital intensive: We have been highlighting the deteriorating working capital
situation at Sintex (refer our note dated Oct 11, 2010). We believe any business with such
high working capital requirements (even if they are on account of government contracts) has
limited potential to create significant value for the investors in the long term.
Similar to EPC business – would struggle to generate reasonable ROEs. We note that
the character of the business is similar to other construction companies in terms of:
High working capital requirements
Low entry barriers
Largely government orders
As of now because of the low scale of the business, the impact is not evident. As the
business scales up, we expect Sintex to face similar challenges as other construction
companies have faced in the past two years.
We highlight the low P/E multiples which are being ascribed to the construction companies
at current prices (Exhibit 3). Our research team values the standalone construction
companies at an average of 12X FY2012E EPS (Exhibit 4). We argue for similar multiples to
value the monolithic business.
Other conference call highlights
The working capital in term of number of days of sales has remained constant qoq.
Company has acquired a stake of 13% in Wasaukee for US$1 mn as per the agreement
at the time of acquiring the initial stake. With this purchase, the company owns 100% of
the equity in Wasaukee.
The management explained the rationale for taking minority stake in the power SPV
(floated by the promoters) as need to reduce energy cost for the business. According to
the management, the company buys electricity from the grid at rates ranging from
Rs5/unit to Rs9/unit. With power available on a captive basis, there would be substantial
reduction in the energy costs of the company.
Retain REDUCE rating with a target price of Rs180 (Rs210 previously)
We have adjusted our earning estimates downwards for FY2012E and FY2013E marginally
on account of adjustments to our other income and interest expense estimates and reduced
our target P/E multiple from 15X to 13X on account of:
Lower multiple for monolithic business which is driving bulk of the future growth in
earnings. The management plans to rapidly scale up execution in this business as is
evident by the current acquisition of (~30% stake) Durha Constructions. As per our
understanding, the company would do further acquisitions in the construction space. In
our opinion, monolithic business should get a lower P/E multiple in line with the current
multiples being used by our research team for valuing construction companies.
Large proportion of company’s top line (~30% on FY2012E basis) comes from auto
ancillary business which is valued at similar multiples as per our understanding.
The current multiple is more in line with the average 1 year-fwd P/E multiple at which the
stock has traded from FY2005 onwards.
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