Infrastructure - Sector Update & Q3FY12 Preview - Fundamentals stressed for construction sector - Centrum

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Sector Update & Q3FY12 Preview

Infrastructure

Fundamentals stressed for construction sector, but valuations ripe; asset owners better placed. ITNL & NCC our top Infra picks

m  Headwinds galore for construction sector – Macro stress, low order-tendering, intense competition, volatile operating margins and high interest expenses on elevated debt/equity, will impact construction companies’ results in the next 6m-1yr. Our CMIE report on Q3FY12 data also reflects a grim picture on project execution (indirectly, revenue of construction companies) and order-intake (as new project announcements are low).

m  We are cautious on the Infrastructure sector, particularly construction but after deep price correction, we upgrade some stocks - We believe, Q3FY12 would again produce the shocks the investors witnessed in Q2FY12 (macro issues leading to lower execution, volatile operating margins, etc). Construction companies under our coverage are expected to deliver revenue de-growth of 3% YoY (Including L&T, unrated, revenue growth is expected at 12.4%) in the quarter. However, we upgrade our recommendations on the sector purely because valuations are cheap on stock price corrections witnessed in past 3m.

m  Operating margins difficult to predict post H1FY12 results - However, we estimate 10.7% for construction companies under our coverage. Interest expense would again be a major dampener to bottom-line. We expect overall net profit to decline by 67% YoY (53% QoQ), and expect HCC and CCCL to show a loss.

m  Road developers are safer – EPC revenue from internal EPC projects will be the driving force for overall growth of all road developers. Higher interest charge will impact profit, but not in a major way. For road developers under coverage we expect revenue growth of 40%, operating profit growth of 46% and profit growth of 9%.

m  Estimates & ratings revised, ITNL and NCC top picks - We have revised estimates downwards but ratings positively on account of the prevailing macro scenario and stock price correction, respectively. ITNL and NCC are top picks in road developers & construction respectively.