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Our meeting with VA Tech’s management suggests optimism in
the India industrial segment and indicates strong progress in
some of the overseas markets such as Turkey, Saudi Arabia
and Sri Lanka. The management targets reduction in costs in
its overseas operations by 600bps eventually by increasing
India-based support. This would enable the company to report
modest international margin improvements despite expanding
into more markets, as it has been doing. Our target P/E
multiple of 15x is in line with the increase in peer valuation.
This increases our TP to Rs491. Maintain BUY.
Higher demand expected from India industrial segment: In
India, regulation is pressurising companies to undertake effluent
treatment and use treated sea-water and sewage as in-feed instead of
municipal water. We believe that this, in conjunction with easing
interest rates, should drive industrial demand. We build in 13-14%
growth in industrial order inflow in the medium term.
Strong traction in some new international markets: The
company expects order inflow from Turkey and Saudi Arabia to begin
based on progress made by the local teams and it expects US$50m+
orders from Sri Lanka. Although progress of the JV with Sumitomo
was impacted by political turbulence in Egypt and Maldives, the
company expects a large order win in 2012. The company targets
€1bn revenue in five years, based on a mix of organic and inorganic
growth. This implies a €100m+ acquisition (see calculations inside),
which seems ambitious.
Operating leverage should drive overseas margin expansion:
Significant operating leverage is embedded since expansion into
Turkey, Saudi and Sri Lanka has seen costs hit P&L without revenue.
The management targets to reduce total cost of operations by setting
up local operations in individual markets rather than having
centralised operations in Vienna. These factors should enable the
company to preserve margins or expand them marginally even as it
extends operations to more countries.
India industrial segment poised for strong growth
India industrial sector to be the key: Industries are under
increasing pressure with regard to treatment of effluents and more
stringent regulations prevent industries from releasing effluents into
the sea without treating them. The industry is also under pressure to
use sea water as in-feed instead of municipal water. In Gujarat,
industrial in-feed in some plants from desalination is required to be
100MLD per day, which is significant. The management expects all
these to fuel higher demand for industrial water treatment.
In our view, this coupled with the easing of interest rate cycle should
support the industrial segment. We build in 13-14% growth in
industrial order inflow in the medium term.
VA Tech remains focussed on municipal projects with multilateral
funding: While municipal demand has remained sluggish so
far, some other states are contemplating desalination. This could
drive municipal order inflow in the medium term.
VA Tech prefers multilateral / bilateral funded jobs. While these
funds are at concessional rates, cost of funds increases as they are
administered down – 10% lending at state level; 15% interest rate
at municipality level. Hence VA Tech prefers to deploy its own funds
instead of taking high cost advances from customers as far as
possible.
We build in 9-10% growth in municipal order inflow in the medium
term.
Even seemingly “low-tech” projects have technological
challenges: While sewage treatment and water treatment (other
than desalination) may sound low-tech, that is not necessarily the
case. For instance, in a 450MLD surface water project for BMC, the
technological challenge was in making the footprint small. Only VA
Tech and one more competitor qualified, out of which VA Tech
emerged the winner.
Another example is the sewage treatment plant in Perungudi for
which the project cost was Rs320m, well below the Rs3.5bn cost for
a similar capacity sewage plant in the Middle East as the latter
employed a membrane bio-reactor, which is far more expensive.
Hence technology, capability and costs could be vastly different
depending on the scope of the project.
Chennai desal plant cost effective: The Chennai desalination
plant is producing water at 4.8p/litre, well below the Rs11/litre
average for bottled water. So people can afford to pay much more.
In domestic projects, average contribution margin (revenue less cost
of bought items divided by revenue) is 20-21%. The Ebitda margin
is ~12% which means that the total cost of operation is ~9% of the
revenue. The management expects this to reduce by 100 bps in the
medium term.
We build in a 100 bps stand-alone (mainly India and a few
neighbouring countries) margin expansion over FY11-16 owing to
better cost control and higher mix of O&M contracts. A 100 bps
Ebitda margin expansion would translate to ~7% increase in our TP.
Strong traction in new markets in overseas business
JV with Sumitomo expected to secure a major win in 2012:
VA Tech’s JV with Sumitomo aims at tackling large BOOT projects
internationally. The JV was close to winning new orders in Maldives
and Egypt, but political turbulence in both countries disturbed plans.
But the company expects to secure a major order win in 2012.
In such projects, 30–40% will be EPC and revenue will be spread
over three years for VA Tech. It may additionally have equity returns
from 10% ownership and for a brief period this may be negative, but
net from equity returns + EPC revenue would be positive from the
first year.
Expect strong traction in Turkey, Saudi Arabia and Sri Lanka:
The Turkish team is very bullish and expects revenue of US$25m–
30m. The team is ramping up fast, gaining experience and expects
hit rate to improve. This should eventually result in acceleration in
revenue growth.
The management anticipates US$17m–18m of orders from Saudi
Arabia. Sri Lanka projects are also reasonably large (US$50m+).
The current Dambulla order is worth US$80m. One more order from
Sri Lanka is expected in 2012.
Vast international expansion entails a need for tight monitoring. So
VA Tech has installed an ERP system that enables real-time MIS
generation for all projects, instead of instructing local teams to
prepare reports.
Focus continues on international cost control: While the
overheads in the overseas business remain high, the company has
succeeded in paring the run-rate down from US$21m in FY10 to
US$15m in FY11. The company targets $12m overheads in FY12.
Czech Republic is a low-cost market. VA Tech is trying for an
industrial hub for water in-feed, and the costs are estimated to be
1/3rd of that in nearby Austria. In Switzerland, the cost problem is
not as high as the government supports good businesses.
Operating leverage in the medium term: Significant operating
leverage is embedded since expansion into Sri Lanka, Turkey, Saudi,
Egypt and Maldives has costs in P&L without revenue. International
contribution margin has risen from 35% in FY11 to 41% in FY12,
though Ebitda is in low single digits. The management targets to
reduce total cost of operations as a proportion of revenue by 600
bps eventually by setting up local operations in individual markets
rather than having centralised operations in Vienna. Our calculations
suggest that a 100bps margin expansion could result in 6% upside
to our TP.
This makes us build stable Ebitda margin in the medium term
despite expansion into new markets. Growing revenue and
improving results from cost reduction should drive higher margin
post FY14.
Guidance and overall projections
The company expects 4QFY12 order intake to be Rs11bn. This
includes Rs5.3bn (Ulhasnagar, Aurangabad, Namibia); Rs2.2bn from
other international projects; India refinery project in which the order
award is expected soon, and this will be Rs3.5bn–4bn.
FY12 PAT will be consistent with guidance so far, i.e. Rs680m-700m,
which is based on 30% YoY growth. In FY13 PAT growth is likely to
be ~30%, based on 20% top-line growth.
We build in Rs11bn order inflow in 4QFY12 and do not change our
FY12 PAT estimate which is inline with the management guidance.
However, our FY13 revenue and EPS growth estimates are lower
than the guidance at 13% and 19% respectively.
The company targets €1bn revenue in five years, based on a mix of
organic and inorganic growth. If one assumes a 15% Cagr over five
years for organic revenue as well as inorganic revenue, 10% Ebitda
margin for the target(s) and a 4x target EV/Ebitda, the EV of the
target(s) comes to ~€125m. This is ambitious considering that
FY12ii cash balance is ~€50m.
Note that the lower-margin and faster-growing international
business keeps consolidated margins from rising despite margin
improvement modelled in India.
Maintain BUY; Increase TP to Rs491
We change our estimates marginally to take into account the higher
proportion of higher margin domestic orders in the order book as of
3QFY12. This raises our FY13 EPS by 2.8%. We largely maintain our
FY14 numbers unchanged as the mix reverses itself on Rs6bn Libya
order inflow in late FY13.
Higher target P/E results in our new TP of Rs491: Our earlier
TP of Rs416 was based on 13x 1-year forward P/E whereas peers
were trading at 12x. Now the peer group valuation has moved to
15x. Consequently we raise our target P/E to 15x. This results in our
TP increasing to Rs491 and translating into total return of 10.7%.
Figure 9: We value VA Tech at 15x P/E compared with its current 1‐yr fwd multiple of
14.4x
Item Value
Target PER 15.0
2 yr fwd PAT (Rs m) 882
M‐Cap gross of litigation risk (Rs m) 13,234
Litigation (Tax) risk amount (Rs m) 250
M‐Cap (Rs m) 12,984
#shares (m) 26
Per share (Rs) 491
CMP (Rs) 450
Upside 9.1%
Dividend per share (Rs) 7.1
Total Return 10.7%
Source: IIFL Research
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
Our meeting with VA Tech’s management suggests optimism in
the India industrial segment and indicates strong progress in
some of the overseas markets such as Turkey, Saudi Arabia
and Sri Lanka. The management targets reduction in costs in
its overseas operations by 600bps eventually by increasing
India-based support. This would enable the company to report
modest international margin improvements despite expanding
into more markets, as it has been doing. Our target P/E
multiple of 15x is in line with the increase in peer valuation.
This increases our TP to Rs491. Maintain BUY.
Higher demand expected from India industrial segment: In
India, regulation is pressurising companies to undertake effluent
treatment and use treated sea-water and sewage as in-feed instead of
municipal water. We believe that this, in conjunction with easing
interest rates, should drive industrial demand. We build in 13-14%
growth in industrial order inflow in the medium term.
Strong traction in some new international markets: The
company expects order inflow from Turkey and Saudi Arabia to begin
based on progress made by the local teams and it expects US$50m+
orders from Sri Lanka. Although progress of the JV with Sumitomo
was impacted by political turbulence in Egypt and Maldives, the
company expects a large order win in 2012. The company targets
€1bn revenue in five years, based on a mix of organic and inorganic
growth. This implies a €100m+ acquisition (see calculations inside),
which seems ambitious.
Operating leverage should drive overseas margin expansion:
Significant operating leverage is embedded since expansion into
Turkey, Saudi and Sri Lanka has seen costs hit P&L without revenue.
The management targets to reduce total cost of operations by setting
up local operations in individual markets rather than having
centralised operations in Vienna. These factors should enable the
company to preserve margins or expand them marginally even as it
extends operations to more countries.
India industrial segment poised for strong growth
India industrial sector to be the key: Industries are under
increasing pressure with regard to treatment of effluents and more
stringent regulations prevent industries from releasing effluents into
the sea without treating them. The industry is also under pressure to
use sea water as in-feed instead of municipal water. In Gujarat,
industrial in-feed in some plants from desalination is required to be
100MLD per day, which is significant. The management expects all
these to fuel higher demand for industrial water treatment.
In our view, this coupled with the easing of interest rate cycle should
support the industrial segment. We build in 13-14% growth in
industrial order inflow in the medium term.
VA Tech remains focussed on municipal projects with multilateral
funding: While municipal demand has remained sluggish so
far, some other states are contemplating desalination. This could
drive municipal order inflow in the medium term.
VA Tech prefers multilateral / bilateral funded jobs. While these
funds are at concessional rates, cost of funds increases as they are
administered down – 10% lending at state level; 15% interest rate
at municipality level. Hence VA Tech prefers to deploy its own funds
instead of taking high cost advances from customers as far as
possible.
We build in 9-10% growth in municipal order inflow in the medium
term.
Even seemingly “low-tech” projects have technological
challenges: While sewage treatment and water treatment (other
than desalination) may sound low-tech, that is not necessarily the
case. For instance, in a 450MLD surface water project for BMC, the
technological challenge was in making the footprint small. Only VA
Tech and one more competitor qualified, out of which VA Tech
emerged the winner.
Another example is the sewage treatment plant in Perungudi for
which the project cost was Rs320m, well below the Rs3.5bn cost for
a similar capacity sewage plant in the Middle East as the latter
employed a membrane bio-reactor, which is far more expensive.
Hence technology, capability and costs could be vastly different
depending on the scope of the project.
Chennai desal plant cost effective: The Chennai desalination
plant is producing water at 4.8p/litre, well below the Rs11/litre
average for bottled water. So people can afford to pay much more.
In domestic projects, average contribution margin (revenue less cost
of bought items divided by revenue) is 20-21%. The Ebitda margin
is ~12% which means that the total cost of operation is ~9% of the
revenue. The management expects this to reduce by 100 bps in the
medium term.
We build in a 100 bps stand-alone (mainly India and a few
neighbouring countries) margin expansion over FY11-16 owing to
better cost control and higher mix of O&M contracts. A 100 bps
Ebitda margin expansion would translate to ~7% increase in our TP.
Strong traction in new markets in overseas business
JV with Sumitomo expected to secure a major win in 2012:
VA Tech’s JV with Sumitomo aims at tackling large BOOT projects
internationally. The JV was close to winning new orders in Maldives
and Egypt, but political turbulence in both countries disturbed plans.
But the company expects to secure a major order win in 2012.
In such projects, 30–40% will be EPC and revenue will be spread
over three years for VA Tech. It may additionally have equity returns
from 10% ownership and for a brief period this may be negative, but
net from equity returns + EPC revenue would be positive from the
first year.
Expect strong traction in Turkey, Saudi Arabia and Sri Lanka:
The Turkish team is very bullish and expects revenue of US$25m–
30m. The team is ramping up fast, gaining experience and expects
hit rate to improve. This should eventually result in acceleration in
revenue growth.
The management anticipates US$17m–18m of orders from Saudi
Arabia. Sri Lanka projects are also reasonably large (US$50m+).
The current Dambulla order is worth US$80m. One more order from
Sri Lanka is expected in 2012.
Vast international expansion entails a need for tight monitoring. So
VA Tech has installed an ERP system that enables real-time MIS
generation for all projects, instead of instructing local teams to
prepare reports.
Focus continues on international cost control: While the
overheads in the overseas business remain high, the company has
succeeded in paring the run-rate down from US$21m in FY10 to
US$15m in FY11. The company targets $12m overheads in FY12.
Czech Republic is a low-cost market. VA Tech is trying for an
industrial hub for water in-feed, and the costs are estimated to be
1/3rd of that in nearby Austria. In Switzerland, the cost problem is
not as high as the government supports good businesses.
Operating leverage in the medium term: Significant operating
leverage is embedded since expansion into Sri Lanka, Turkey, Saudi,
Egypt and Maldives has costs in P&L without revenue. International
contribution margin has risen from 35% in FY11 to 41% in FY12,
though Ebitda is in low single digits. The management targets to
reduce total cost of operations as a proportion of revenue by 600
bps eventually by setting up local operations in individual markets
rather than having centralised operations in Vienna. Our calculations
suggest that a 100bps margin expansion could result in 6% upside
to our TP.
This makes us build stable Ebitda margin in the medium term
despite expansion into new markets. Growing revenue and
improving results from cost reduction should drive higher margin
post FY14.
Guidance and overall projections
The company expects 4QFY12 order intake to be Rs11bn. This
includes Rs5.3bn (Ulhasnagar, Aurangabad, Namibia); Rs2.2bn from
other international projects; India refinery project in which the order
award is expected soon, and this will be Rs3.5bn–4bn.
FY12 PAT will be consistent with guidance so far, i.e. Rs680m-700m,
which is based on 30% YoY growth. In FY13 PAT growth is likely to
be ~30%, based on 20% top-line growth.
We build in Rs11bn order inflow in 4QFY12 and do not change our
FY12 PAT estimate which is inline with the management guidance.
However, our FY13 revenue and EPS growth estimates are lower
than the guidance at 13% and 19% respectively.
The company targets €1bn revenue in five years, based on a mix of
organic and inorganic growth. If one assumes a 15% Cagr over five
years for organic revenue as well as inorganic revenue, 10% Ebitda
margin for the target(s) and a 4x target EV/Ebitda, the EV of the
target(s) comes to ~€125m. This is ambitious considering that
FY12ii cash balance is ~€50m.
Note that the lower-margin and faster-growing international
business keeps consolidated margins from rising despite margin
improvement modelled in India.
Maintain BUY; Increase TP to Rs491
We change our estimates marginally to take into account the higher
proportion of higher margin domestic orders in the order book as of
3QFY12. This raises our FY13 EPS by 2.8%. We largely maintain our
FY14 numbers unchanged as the mix reverses itself on Rs6bn Libya
order inflow in late FY13.
Higher target P/E results in our new TP of Rs491: Our earlier
TP of Rs416 was based on 13x 1-year forward P/E whereas peers
were trading at 12x. Now the peer group valuation has moved to
15x. Consequently we raise our target P/E to 15x. This results in our
TP increasing to Rs491 and translating into total return of 10.7%.
Figure 9: We value VA Tech at 15x P/E compared with its current 1‐yr fwd multiple of
14.4x
Item Value
Target PER 15.0
2 yr fwd PAT (Rs m) 882
M‐Cap gross of litigation risk (Rs m) 13,234
Litigation (Tax) risk amount (Rs m) 250
M‐Cap (Rs m) 12,984
#shares (m) 26
Per share (Rs) 491
CMP (Rs) 450
Upside 9.1%
Dividend per share (Rs) 7.1
Total Return 10.7%
Source: IIFL Research
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