Macquarie Research: Nagarjuna Construction -Working capital pains to limit growth

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Nagarjuna Construction
Working capital pains to limit growth
Event
 NJCC reported disappointing 3Q FY11 results. Revenues were Rs13.4bn
(+13% YoY) and earnings were Rs0.4bn (-16% YoY).
 The significant increase in leverage and working capital is concerning and
may limit growth despite the strong order book. We are cutting our FY11 and
FY12 standalone revenue estimates by 8% and 20% factoring in a slowdown in
execution, and earning estimates by 25% and 45% factoring in higher interest
costs due to increasing working capital. Our revised target price is Rs121.

Impact
 Ballooning working capital and debt matter of real concern:  NJCC’s
working capital has significantly worsened from 170-180 days to 232 days in
FY11 till date. The net debt to equity has also increased to 1.1x as on date
from 0.8x in FY10. The working capital continues to be financed through debt,
which obviously has limits. We remain very concerned that revenue growth
could remain muted despite order book growth as company’s ability to keep
raising debt is limited, unless dilution comes through.
 Severe revenue disappointment, guidance for FY11 scaled down: NJCC
had a disappointing revenue growth of 13% in 3QFY11 and 11% in 9MFY11.
NJCC attributes a miss of Rs2bn revenues due to extended monsoon, delay
in payments from customers and delays due to land acquisition. We expect
company to miss its original guidance by 10% in FY11.
Scaling down our FY12 revenue forecast by 20%: We revised our
FY12 revenue estimate to Rs60.4bn due to limits on debt financing.
 Subsidiaries would continue to need funding: NJCC has acquired 55%
stake in 1,320MW power plant of Nelcast group by paying Rs1.5bn, which
takes out risk due to PPA signed for Sompeta power project which faced
environmental clearance issues.. NJCC has claimed that it has tied up 65% of
the debt requirement and expects to achieve financial closure by March 2011.
However, it would need equity of Rs9bn over next 3 years for the project.
Earnings and target price revision
 We have cut our FY11-FY12 EPS by 25% and 45% respectively. We have
reduced our target price to Rs121 from Rs207 to factor in higher debt, interest
costs and slower execution due to working capital issues.
Price catalyst
 12-month price target: Rs121.00 based on a Sum of Parts methodology.
 Catalyst: improvement in working capital and pickup in execution
Action and recommendation
 Reducing our target price to Rs121, maintain Outperform: We reduce our
target price to Rs121 (from Rs207 earlier). We maintain Outperform as we
think it trades at attractive valuation of 1x consolidated book value. However,
the company needs to sort out its execution problems and improve its working
capital situation to avoid further derating.