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Hindustan Construction
N(V): Nothing going right; wait for a catalyst
Q1 EPS earnings fell 90% (c71% below consensus) due to
higher rates on refinanced debt and rise in working capital
Stake sale in Infra assets is a near term positive as it
reduces strain on consolidated balance sheet from
sustained losses in Lavasa project due to work stoppage.
Retain N(V) with a TP of INR36 (INR38); a public listing of
Lavasa is a key re-rating catalyst
Poor 1Q earnings as interest costs soar. HCC reported revenues of INR10.6bn, which
were in line with HSBC estimates, while EBITDA margin at 13% (+40 bp y-o-y) also
surprised us on the upside by 40bp. However, a triple impact of high cost debt (foreign
currency borrowings refinanced with higher domestic debt) along with rising interest rates
(+c150bp y-o-y) and a sustained increase in working capital (c300 days from 288 days in
FY11) pulled down earnings by 90% y-o-y at INR29m (71% below consensus and 78%
below HSBC estimates).
Stake sale in the infra assets subsidiary is a near term positive. HCC sold a 14.5%
stake in HCC Infrastructure (owns six road assets) through a fresh equity issuance to
Xander Group for INR2.4bn, implying a company value of INR16.5bn. While the implied
deal value is c65% higher than our estimated value, we continue to expect that in the
absence of clear visibility on the operational data from the projects, we continue to value
it at 1.3x current invested equity. Overall, we expect the deal to reduce the strain on
HCC’s consolidated balance sheet, which continues to remain under pressure from
sustained losses due to the work stoppage at Lavasa.
Retain N (V) with a lower TP of INR36. We have cut our EPS forecast for FY12 and FY13
by 13% and 7%, respectively along with accounting for the ongoing cash loss at Lavasa
(INR20m per day). In line with that, we have lowered our target price for HCC to INR36
(INR38 earlier). We continue to value HCC’s construction business at 7x March 2013 EPS and
subsidiaries at a revised value of INR25 (INR27 earlier). We continue to expect that a
combination of weak construction business and work stoppage at Lavasa will continue to be a
drag on HCC’s valuations and a public listing by Lavasa could act as a re-rating catalyst.
Cut earnings by 7-13% for FY12 -13
HCC’s working capital cycle remains stretched (300 days as at 1QFY12 vs. 288 days in FY11), which
coupled with the slowdown in execution pace would lead to higher funding costs. Our revised estimated
funding cost is expected to increase by c2-3% in FY12 and FY13, which in turn is likely to create
downward pressure on earnings. Thereby, while we have retained our top line and operating margin
estimates, the incremental funding cost had let to a cut of 13% and 7% to our FY12 and FY13 estimates,
respectively. Our revised estimates are still 11% above consensus for FY12 earnings and 4% for FY13.
Retain N(V) rating with a revised target price of INR36
We think HCC has a better business model than its peers, with a high book to bill ratio of 4.4x which
provides revenue visibility over the next 2-3 years. Additionally, complex projects help HCC earn better
operating margins (c12-13% as against peers’ 9-10%). However, HCC has been unable to contain the
rising leverage on its balance sheet owing to weak recoveries on its receivables. Rising funding cost upon
higher leverage along would impact faster execution leading to weak earnings growth. We estimate
earnings to grow at a slow pace of 13% CAGR over FY12-13.
While there has been positive news flow on the Lavasa issue (Environment clearance from Ministry of
Environment Forests) in the past few months, there is still lack of clarity on the time line of a resolution
of the same. Hence in the absence of clarity we expect Lavasa valuations to continue to remain low. We
have also accounted for the ongoing cash loss at Lavasa (INR20m per day) during Q1 FY12 in our
valuation. In line we have reduced our value for Lavasa from INR6 per share from INR8 per share (target
NAV discount maintained at 60%). In line, our target price has reduced from INR38 to INR36. We have
maintained our valuation for the construction business at 7x FY13 EPS.
Key downside risks include: 1) Sustained high receivable days leading to deterioration in the company’s
working capital cycle and in turn a weaker-than expected balance sheet. 2) Delay in resolving the
approvals issue for Lavasa project with the Ministry of Environment and Forest (MoEF). Key upside risks
include: 1) Faster recoveries in response to the improved focus on management to lower balance sheet
leverage. 2) Better-than-estimated valuation for Lavasa project by the market.
Under our research model, for Indian stocks with a volatility indicator, the Neutral band is 10 percentage
points above and below the hurdle rate of 11%, i.e. a Neutral band of 1-21% potential return. Our target
price implies a potential return of 10.6%
