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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.
