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Jaiprakash Associates
Value unlocking appears to be prime trigger
Tight credit environment posing challenges; reiterating Hold
This note marks the transfer of primary coverage of the stock from Manish Saxena
to Chockalingam Narayanan. We met management to understand the challenges
of credit tightness on the proposed asset build up. In 9MFY11, the company
resorted to land sales to boost cash generation and offset the fall in FCF from
cement. But in the mid term, JAL may have to unlock value in upcoming power,
real estate and possibly cement assets in an effort to fund growth initiatives. We
reiterate Hold as the timing and method of value unlocking look uncertain.
Management allays fear of any short-term cash crunch for at least 12 months
However, medium-term cash requirements could reach INR50-52bn, including (1)
equity funding of INR20-25bn for thermal power projects; (2) annual cash
requirement of INR15bn for building real estate; and (3) refinancing existing loans,
etc. This may require efforts to unlock value in assets under construction.
Management remained non-committal on the timing and method.
Ability to accelerate value unlocking is the key
As per our earnings model, JAL’s options could include the securitization of the
1,000MW Karcham project, equity infusion through stake sale in power assets
(guidance of INR35bn) and sale of treasury shares (INR16.7bn at current prices).
But these calculations depend on the ability of cement producers to maintain
production discipline (cement is c55% of JAL’s total cash generation).
Reiterating Hold with a new target price of INR85/sh (earlier INR93/sh)
We have lifted FY11E earnings sharply, primarily to factor in one-time land sales
and rectify a linking error in our previous note (see p.4). Neither change has a
significant impact on valuation, although we have cut our target price to reflect a
lower exit EBITDA multiple for the EPC business (to factor in the low book to bill
ratio of funded projects). Given 43% 12m underperformance to the Sensex, we
reiterate Hold. Key upside risk is ability to unlock value at a price greater than
estimated. Key downside risk is credit squeeze impacting cost of debt servicing.
Management discussions
Management allays fears of short-term cash crunch
Medium-term cash requirements could reach INR50-52bn, including (1) equity funding of
INR20-25bn for thermal power projects; (2) annual cash requirement of INR15bn for building
real estate; and (3) refinancing the bullet repayment of banks, etc. The company may need to
unlock value in assets being constructed. Management remained non-committal on the
timing and method but felt that there is unlikely to be any short-term cash crunch for at least
12 months. Gross consolidated debt of cINR360bn in FY10 and standalone debt of
cINR210bn in 1HFY11 (requiring annual interest servicing of cINR17bn in FY12E, by our
estimates) is not an issue as JAL has a cash balance of cINR40bn in standalone books.
Jaypee Infratech does not need any further equity infusion as c12-15 m sq ft of annual real
estate construction can be funded out of its own cash flow. While there has been some
slippage (c6m to one year) in the start of tolling operations, the impact is not material. In the
power business, equity infusion can be funded out of the proposed stake sale or partly
through securitization of the upcoming Karcham project.
The other key highlights of the discussion were as follows:
„ Karcham Wangtoo and Bina I – progressing on schedule: In the power business,
management sounded confident of commissioning the Karcham Wangtoo project by
May 2011 and the Bina thermal power plant by February 2012. The machinery orders for
Bara, Karchana and Nigrie have been placed and work is progressing largely on schedule.
„ Company set to achieve 26.2mt of capacity by FY12E and 35.9mt in FY13E:
Notwithstanding the slowdown in cement demand, JAL’s capacity expansion program
continues. The company reiterated its guidance to reach 35.9m tonnes (from 22.8m
tonnes in FY10) in the coming 12-18 months. While the captive coal mine is yet to get
environmental clearance, the company is hopeful of commissioning the mine by FY13E.
„ Construction division operations will grow, but at a slower pace: While the company
has not yet provided details of the order book from funded projects (financially closed
projects – both equity and debt), it has maintained its guidance that the E&C division
should be able to grow revenues (vs. our estimate of flat growth in FY12E). However, it
stated that margins for the E&C business may be lower than in FY10 as the proportion of
hydro construction (higher margin projects) continues to dip, while the pickup in
construction activity seems to be largely from real estate. Normalized margins could
settle around 16-18%, in line with our estimates, vs. 21% in FY10. JAL is not bidding for
third party contracts given the large scope of work within the group. Improvement is
likely when hydro projects like Lower Siang and Hirong kick in towards 2HFY12E.
„ Proposal to raise up to cINR35bn in JPVL: The board of JPVL (power subsidiary) has
approved the amalgamation of the two SPVs that will operate the upcoming 1000MW
Karcham Wangtoo and 500MW Bina phase 1 projects. This, if approved by the high
courts, could potentially create a treasury stock of 371m shares (cINR15bn at the current
price) at JPVL level. The board also approved the raising of up to cINR35bn (from up to
cINR25bn earlier) through QIPs/FCCBs/ADRs/GDRs/FPO etc to fund ongoing projects.
„ Yamuna expressway targeted to start by 2QFY12E: Work on the expressway is
progressing well with likely completion by 2QFY12E. However, tolling may not start
before FY13E.
„ Focus is largely on selling volumes in real estate: Real estate business across the
parent and subsidiaries – Jaypee Infratech and Jaypee sports city – is progressing well
(c39m sq ft already sold). JAL will continue to focus on selling volumes and execution.
Forecast and valuation
Our EPS is below consensus by 51% in FY12E and 40% in FY13E
We have lifted our 2011 earnings estimates sharply, primarily to factor in one-time land sales
as well as to rectify a linking error in our previous note. Neither change had a significant
impact on our valuation, although we have cut our target price to reflect a lower assumed
EBITDA multiple in the EPC business (from 6x to 4x FY12E) to factor the low book to bill ratio
for funded projects.
Real estate land sales take up FY11E EPS by c56%. JPA has about 24m sq feet to sell in the
land parcels near the Yamuna expressway. While the company had previously indicated that
it would be looking at selling developed properties, we found to our surprise that the
company sold it partly (figure not yet disclosed) as land parcels. Accordingly, we have
assumed that the company will now sell c1m sq feet as land parcels in 4QFY11. Aligning
these additional land sales along with the sales in Q3, the company’s net income, on a oneoff basis, increases by 56% in FY11E. This has also resulted in FY12E EPS rising by 6% and
FY13E EPS falling by 3%.
Also, our revenue estimates for FY11 were erroneously understated by c5% in the report
dated 18 January 2011. We have rectified the error in this note resulting in a c20% increase
in our FY11E EPS. In addition, our revised numbers now factor in lower construction division
margins (revised downwards by 100bps) as the proportion of high margin hydropower
projects in construction looks to be lower (due to the commencement of work in hydro
power projects being pushed back).
Our revised target price of INR85/sh is 36% below consensus
For JPA, which is a conglomerate of (1) cement, construction (2) power assets and (3) roads
and real estate, our SOTP-based 12-month target price is INR85/sh, (see Figure 2), c36%
below consensus. The key change in the target price is due to the lowering of our target exit
FY12E EV/EBITDA multiple for the construction business from 6x to 4x to factor the low book
to bill for the EPC business.
„ We have estimated the value of the EPC division at INR18/share, at 4x FY12E EV/EBITDA
and at a discount to peers as c75% of sales is netted out on consolidation. Note our
multiple factors in a reduction of long-term RoE and margins for the EPC business.
„ We have estimated the value of the cement business at INR70/share, using a
replacement value of USD100/tonne. The asset valuation is comparable to its peers in
the Indian cement space
„ Power assets: are estimated at a value of INR45/share based on an average of current
market price and our target price of JPVL and adjusted for the JAL stake.
„ Jaypee Infratech – for the Yamuna Expressway we have used an NPV-based valuation
with a COE of 12.5% for the road division; we used a COE of 16.5% for the real estate
division, which is in line with our property analyst Abhay Shanbhag's assumption for
other real estate companies. An average of the value as derived above and the current
market price yields a value of INR35/share.
„ Jaypee Greens and Hotels – we have valued Jaypee Green real estate projects in the
standalone entity at INR2/share using the NPV method, while we value the hotels
division at 6x FY12E EV/EBITDA, at INR2/share.
„ We value investments at FY11E BV, while the wind power valuation is based on the
replacement value of INR6m/MW. We value JAL's treasury shares at the current price.
„ Our SOTP now factors in a conglomerate discount of 20% (same as earlier) given that
consolidated earnings now are less than standalone earnings – increasing the risk of
underestimating the inter-divisional sales. In other conglomerates within our India infra
coverage, the consolidated earnings are higher than standalone earnings.
Risks
The key downside risks to our call are: (1) any government probe into the cement price rise;
(2) ongoing quest for market share in the cement market irrespective of profitability levels; (3)
continued delay in EPC business order inflow from either group companies or third parties;
(4) cement demand growth below 8% for FY12E. Other risks are a slowdown in the real
estate markets of Jaypee Infratech, a tight liquidity environment, and competition from other
developers in EPC and power businesses. Please note that a 1% rise in cement prices from
our estimates would increase our earnings by 8.1% in FY12E and vice versa. Similarly, 1%
higher volume growth would increase our earnings by 2.4% in FY12E and vice versa.
Key upside risks: (1) convergence of consolidated and standalone earnings. A step in that
direction could reduce the conglomerate discount; (2) production discipline in the cement
sector for a period of over and above estimates of 6-7 months could drive the company's
earnings. Note that Jaiprakash has one of the highest operating leverages to upside in
cement volumes and prices. A 1% rise in cement prices raises our FY12E EPS by 8.1%,
while a 5% increase in volumes increases our FY12E EPS by 12%.
Q3FY11 results –
driven by real estate
Recurring earnings decline three quarters in a row
JAL’s standalone recurring PAT declined for the third quarter in a row by 26% YoY to
INR2.32bn in 3QFY11 as (1) softer cement realizations (down INR166/t QoQ) and higher
energy cost pressures pulled cement EBIT down by 40% YoY to INR1.42bn; (2) construction
revenues came down by 23% YoY to INR12.6bn due to the key Karcham Wangtoo and
Yamuna expressway projects nearing their commissioning stage; and (3) financing costs
jumping 22% YoY to INR3.38bn.
Revenues at INR29.5bn (+1% YoY) were largely driven by revenue from the cement (at
INR12.4bn +30% YoY) and real estate divisions (at INR4.25bn, +23%yoy). However, with
most of the large projects in the current round of construction nearing commissioning, the
construction division reported a decline in revenue booking by almost c23% YoY. Margin
pressures were lower, as the real estate business with plotted land sales showed a strong
69% EBIT margin
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
Jaiprakash Associates
Value unlocking appears to be prime trigger
Tight credit environment posing challenges; reiterating Hold
This note marks the transfer of primary coverage of the stock from Manish Saxena
to Chockalingam Narayanan. We met management to understand the challenges
of credit tightness on the proposed asset build up. In 9MFY11, the company
resorted to land sales to boost cash generation and offset the fall in FCF from
cement. But in the mid term, JAL may have to unlock value in upcoming power,
real estate and possibly cement assets in an effort to fund growth initiatives. We
reiterate Hold as the timing and method of value unlocking look uncertain.
Management allays fear of any short-term cash crunch for at least 12 months
However, medium-term cash requirements could reach INR50-52bn, including (1)
equity funding of INR20-25bn for thermal power projects; (2) annual cash
requirement of INR15bn for building real estate; and (3) refinancing existing loans,
etc. This may require efforts to unlock value in assets under construction.
Management remained non-committal on the timing and method.
Ability to accelerate value unlocking is the key
As per our earnings model, JAL’s options could include the securitization of the
1,000MW Karcham project, equity infusion through stake sale in power assets
(guidance of INR35bn) and sale of treasury shares (INR16.7bn at current prices).
But these calculations depend on the ability of cement producers to maintain
production discipline (cement is c55% of JAL’s total cash generation).
Reiterating Hold with a new target price of INR85/sh (earlier INR93/sh)
We have lifted FY11E earnings sharply, primarily to factor in one-time land sales
and rectify a linking error in our previous note (see p.4). Neither change has a
significant impact on valuation, although we have cut our target price to reflect a
lower exit EBITDA multiple for the EPC business (to factor in the low book to bill
ratio of funded projects). Given 43% 12m underperformance to the Sensex, we
reiterate Hold. Key upside risk is ability to unlock value at a price greater than
estimated. Key downside risk is credit squeeze impacting cost of debt servicing.
Management discussions
Management allays fears of short-term cash crunch
Medium-term cash requirements could reach INR50-52bn, including (1) equity funding of
INR20-25bn for thermal power projects; (2) annual cash requirement of INR15bn for building
real estate; and (3) refinancing the bullet repayment of banks, etc. The company may need to
unlock value in assets being constructed. Management remained non-committal on the
timing and method but felt that there is unlikely to be any short-term cash crunch for at least
12 months. Gross consolidated debt of cINR360bn in FY10 and standalone debt of
cINR210bn in 1HFY11 (requiring annual interest servicing of cINR17bn in FY12E, by our
estimates) is not an issue as JAL has a cash balance of cINR40bn in standalone books.
Jaypee Infratech does not need any further equity infusion as c12-15 m sq ft of annual real
estate construction can be funded out of its own cash flow. While there has been some
slippage (c6m to one year) in the start of tolling operations, the impact is not material. In the
power business, equity infusion can be funded out of the proposed stake sale or partly
through securitization of the upcoming Karcham project.
The other key highlights of the discussion were as follows:
„ Karcham Wangtoo and Bina I – progressing on schedule: In the power business,
management sounded confident of commissioning the Karcham Wangtoo project by
May 2011 and the Bina thermal power plant by February 2012. The machinery orders for
Bara, Karchana and Nigrie have been placed and work is progressing largely on schedule.
„ Company set to achieve 26.2mt of capacity by FY12E and 35.9mt in FY13E:
Notwithstanding the slowdown in cement demand, JAL’s capacity expansion program
continues. The company reiterated its guidance to reach 35.9m tonnes (from 22.8m
tonnes in FY10) in the coming 12-18 months. While the captive coal mine is yet to get
environmental clearance, the company is hopeful of commissioning the mine by FY13E.
„ Construction division operations will grow, but at a slower pace: While the company
has not yet provided details of the order book from funded projects (financially closed
projects – both equity and debt), it has maintained its guidance that the E&C division
should be able to grow revenues (vs. our estimate of flat growth in FY12E). However, it
stated that margins for the E&C business may be lower than in FY10 as the proportion of
hydro construction (higher margin projects) continues to dip, while the pickup in
construction activity seems to be largely from real estate. Normalized margins could
settle around 16-18%, in line with our estimates, vs. 21% in FY10. JAL is not bidding for
third party contracts given the large scope of work within the group. Improvement is
likely when hydro projects like Lower Siang and Hirong kick in towards 2HFY12E.
„ Proposal to raise up to cINR35bn in JPVL: The board of JPVL (power subsidiary) has
approved the amalgamation of the two SPVs that will operate the upcoming 1000MW
Karcham Wangtoo and 500MW Bina phase 1 projects. This, if approved by the high
courts, could potentially create a treasury stock of 371m shares (cINR15bn at the current
price) at JPVL level. The board also approved the raising of up to cINR35bn (from up to
cINR25bn earlier) through QIPs/FCCBs/ADRs/GDRs/FPO etc to fund ongoing projects.
„ Yamuna expressway targeted to start by 2QFY12E: Work on the expressway is
progressing well with likely completion by 2QFY12E. However, tolling may not start
before FY13E.
„ Focus is largely on selling volumes in real estate: Real estate business across the
parent and subsidiaries – Jaypee Infratech and Jaypee sports city – is progressing well
(c39m sq ft already sold). JAL will continue to focus on selling volumes and execution.
Forecast and valuation
Our EPS is below consensus by 51% in FY12E and 40% in FY13E
We have lifted our 2011 earnings estimates sharply, primarily to factor in one-time land sales
as well as to rectify a linking error in our previous note. Neither change had a significant
impact on our valuation, although we have cut our target price to reflect a lower assumed
EBITDA multiple in the EPC business (from 6x to 4x FY12E) to factor the low book to bill ratio
for funded projects.
Real estate land sales take up FY11E EPS by c56%. JPA has about 24m sq feet to sell in the
land parcels near the Yamuna expressway. While the company had previously indicated that
it would be looking at selling developed properties, we found to our surprise that the
company sold it partly (figure not yet disclosed) as land parcels. Accordingly, we have
assumed that the company will now sell c1m sq feet as land parcels in 4QFY11. Aligning
these additional land sales along with the sales in Q3, the company’s net income, on a oneoff basis, increases by 56% in FY11E. This has also resulted in FY12E EPS rising by 6% and
FY13E EPS falling by 3%.
Also, our revenue estimates for FY11 were erroneously understated by c5% in the report
dated 18 January 2011. We have rectified the error in this note resulting in a c20% increase
in our FY11E EPS. In addition, our revised numbers now factor in lower construction division
margins (revised downwards by 100bps) as the proportion of high margin hydropower
projects in construction looks to be lower (due to the commencement of work in hydro
power projects being pushed back).
Our revised target price of INR85/sh is 36% below consensus
For JPA, which is a conglomerate of (1) cement, construction (2) power assets and (3) roads
and real estate, our SOTP-based 12-month target price is INR85/sh, (see Figure 2), c36%
below consensus. The key change in the target price is due to the lowering of our target exit
FY12E EV/EBITDA multiple for the construction business from 6x to 4x to factor the low book
to bill for the EPC business.
„ We have estimated the value of the EPC division at INR18/share, at 4x FY12E EV/EBITDA
and at a discount to peers as c75% of sales is netted out on consolidation. Note our
multiple factors in a reduction of long-term RoE and margins for the EPC business.
„ We have estimated the value of the cement business at INR70/share, using a
replacement value of USD100/tonne. The asset valuation is comparable to its peers in
the Indian cement space
„ Power assets: are estimated at a value of INR45/share based on an average of current
market price and our target price of JPVL and adjusted for the JAL stake.
„ Jaypee Infratech – for the Yamuna Expressway we have used an NPV-based valuation
with a COE of 12.5% for the road division; we used a COE of 16.5% for the real estate
division, which is in line with our property analyst Abhay Shanbhag's assumption for
other real estate companies. An average of the value as derived above and the current
market price yields a value of INR35/share.
„ Jaypee Greens and Hotels – we have valued Jaypee Green real estate projects in the
standalone entity at INR2/share using the NPV method, while we value the hotels
division at 6x FY12E EV/EBITDA, at INR2/share.
„ We value investments at FY11E BV, while the wind power valuation is based on the
replacement value of INR6m/MW. We value JAL's treasury shares at the current price.
„ Our SOTP now factors in a conglomerate discount of 20% (same as earlier) given that
consolidated earnings now are less than standalone earnings – increasing the risk of
underestimating the inter-divisional sales. In other conglomerates within our India infra
coverage, the consolidated earnings are higher than standalone earnings.
Risks
The key downside risks to our call are: (1) any government probe into the cement price rise;
(2) ongoing quest for market share in the cement market irrespective of profitability levels; (3)
continued delay in EPC business order inflow from either group companies or third parties;
(4) cement demand growth below 8% for FY12E. Other risks are a slowdown in the real
estate markets of Jaypee Infratech, a tight liquidity environment, and competition from other
developers in EPC and power businesses. Please note that a 1% rise in cement prices from
our estimates would increase our earnings by 8.1% in FY12E and vice versa. Similarly, 1%
higher volume growth would increase our earnings by 2.4% in FY12E and vice versa.
Key upside risks: (1) convergence of consolidated and standalone earnings. A step in that
direction could reduce the conglomerate discount; (2) production discipline in the cement
sector for a period of over and above estimates of 6-7 months could drive the company's
earnings. Note that Jaiprakash has one of the highest operating leverages to upside in
cement volumes and prices. A 1% rise in cement prices raises our FY12E EPS by 8.1%,
while a 5% increase in volumes increases our FY12E EPS by 12%.
Q3FY11 results –
driven by real estate
Recurring earnings decline three quarters in a row
JAL’s standalone recurring PAT declined for the third quarter in a row by 26% YoY to
INR2.32bn in 3QFY11 as (1) softer cement realizations (down INR166/t QoQ) and higher
energy cost pressures pulled cement EBIT down by 40% YoY to INR1.42bn; (2) construction
revenues came down by 23% YoY to INR12.6bn due to the key Karcham Wangtoo and
Yamuna expressway projects nearing their commissioning stage; and (3) financing costs
jumping 22% YoY to INR3.38bn.
Revenues at INR29.5bn (+1% YoY) were largely driven by revenue from the cement (at
INR12.4bn +30% YoY) and real estate divisions (at INR4.25bn, +23%yoy). However, with
most of the large projects in the current round of construction nearing commissioning, the
construction division reported a decline in revenue booking by almost c23% YoY. Margin
pressures were lower, as the real estate business with plotted land sales showed a strong
69% EBIT margin
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