Edelweiss: Buy IVRCL Infrastructure - Concerns remain but stock correction overdone

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IVRCL Infrastructure (IVRC IN, INR 74, Buy)

n  Concerns remain but stock correction overdone

We see two major concerns in IVRCL: 1) Double whammy of execution slowdown and rise in interest costs, impacting profits in the construction business; and 2) funding issues in IVR Assets business. However, we believe these concerns are now priced in with ~50% fall in stock price in the past three months. We estimate that the core construction business is now available at 6.5x implied FY11 P/E on our revised estimates, similar to the levels during 2008 crash.

n  Management continues to guide for strong H2FY11 execution

Management has trimmed its revenue guidance to INR 60.0-62.5 bn from earlier INR 65 bn, implying a healthy 30% Y-o-Y growth in H2FY11. We have build in revenues of INR 57 bn in FY11E, cutting revenue estimates by 4-5% over FY11-12. We expect EBIDTA margins (~9.5%) to remain largely unimpacted by rising material cost as more than 90% of contracts have pass-through clauses.

n  Earnings likely to remain subdued driven by ballooning interest costs

IVRCL’s debt stands at INR 22 bn (largely unchanged from Q2FY11 end). Blended interest rates have risen 250bps Y-o-Y, to 10.5%, for working capital loans. We have further raised our interest cost forecasts by 6-9% over FY11-12, thereby lowering our earnings forecasts by 15-20% over the same period.

n  Focus shifts away from roads; back on traditional businesses

While there has been some pickup in road project awards, management believes bidding has been very aggressive, especially from smaller players. IVRCL is likely to stay away from new road project bids for now and focus on achieving financial closure and starting execution on Goa–Karnataka and Sion-Panvel projects. Focus would also be on water/irrigation business, the company’s forte, with orders expected from Madhya Pradesh, Gujarat, Bihar and Maharashtra.

n  Outlook and valuations: Attractive over medium term; maintain ‘BUY’

Considering the company’s strong order book (INR 250 bn), we expect execution to pick up over the next 1-2 quarters. However, high interest cost is likely to keep a check on earning growth.  We have valued the company on SOTP at INR 101/share (INR 162/share earlier), consisting of construction business’ INR 64/share at 10x FY12E EPS (12x earlier), IVR assets at INR 26/share and Hindustan Dorr Oliver at INR 10/share based on current market cap. We maintain ‘BUY’ on the stock and rate it ‘Sector Performer’ on relative return basis