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IRB Infrastructure (IRB)
Infrastructure
Ahmedabad-Vadodara: Margin of safety low on a large capital investment.
Returns from IRB’s recent project win (Ahmedabad-Vadodara, Rs42 bn) are likely to be
low (13%) and heavily back-ended (FCFE break-even in FY2030E). Project, though,
seems more reasonable (16% equity IRR), including in-house construction. Margin of
safety is low based on narrow spread on variables such as base traffic, traffic shift,
growth, inflation, project cost etc. IRB is likely to be equity surplus, despite this project.
Narrow spread and very back-ended returns on a large capital investment
Prima facie analysis for the Ahmedabad-Vadodara project reveals that returns provide narrow
spread (13%) and are likely to be back-ended (FCFE break-even in FY2030E). Including in-house
construction, returns seem more reasonable at about 16% or so. Project cost is worth Rs42 bn
(including IDC and EPC) and another Rs6 bn of premium is capitalized till NH8 tolling has not
started. Equity requirement is Rs13 bn and another Rs7 bn of subordinate debt would be needed.
Margin of safety low on several key variables effecting project viability
We believe that narrow spread provide low margin of safety on variables such as (1) base traffic,
(2) traffic growth (7% growth till FY2020E and 6% thereafter) – several projects have reported
lower growth recently, (3) traffic shift – higher toll on NH8 can drive more than expected shift,
(4) inflation related toll increase, (5) debt funding (assumed at 10.5%) and associated costs.
Equity surplus even with new project; Mumbai-Pune remains key; FCFE of new ones is low
Even including the equity requirement of the recent project, the cash flows from the operational
projects and construction arm are likely to be more than sufficient. However, new projects do not
meaningfully contribute FCFE even till FY2018E, leading to over-dependence on Mumbai-Pune.
Company chose larger opportunity at slightly lower returns vs even more competitive small ones
Company has bid building in 16% equity IRR return (versus 18%) as slightly lower return on a
large opportunity is acceptable. Smaller projects are even more competitive with many smaller
construction companies qualifying for the same and possibly afford even poorer returns.
Rate ADD (TP: Rs230); as competition affords low returns in incremental projects with risks
Rate ADD as competition affords low returns in incremental projects despite company’s strengths
in terms of balance sheet and execution capability. Our SOTP-based target price of Rs230/share is
composed of (1) March-12 based FCFE of projects – Rs150, (2) construction value – Rs50 (earlier
Rs100) based on NPV of cash flows till FY2015E, and (3) Rs20 to incremental projects based on
0.5X incremental P/B on projects of 400 km.
Project returns (excl. construction cash flows) likely to be very back-ended
Our prima facie analysis of IRB’s Ahmedabad-Vadodara project win reveals that the project
returns are likely to be very back-ended in nature. The project involves a construction cost
and IDC etc. of Rs42 bn for the six-laning of the Ahmedabad-Vadodara section of NH-8
(102 km) and improvement of existing Ahmedabad Vadodara Expressway (93 km). The
project requires that the long-term growth estimates pan out with potential break-even on
equity only post 15-18 years.
Arrive at a rough valuation of Rs1.1 bn for the project
Based on a rough valuation of the project, we arrive at a FCFE-based value of Rs1.15 bn for
the Ahmedabad-Vadodara project. This implies a per share value of Rs3.4 for IRB. Key
assumptions underlying our valuation include (1) annual traffic growth of 6% throughout
the life of the project, (2) toll increase of 5% per annum, and (3) cost of equity of 12.5%.
Higher-than-expected near-term traffic and inflation may help valuation
Our model builds in a 7% traffic growth till FY2020E and 6% thereafter and 5% yoy
increase in traffic rates throughout the concession agreement period. Note that the
valuation of the project is highly sensitive to traffic growth and inflation estimates and
higher near-term traffic growth and/or inflation could significantly increase the value of the
project. The exhibit below demonstrates the sensitivity of the value to the project to traffic
growth and inflation estimates.
Construction margins aid returns but may be unsustainable considering risks
While the construction margins do aid equity returns of a project it does not boost the
returns by a very large extent. We have conducted an exercise on evaluating the returns
earned including construction margins. Adding the construction margins and adjusting for
the equity investment results in an equity IRR of about 16% on the project versus potential
pure holding value of only about 13%.
Full incidence of taxation on construction profits reduces the return benefit of having inhouse
construction. Higher construction margins and thus high profits lead to significant
value leakage as tax.
Majority of companies have in-house construction; makes it necessary for
competitiveness
We note that majority of the road developers have in-house construction capabilities such as
L&T, Sadbhav Engg, IVRCL, HCC etc. This makes necessary for companies to develop inhouse
capabilities in order to remain competitive in the field. Several players such as GMR
Infra, GVKPIL and ITNL which used to earlier sub-contract the construction are also
developing in-house capabilities.
Equity surplus even including recent project; however over-dependence on
Mumbai-Pune remains significant
IRB would now have a total project portfolio of 16 road project (including the Ahmedabad-
Vadodara project) of which nine are operational and seven are under construction/
development. The under construction/ development projects are likely to have a total equity
requirement of Rs27-28 bn over FY2011-18E. We believe that this would be more than met
by the cash flows from the operational projects (FY2011-18E cumulative FCFE of Rs24 bn)
and the construction arm (FY2011-15E cumulative FCFE of Rs19 bn) of the company.
Majority of the cash flows from the operational projects is derived from the Mumbai-Pune
project. The new projects do not meaningfully contribute to the cash flows of the company
till FY2018E, leading to continued over-dependence on the Mumbai-Pune project
Ahmedabad-Vadodara project details
IRB recently announced that it has been declared as the preferred bidder for NHAI’s
Ahmedabad-Vadodara project. The project consists of two sections, (1) six laning of the 2
lane Ahemdabad-Vadodara section on NH-8 (102 km) and (2) improvement of existing
Ahemdabad-Vadodara expressway (93 km). NHAI awarded the project to IRB as part of
phase V of its NHDP program on a Design Build Finance Operate Transfer toll (DBFOT) basis.
The total construction cost of the project is estimated at Rs42 bn over the 3 year
construction period. The concession agreement stands for 25 years. IRB has offered an
annual premium of Rs3.1 bn (annual increase of 5%) for the tolling rights of the project
Rate ADD as competition affords low return in incremental projects despite
company-specific strengths
Rate ADD (from BUY earlier) as competition affords low returns in incremental projects in
spite of company’s strengths in terms of balance sheet and execution capability. Our SOTPbased
target price of Rs230/share is composed of (1) March-12 based FCFE of projects –
Rs150, (2) Construction value – Rs50 (earlier Rs100) based on NPV of cash flows till FY2015E,
and (3) Rs20 to incremental projects based on 0.5X incremental P/B on projects of 400 Km.
We have reduced our construction value for following reasons: (1) Construction is
conducted at unusually high margins of 18-20% and thus placing a high multiple (6X
EV/EBITDA earlier) on that creates risk of overvaluation, (2) construction is completely inhouse
and thus construction earnings are capital expenditure costs for a sister concern and
thus placing a multiple on that is inappropriate, (3) we have separately valued the potential
value from new projects and thus placing a long-term value multiple on construction
overvalues the future potential, (4) construction earnings are incrementally useful for
bringing the projects to basic level of viability as we observed in Ahmedabad-Vadodara
project.
We are now valuing construction as present value of cash flows to be generated from that
business till FY2015E.
Ascribe Rs20/share to potential to win new projects – 400 km projects at P/B of 1.5X
Our SOTP-based target price of Rs300/share comprises Rs20/share for value from
incremental project wins. We expect IRB to win additional projects to the tune of about 400
km. Assuming an average project cost of about Rs110 mn/km and a debt:equity of 70:30,
these projects would require an equity investment of Rs13-14 bn. We have valued this at
1.5X book value - Rs6.6 bn or Rs20/share.
Lower-than-expected traffic growth & base traffic is key risk
Lower-than-expected traffic growth and base-year traffic assumption remains the key risk to
the value of BOT projects. A 1% lower traffic growth assumption for the full period of the
concession period results in 27% lower value for road projects versus our target value and a
15% impact on our target price.
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
IRB Infrastructure (IRB)
Infrastructure
Ahmedabad-Vadodara: Margin of safety low on a large capital investment.
Returns from IRB’s recent project win (Ahmedabad-Vadodara, Rs42 bn) are likely to be
low (13%) and heavily back-ended (FCFE break-even in FY2030E). Project, though,
seems more reasonable (16% equity IRR), including in-house construction. Margin of
safety is low based on narrow spread on variables such as base traffic, traffic shift,
growth, inflation, project cost etc. IRB is likely to be equity surplus, despite this project.
Narrow spread and very back-ended returns on a large capital investment
Prima facie analysis for the Ahmedabad-Vadodara project reveals that returns provide narrow
spread (13%) and are likely to be back-ended (FCFE break-even in FY2030E). Including in-house
construction, returns seem more reasonable at about 16% or so. Project cost is worth Rs42 bn
(including IDC and EPC) and another Rs6 bn of premium is capitalized till NH8 tolling has not
started. Equity requirement is Rs13 bn and another Rs7 bn of subordinate debt would be needed.
Margin of safety low on several key variables effecting project viability
We believe that narrow spread provide low margin of safety on variables such as (1) base traffic,
(2) traffic growth (7% growth till FY2020E and 6% thereafter) – several projects have reported
lower growth recently, (3) traffic shift – higher toll on NH8 can drive more than expected shift,
(4) inflation related toll increase, (5) debt funding (assumed at 10.5%) and associated costs.
Equity surplus even with new project; Mumbai-Pune remains key; FCFE of new ones is low
Even including the equity requirement of the recent project, the cash flows from the operational
projects and construction arm are likely to be more than sufficient. However, new projects do not
meaningfully contribute FCFE even till FY2018E, leading to over-dependence on Mumbai-Pune.
Company chose larger opportunity at slightly lower returns vs even more competitive small ones
Company has bid building in 16% equity IRR return (versus 18%) as slightly lower return on a
large opportunity is acceptable. Smaller projects are even more competitive with many smaller
construction companies qualifying for the same and possibly afford even poorer returns.
Rate ADD (TP: Rs230); as competition affords low returns in incremental projects with risks
Rate ADD as competition affords low returns in incremental projects despite company’s strengths
in terms of balance sheet and execution capability. Our SOTP-based target price of Rs230/share is
composed of (1) March-12 based FCFE of projects – Rs150, (2) construction value – Rs50 (earlier
Rs100) based on NPV of cash flows till FY2015E, and (3) Rs20 to incremental projects based on
0.5X incremental P/B on projects of 400 km.
Project returns (excl. construction cash flows) likely to be very back-ended
Our prima facie analysis of IRB’s Ahmedabad-Vadodara project win reveals that the project
returns are likely to be very back-ended in nature. The project involves a construction cost
and IDC etc. of Rs42 bn for the six-laning of the Ahmedabad-Vadodara section of NH-8
(102 km) and improvement of existing Ahmedabad Vadodara Expressway (93 km). The
project requires that the long-term growth estimates pan out with potential break-even on
equity only post 15-18 years.
Arrive at a rough valuation of Rs1.1 bn for the project
Based on a rough valuation of the project, we arrive at a FCFE-based value of Rs1.15 bn for
the Ahmedabad-Vadodara project. This implies a per share value of Rs3.4 for IRB. Key
assumptions underlying our valuation include (1) annual traffic growth of 6% throughout
the life of the project, (2) toll increase of 5% per annum, and (3) cost of equity of 12.5%.
Higher-than-expected near-term traffic and inflation may help valuation
Our model builds in a 7% traffic growth till FY2020E and 6% thereafter and 5% yoy
increase in traffic rates throughout the concession agreement period. Note that the
valuation of the project is highly sensitive to traffic growth and inflation estimates and
higher near-term traffic growth and/or inflation could significantly increase the value of the
project. The exhibit below demonstrates the sensitivity of the value to the project to traffic
growth and inflation estimates.
Construction margins aid returns but may be unsustainable considering risks
While the construction margins do aid equity returns of a project it does not boost the
returns by a very large extent. We have conducted an exercise on evaluating the returns
earned including construction margins. Adding the construction margins and adjusting for
the equity investment results in an equity IRR of about 16% on the project versus potential
pure holding value of only about 13%.
Full incidence of taxation on construction profits reduces the return benefit of having inhouse
construction. Higher construction margins and thus high profits lead to significant
value leakage as tax.
Majority of companies have in-house construction; makes it necessary for
competitiveness
We note that majority of the road developers have in-house construction capabilities such as
L&T, Sadbhav Engg, IVRCL, HCC etc. This makes necessary for companies to develop inhouse
capabilities in order to remain competitive in the field. Several players such as GMR
Infra, GVKPIL and ITNL which used to earlier sub-contract the construction are also
developing in-house capabilities.
Equity surplus even including recent project; however over-dependence on
Mumbai-Pune remains significant
IRB would now have a total project portfolio of 16 road project (including the Ahmedabad-
Vadodara project) of which nine are operational and seven are under construction/
development. The under construction/ development projects are likely to have a total equity
requirement of Rs27-28 bn over FY2011-18E. We believe that this would be more than met
by the cash flows from the operational projects (FY2011-18E cumulative FCFE of Rs24 bn)
and the construction arm (FY2011-15E cumulative FCFE of Rs19 bn) of the company.
Majority of the cash flows from the operational projects is derived from the Mumbai-Pune
project. The new projects do not meaningfully contribute to the cash flows of the company
till FY2018E, leading to continued over-dependence on the Mumbai-Pune project
Ahmedabad-Vadodara project details
IRB recently announced that it has been declared as the preferred bidder for NHAI’s
Ahmedabad-Vadodara project. The project consists of two sections, (1) six laning of the 2
lane Ahemdabad-Vadodara section on NH-8 (102 km) and (2) improvement of existing
Ahemdabad-Vadodara expressway (93 km). NHAI awarded the project to IRB as part of
phase V of its NHDP program on a Design Build Finance Operate Transfer toll (DBFOT) basis.
The total construction cost of the project is estimated at Rs42 bn over the 3 year
construction period. The concession agreement stands for 25 years. IRB has offered an
annual premium of Rs3.1 bn (annual increase of 5%) for the tolling rights of the project
Rate ADD as competition affords low return in incremental projects despite
company-specific strengths
Rate ADD (from BUY earlier) as competition affords low returns in incremental projects in
spite of company’s strengths in terms of balance sheet and execution capability. Our SOTPbased
target price of Rs230/share is composed of (1) March-12 based FCFE of projects –
Rs150, (2) Construction value – Rs50 (earlier Rs100) based on NPV of cash flows till FY2015E,
and (3) Rs20 to incremental projects based on 0.5X incremental P/B on projects of 400 Km.
We have reduced our construction value for following reasons: (1) Construction is
conducted at unusually high margins of 18-20% and thus placing a high multiple (6X
EV/EBITDA earlier) on that creates risk of overvaluation, (2) construction is completely inhouse
and thus construction earnings are capital expenditure costs for a sister concern and
thus placing a multiple on that is inappropriate, (3) we have separately valued the potential
value from new projects and thus placing a long-term value multiple on construction
overvalues the future potential, (4) construction earnings are incrementally useful for
bringing the projects to basic level of viability as we observed in Ahmedabad-Vadodara
project.
We are now valuing construction as present value of cash flows to be generated from that
business till FY2015E.
Ascribe Rs20/share to potential to win new projects – 400 km projects at P/B of 1.5X
Our SOTP-based target price of Rs300/share comprises Rs20/share for value from
incremental project wins. We expect IRB to win additional projects to the tune of about 400
km. Assuming an average project cost of about Rs110 mn/km and a debt:equity of 70:30,
these projects would require an equity investment of Rs13-14 bn. We have valued this at
1.5X book value - Rs6.6 bn or Rs20/share.
Lower-than-expected traffic growth & base traffic is key risk
Lower-than-expected traffic growth and base-year traffic assumption remains the key risk to
the value of BOT projects. A 1% lower traffic growth assumption for the full period of the
concession period results in 27% lower value for road projects versus our target value and a
15% impact on our target price.
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