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Engineering and Construction
Poor execution momentum, delayed payments and weak order flow
momentum remain the story in this sector. We expect moderate revenue
growth (5%-10%) in 3QFY12 for most players and expect EBITDA margins
to decline on a YoY basis due to rising material costs, under-absorption of
fixed overheads and higher interest rates impacting hiring and
subcontracting costs. However, the key will be — declining PBT and PAT
margins given the continuing ruthless impact of high interest rates on
rising leverage due to payment delays. In the E&C space, we prefer
companies such as such as EIL, Voltas, VA Tech and KNR for their superior
balance sheets (low leverage) and strong competitive position.
Muted revenue growth of 5%-10% in 3QFY12E: Similar to 1HFY12, existing
infrastructure projects are currently slow moving, due to either regulatory issues or
slowdown in the pace of public/private investments in the existing projects. Our
interaction with industry participants highlights that the higher interest rates and
credit pullbacks by bankers to project developers, are keeping project awards and
execution slow. Order flow remains subdued with only small pockets of
opportunity arising from the buildings, roads, healthcare and hospitality sectors.
Rising debt will lower net earnings on a YoY basis: Barring EIL, VA Tech and
KNR, we expect EBITDA and PBT margins to decline (YoY) by 50bps-500bps and
100bps-700bps respectively, for E&C companies under coverage. Execution
slowdown and payment delays are increasing the cash requirements for most of
the E&C companies. Companies with low/nil leverage (EIL, Voltas, VA Tech and
KNR) are better placed to handle the near-term challenges compared to
companies with high debt (IVRCL, CCCL, NCC and Blue Star) which will see a
sharp decline in their net earnings in 3QFY12.
Preparing for the upcoming results
For the construction companies (IVRCL, CCCL, KNR and NCC), we model revenue
growth of 3%-8% (YoY) and PBT margin in the range of 2.0%-2.5% (ex-KNR) for
3QFY12. For the MEP players (Voltas and Blue Star), we expect revenues to remain
flat or marginally decline (YoY) as we expect poor execution/weaker demand in
projects and products businesses. Increasing competition and rising costs will result
in a sharp YoY decline in EBITDA margin (300bps-500bps) in both the businesses.
For VA Tech and EIL (pure project management companies), we expect revenues to
grow by 8% and 25%, and EBITDA margin by 9% and 21% respectively.
Ambit v/s consensus
For 3QFY12, whilst our IVRCL’s and NCC’s revenue estimates are 3%-4% lower
than consensus, our PBT estimates are 33% and 9% lower than consensus,
respectively. Our assumptions of higher interest costs (due to increasing debt levels
for funding BOT assets and working capital needs) keep our PBT estimates lower
than consensus. For Voltas, whilst our revenues are 3% lower than consensus, our
PBT is 50% below consensus as we expect significant YoY decline in the EBITDA
margin for the MEP players. For other E&C companies — Blue Star, EIL, VA Tech,
KNR and CCCL — there are no quarterly consensus estimates available.
Recommendation
A decline in interest rates could lead to a marginal upswing in the stock prices and
valuations of E&C companies in the near term. However, valuations will face
resistance on the upside as companies find themselves with high debt:equity and
starved of capital needed for growth. In the current uncertain environment, we
prefer companies with excellent execution/project management capabilities,
history of high RoCEs and free cash flow generation and strong balance sheet. We
maintain our BUY stance on EIL, Voltas and VA Tech.
Blue Star (BLSTR IN, mcapUS$280mn, SELL, TP `147,
11% downside)
Why are we revising our estimates? We lower our order flow and revenue
growth estimates for the EMP segment in FY12E and FY13E due to lower-thanexpected
order flow in 1HFY12 (~19% YoY decline considering only EMP segment
revenues) and weak order flow momentum expected over next 12 months in the
fast moving commercial real estate sector. In the cooling products segment, whilst
Blue Star’s recent entry into residential room air-conditioning (RAC) segment will
drive growth ahead of peers (mainly Voltas), increasing competition from Japanese
players will limit growth to 14%-16% compared to our earlier estimate of ~20%.
We lower our FY12 and FY13 EBITDA margin estimates due to: (a) rising raw
material prices, (b) rupee depreciation against the dollar resulting in higher costs
for imported manufacturing parts, and (c) increasing competition leading to
aggressive bidding. In 1HFY12, whilst Blue Star reported a PBIT loss in the EMP
segment, PBIT margins declined by ~700bps in the cooling products segment. In
addition, increasing debt equity (due to increasing working capital requirement) in
a scenario of high interest rates, further lowers our FY12 and FY13 PBT estimates.
At Sept 2011, debt:equity increased to 1.1x v/s 0.9x at the end of March 2011.
Valuation and recommendation: We lower our core business value to
`145/share (`198/share earlier), maintain our SELL recommendation as we
believe that increasing leverage will impact Blue Star’s competitiveness and lead to
lower growth and profitability. Adding `2/share for Blue Star’s 30% stake in Blue
Star Infotech, our SOTP value is `147/share. Our core DCF value implies a PE of
14x based on FY13 EPS, which is lower than the 5-year historical average of 19x.
Whilst valuation is at a discount to historical averages, we expect near-term
business uncertainty to pull valuations lower. On the revised FY13 EPS of `10.3,
Blue Star is presently trading at a PE of 15x.
Voltas (VOLT IN, mcap US$479mn, BUY, TP `111, 45% upside)
Why are we revising our estimates? We lower our order flow estimate for the
domestic EMP business in FY12 and FY13 due to weak order flow momentum in
the commercial real estate and infrastructure sectors. However, we maintain our
order flow estimate for the international business as we had already modelled a
25% YoY decline in international order flows in FY12 and FY13. Whilst we lower
our order flow estimates, we marginally increase our revenue growth estimates for
the EMP segment for FY12 and FY13, as we expect faster execution of large
international projects which are expected to be completed by 1HFY13. In the
products segment, though we maintain our estimates for FY12, we moderate FY13
revenue growth to 8% as increasing competition will reduce Voltas’ market share.
Increasing competition and rising raw material prices led to a sharp decline in the
PBIT margins for both the EMP and cooling products segments in 1HFY12 (overall
PBIT margin declined by 455bps in 1HFY12). Given that competition is further
expected to increase and rupee depreciation v/s the dollar will increase the prices
of manufactured goods sourced from China, we expect EBITDA margin to decline
in 2HFY12 and FY13. Unlike peers, Voltas has a strong balance sheet (debt:equity
of 0.2x), therefore high interest rates will not further impact PBT margins.
Valuation and recommendation: We lower our core business value estimate to
`103/share (`127/share earlier), which implies a PE of 14x, which is lower than
the 5-year historical average of 16x. Adding `8/share for Voltas’s rental income,
our SOTP value is `111/share. We maintain our BUY recommendation on Voltas,
as we believe that Voltas’ core business valuations will recover faster versus peers
with the improvement in the business environment and with a gradual recognition
of Voltas’s balance sheet strength compared with limitations of peers. Voltas is
presently trading at a PE of 11x on our revised FY13 EPS of `7.2.
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
Engineering and Construction
Poor execution momentum, delayed payments and weak order flow
momentum remain the story in this sector. We expect moderate revenue
growth (5%-10%) in 3QFY12 for most players and expect EBITDA margins
to decline on a YoY basis due to rising material costs, under-absorption of
fixed overheads and higher interest rates impacting hiring and
subcontracting costs. However, the key will be — declining PBT and PAT
margins given the continuing ruthless impact of high interest rates on
rising leverage due to payment delays. In the E&C space, we prefer
companies such as such as EIL, Voltas, VA Tech and KNR for their superior
balance sheets (low leverage) and strong competitive position.
Muted revenue growth of 5%-10% in 3QFY12E: Similar to 1HFY12, existing
infrastructure projects are currently slow moving, due to either regulatory issues or
slowdown in the pace of public/private investments in the existing projects. Our
interaction with industry participants highlights that the higher interest rates and
credit pullbacks by bankers to project developers, are keeping project awards and
execution slow. Order flow remains subdued with only small pockets of
opportunity arising from the buildings, roads, healthcare and hospitality sectors.
Rising debt will lower net earnings on a YoY basis: Barring EIL, VA Tech and
KNR, we expect EBITDA and PBT margins to decline (YoY) by 50bps-500bps and
100bps-700bps respectively, for E&C companies under coverage. Execution
slowdown and payment delays are increasing the cash requirements for most of
the E&C companies. Companies with low/nil leverage (EIL, Voltas, VA Tech and
KNR) are better placed to handle the near-term challenges compared to
companies with high debt (IVRCL, CCCL, NCC and Blue Star) which will see a
sharp decline in their net earnings in 3QFY12.
Preparing for the upcoming results
For the construction companies (IVRCL, CCCL, KNR and NCC), we model revenue
growth of 3%-8% (YoY) and PBT margin in the range of 2.0%-2.5% (ex-KNR) for
3QFY12. For the MEP players (Voltas and Blue Star), we expect revenues to remain
flat or marginally decline (YoY) as we expect poor execution/weaker demand in
projects and products businesses. Increasing competition and rising costs will result
in a sharp YoY decline in EBITDA margin (300bps-500bps) in both the businesses.
For VA Tech and EIL (pure project management companies), we expect revenues to
grow by 8% and 25%, and EBITDA margin by 9% and 21% respectively.
Ambit v/s consensus
For 3QFY12, whilst our IVRCL’s and NCC’s revenue estimates are 3%-4% lower
than consensus, our PBT estimates are 33% and 9% lower than consensus,
respectively. Our assumptions of higher interest costs (due to increasing debt levels
for funding BOT assets and working capital needs) keep our PBT estimates lower
than consensus. For Voltas, whilst our revenues are 3% lower than consensus, our
PBT is 50% below consensus as we expect significant YoY decline in the EBITDA
margin for the MEP players. For other E&C companies — Blue Star, EIL, VA Tech,
KNR and CCCL — there are no quarterly consensus estimates available.
Recommendation
A decline in interest rates could lead to a marginal upswing in the stock prices and
valuations of E&C companies in the near term. However, valuations will face
resistance on the upside as companies find themselves with high debt:equity and
starved of capital needed for growth. In the current uncertain environment, we
prefer companies with excellent execution/project management capabilities,
history of high RoCEs and free cash flow generation and strong balance sheet. We
maintain our BUY stance on EIL, Voltas and VA Tech.
Blue Star (BLSTR IN, mcapUS$280mn, SELL, TP `147,
11% downside)
Why are we revising our estimates? We lower our order flow and revenue
growth estimates for the EMP segment in FY12E and FY13E due to lower-thanexpected
order flow in 1HFY12 (~19% YoY decline considering only EMP segment
revenues) and weak order flow momentum expected over next 12 months in the
fast moving commercial real estate sector. In the cooling products segment, whilst
Blue Star’s recent entry into residential room air-conditioning (RAC) segment will
drive growth ahead of peers (mainly Voltas), increasing competition from Japanese
players will limit growth to 14%-16% compared to our earlier estimate of ~20%.
We lower our FY12 and FY13 EBITDA margin estimates due to: (a) rising raw
material prices, (b) rupee depreciation against the dollar resulting in higher costs
for imported manufacturing parts, and (c) increasing competition leading to
aggressive bidding. In 1HFY12, whilst Blue Star reported a PBIT loss in the EMP
segment, PBIT margins declined by ~700bps in the cooling products segment. In
addition, increasing debt equity (due to increasing working capital requirement) in
a scenario of high interest rates, further lowers our FY12 and FY13 PBT estimates.
At Sept 2011, debt:equity increased to 1.1x v/s 0.9x at the end of March 2011.
Valuation and recommendation: We lower our core business value to
`145/share (`198/share earlier), maintain our SELL recommendation as we
believe that increasing leverage will impact Blue Star’s competitiveness and lead to
lower growth and profitability. Adding `2/share for Blue Star’s 30% stake in Blue
Star Infotech, our SOTP value is `147/share. Our core DCF value implies a PE of
14x based on FY13 EPS, which is lower than the 5-year historical average of 19x.
Whilst valuation is at a discount to historical averages, we expect near-term
business uncertainty to pull valuations lower. On the revised FY13 EPS of `10.3,
Blue Star is presently trading at a PE of 15x.
Voltas (VOLT IN, mcap US$479mn, BUY, TP `111, 45% upside)
Why are we revising our estimates? We lower our order flow estimate for the
domestic EMP business in FY12 and FY13 due to weak order flow momentum in
the commercial real estate and infrastructure sectors. However, we maintain our
order flow estimate for the international business as we had already modelled a
25% YoY decline in international order flows in FY12 and FY13. Whilst we lower
our order flow estimates, we marginally increase our revenue growth estimates for
the EMP segment for FY12 and FY13, as we expect faster execution of large
international projects which are expected to be completed by 1HFY13. In the
products segment, though we maintain our estimates for FY12, we moderate FY13
revenue growth to 8% as increasing competition will reduce Voltas’ market share.
Increasing competition and rising raw material prices led to a sharp decline in the
PBIT margins for both the EMP and cooling products segments in 1HFY12 (overall
PBIT margin declined by 455bps in 1HFY12). Given that competition is further
expected to increase and rupee depreciation v/s the dollar will increase the prices
of manufactured goods sourced from China, we expect EBITDA margin to decline
in 2HFY12 and FY13. Unlike peers, Voltas has a strong balance sheet (debt:equity
of 0.2x), therefore high interest rates will not further impact PBT margins.
Valuation and recommendation: We lower our core business value estimate to
`103/share (`127/share earlier), which implies a PE of 14x, which is lower than
the 5-year historical average of 16x. Adding `8/share for Voltas’s rental income,
our SOTP value is `111/share. We maintain our BUY recommendation on Voltas,
as we believe that Voltas’ core business valuations will recover faster versus peers
with the improvement in the business environment and with a gradual recognition
of Voltas’s balance sheet strength compared with limitations of peers. Voltas is
presently trading at a PE of 11x on our revised FY13 EPS of `7.2.
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