Have a strong stomach for risk? Consider buying the stock of IL&FS Transportation Networks (ITNL), a road development company.
The pessimism surrounding the infrastructure segment is quite justified, with financial constraints hampering both execution and fresh investments. Regulatory obstacles and a drying order pipeline are the other constraints.
But some of these clouds are beginning to part, with project approvals and clearances being pushed through. Lower interest rates from hereon can also provide a fillip to profitability. Companies that have executed projects on time, have a relatively healthier balance sheet and a strong order book will be the first beneficiaries of a turnaround in the sector.
ITNL is one such company, among the largest road development players. It has 16 completed projects under its belt from which it earns steady revenues. Thirteen more are in the works, to be completed between one and three years from now. It has an international presence, which offsets the slow domestic order flow. Recent fund-raising activity has also lowered the strain on its balance-sheet.
Investors with a three- to four-year horizon can buy the stock. But given that the infrastructure sector is still a risky bet, investors can limit portfolio allocations to the stock.
ITNL’s stock is also recovering from the bruising run it had for most of 2013, when it lost over half its price. At Rs 132, the stock trades at five times its trailing 12-month consolidated earnings, below the three-year average of 8 times.
The company focuses on developing large-scale road projects, where competition is limited. Its order book of around Rs 13,100 crore is thrice the trailing 12-month revenues, providing medium-term earnings visibility.
The road projects undertaken are based on toll and annuity. In toll-based projects, collections are dependent on traffic flow and therefore, hold higher risk. Toll rates are, however, linked to the wholesale price index, compensating for lower traffic volumes. In annuity-based projects, the company gets paid a fixed amount each year regardless of traffic . Lucrative road stretches with heavy traffic potential, such as Vadodara-Halol and Pune-Sholapur are on toll basis. Stretches such as Jorbat-Shillong and Chenani-Nashri, in the lower-penetrated North-Eastern regions, are on annuity .
Execution to pick up
Toll revenues for the company are up 22 per cent for the six months to September 2013, compensating partly for lower construction revenues. Ten more projects will turn operational in the next 15 months.
Toll revenues for the company are up 22 per cent for the six months to September 2013, compensating partly for lower construction revenues. Ten more projects will turn operational in the next 15 months.
Existing projects such as the Hazaribagh-Ranchi stretch and part of the Maharashtra border checkpost project turned operational in the first half of this fiscal. Meanwhile, new projects were pending financial closure.
Construction was also yet to commence on other projects. Project clearances for three key projects came through only towards end-June.
As a result, project execution slowed. This, combined with projects being completed, led to construction revenues dropping 6 per cent in the six months to September 2013. With financial closure now complete, and clearances through, execution should pick up in the coming quarters. These projects will help tide over sluggish awarding in the near term.
Diversification to help
ITNL has gradually diversified into urban infrastructure projects where fresh orders are more forthcoming. Its rail project for the Gurgaon metro rail link turned operational in December 2013. ITNL has another project with the same rail project, which will be completed in May 2016.
ITNL has gradually diversified into urban infrastructure projects where fresh orders are more forthcoming. Its rail project for the Gurgaon metro rail link turned operational in December 2013. ITNL has another project with the same rail project, which will be completed in May 2016.
Besides, ITNL has city bus terminal and multi-level car park projects, all of which hold good potential.
The company also has contracts for road maintenance through Elsamex, an established Spain-based player in road maintenance it acquired in 2008. Through this, ITNL executes contracts in Spain, Portugal, Ukraine, Abu Dhabi and Haiti. Revenues from Elsamex were up 6 per cent for the six months to September 2013.
Other international operations include 49 per cent stake in an operational Chinese expressway. ITNL is exploring road development projects in the lucrative West Asian market.
Healthy operating margin
Revenues for the half-year ended September 2013 dropped five per cent due to lower construction expenses. Construction costs also dropped in line with slower execution.
Revenues for the half-year ended September 2013 dropped five per cent due to lower construction expenses. Construction costs also dropped in line with slower execution.
ITNL’s ability to enter into fixed-price contracts (which allow only minimal price escalation) with its sub-contractors also helped.
Operating margin rose to 36 per cent for the first half of this fiscal against the 32 per cent in the year-ago period. Net profit margin, however, was bogged down by the high interest, up 29 per cent.
Net profit margin dropped to 8 per cent for the six months to September 2013. Interest cover declined to 1.6 per cent in this period from the 1.9 per cent in the year ago. Still, cover is higher than most infrastructure peers.
Debt-equity ratio as of end-September is at 3.7 times. Since then, ITNL has raised Rs 650 crore through private preferential issues.
A rights issue in the offing can help mop up about Rs 525 crore. If interest rates trend lower, the debt burden will also lighten. ITNL has also maintained its working capital cycle, unlike most peers.
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