Buy IL&FS Transportation Networks – 3QFY2011 Result Update: Angel Broking

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IL&FS Transportation Networks – 3QFY2011 Result Update

Angel Broking recommends a Buy on IL&FS Transportation Networks with a Target Price of Rs. 285.

For 3QFY2011, on a consolidated basis, IL&FS Transportation Networks (ITNL)

posted disappointing set of numbers reporting de-growth in top-line sequentially,

in-line EBITDA margins, while bottom-line came in much below expectations on

the back of subdued top-line, increase in interest cost and higher tax provision. To

reflect the delays in the pick-up in C&EPC revenues, we are revising downwards

our FY2011 and FY2012 numbers. To adjust for the overall de-rating of the

sector, we are downgrading the multiple assigned to the C&EPC arm. However,

we believe ITNL is well placed to leverage on the upcoming opportunities in the

road sector on account of being a leader with a robust order book and diversified

portfolio. Hence, we maintain a Buy on the stock.

Disappointing performance: ITNL reported top-line of `733.7cr (`883.3cr), a

sequential de-growth of 16.9% primarily due to the decline in C&EPC segment

revenues, which fell following completion of some ongoing projects and certain

newly won projects being at initial stages are yet to contribute significantly to

overall revenues. Operating margins stood at 30.1% in 3QFY2011 v/s 29.6% in

2QFY2011. Bottom-line de-grew by 42.6% mainly on account of the decline in

top-line growth, increase in interest cost and higher tax provision (~41.8%).

Outlook and valuation: There has been a lull in the award activity from NHAI

since the last couple of quarters. However, we expect the award activity to pick-up

going ahead, as NHAI has invited financial bids for projects worth `50,000cr,

which would convert over the next 3-6 months, and ITNL being the market leader

is expected to fare well. We have adopted the SOTP methodology to value ITNL

wherein we have assigned 5.5x EV/EBITDA to its standalone business and valued

its investments on DCF/Mcap/BV basis on FY2012 estimates. We maintain a Buy

on the stock, with a SOTP-based Target Price of `285, implying an upside of

27.9% from current levels.

Top-line dips due to fall in C&EPC revenues

ITNL reported top-line of `733.7cr (`883.3cr), a sequential de-growth of 16.9%

primarily due to the decline in C&EPC revenues due to completion of some

ongoing projects and certain newly won projects being at initial stages are yet to

contribute significantly to overall revenues. Contribution from Elsamex also

dropped due to foreign exchange fluctuations. ITNL achieved financial closure for

its Narketapalli-Addanki project during the quarter. However, the appointed date

for the Chenani-Nashri, Chandrapur-Warora, Pune-Sholapur and Narkattpalli-

Addanki projects is still pending, but is expected in the next few months. We expect

these projects to contribute to ITNL’s revenues in FY2012.

During 3QFY2011, ITNL’s toll collection from Vadodara-Halol, Rajkot-Jetpur and

RIDCOR (Phase 1) grew by 12.3%, 11.5% and 7.1% on sequential basis,

respectively. From October 1, 2010, toll from the Rajkot-Jetpur project was

revised, whereas the Vadodara-Halol toll revenues were auctioned in 2QFY2011.

However, Ahmedabad-Mehsana reported flat numbers as toll revenues were

auctioned. Going ahead, from April 2011, toll of the Ahmedabad-Mehsana and

Vadodara-Halol projects is expected to be hiked (WPI linked). Also, there will be a

fixed 10% toll hike from April 2011 for the RIDCOR project.

Also, contribution from the recently commissioned Beawer-Gomti project is

expected to increase in the coming quarters. We have downgraded our toll income

numbers for the Beawer-Gomti project to `20cr for FY2012 as per management

guidance.

Margins stable, earnings slip

Reduced contribution from the low-margin C&EPC segment resulted in marginal

improvement in overall operating margins to 30.1% in 3QFY2011 v/s 29.6% in

2QFY2011. Elsamex margins remained flat during the quarter to 9%. Going

ahead, margins are expected to decline as contribution from C&EPC revenues is

expected to increase.

For the quarter, bottom-line de-grew 42.6% mainly on account of subdued top-line

growth, increase in interest cost and higher tax provision (~41.8%).

Order book

ITNL’s outstanding order book currently stands at `10,600cr (8.9x FY2011E

parent’s revenues), which lends decent revenue visibility over the next few years. It

should be noted here that the order book does not include the `1,500cr

Udampur-Ramban project and the `161cr Outdoor stadium project, Kerala –

being L1 in the books as financial closure is awaited. It should be noted that ITNL

has high exposure to the J&K region (~41.7%) comprising annuity projects, viz.,

Chenani-Nashri and Udhampur-Ramban, both of which could face delays on the

execution front due to the unrest in the region.

During the quarter, ITNL did not receive any orders primarily due to the slowdown

in the award activity by NHAI. Management had guided for `20,000cr outstanding

order book at the beginning of the year, which has been scaled down considerably

given the lull in the order awarding by NHAI. However, management is hopeful of

bagging more orders going ahead as the awarding of contracts by NHAI is

expected to gather pace.

Revision in estimates

For FY2011 and FY2012, we have revised downwards our top-line estimates to

`3,204cr and `4,691cr from `3,390cr and `5,984cr respectively, to factor in the

weak 3QFY2011 performance and delays on the order awarding front. Further,

there has also been a change in the policy of recognition of revenues with 3%

upfront project development fees and the balance over the construction period as

C&EPC fees. We have revised upwards operating margins have been to factor in

the fall in contribution from C&EPC revenues for FY2011. It may also be noted

here that interest income earned by parent from the advances to subsidiaries and

general management services has been clubbed with top-line thereby increasing

our OPM estimates for FY2011 and FY2012, on standalone basis. With the

increase in interest cost owing to the BOT project requirements, earnings estimates

have been downgraded by 7.2% and 12.8% for FY2011 and FY2012, respectively

Outlook and valuation

There has been a lull in the award activity from NHAI since the last couple of

quarters. However, we expect the award activity to pick-up going ahead, as NHAI

has invited financial bids for projects worth `50,000cr, which would convert over

the next 3-6 months, and ITNL being the market leader is expected to fare well.

We have adopted the SOTP methodology to value ITNL wherein we have assigned

5.5x EV/EBITDA to its standalone business and valued its investments on

DCF/Mcap/BV basis on FY2012 estimates. We maintain a Buy on the stock, with a

SOTP-based Target Price of `285, implying an upside of 27.9% from current

levels.

We are downgrading the multiple assigned to the C&EPC arm to adjust for overall

de-rating of the sector. However, we believe ITNL is well placed to leverage on the

upcoming opportunities in the road sector on account of being a leader with a

robust order book and diversified portfolio. Hence, we maintain a Buy on the stock

with a Target Price of `285.

Investment arguments

Market leader in the growing BOT space

ITNL is a surface transport player, with an established track record of successfully

bidding, developing and operating road BOT projects on a commercial basis.

ITNL was one of the first movers in the road development segment. The company

bagged the Noida toll bridge project in 1998. Since then, ITNL has come a long

way and has a sizeable portfolio currently. The company has one of the largest

portfolios in the country, encompassing over ~7,500 lane km. ITNL’s experience

and technical capability gives it an edge over competition to bid for new projects

Pan-India presence

ITNL has 22 road projects spread across the country. The company has decent

exposure to state highways (41% of the total project capitalisation), which

differentiates it from peers. The one major advantage that state highway projects

enjoy over national highways is that they can be bundled with land, making the

projects viable. Such diversification prevents fluctuation in the company’s revenue

stream due to limited exposure to any one region or project.

Hedged revenue stream

We believe ITNL has a hedged road BOT asset portfolio currently, as it is

bi-furcated equally into toll and annuity projects in revenue terms, thereby

reducing its dependence on traffic-related revenue inflow. Going ahead as well,

we expect the company to continue to have balanced revenue, considering its

projects in the pipeline.

ITNL in sweet spot

We believe ITNL being a market leader, is well poised to leverage on the growing

opportunities in the BOT space, owing to 1) strong parentage (belongs to the IL&FS

Group), 2) experienced management at the helm of affairs (rich experience of over

22 years in the infrastructure business); 3) unique business model (present across

the value chain).

Key concerns

Interest rate: The BOT projects are inherently high leverage. Hence, ITNL’s

business model is vulnerable to interest rate fluctuations, and any hike in the

interest rates could increase its interest costs.

Commodity risks: The road players are facing pressures from the recent price

inflation in commodities like cement and steel, which directly impacts margins.

Execution delays: ITNL has faced delay in the execution of two projects (Pune

Sholapur and Moradabad Bareilly) as the appointment date was extended by

NHAI.

Awarding from NHAI: The recent lull in NHAI’s awarding of projects is a matter

of concern for pure road players like ITNL.