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Patel Engineering – 2QFY2011 Result Update
Angel Broking maintains a Buy on Patel Engineering with a Target Price of Rs565.
Patel Engineering (PEL) posted decent numbers on consolidated basis aided by
real estate revenues of `54cr from its Smondoville Bangalore project, as against
our expectation of clocking the same in 2HFY2011. PEL’s order book position
stood at `8,400cr in 2QFY2011 (2.3x FY2011E revenues) excluding L1 orders
worth `2,100cr. Given decent OB and attractive valuations of 8.0x FY2012E
earnings (adjusted for investments), we maintain a Buy on the stock.
Results beat expectations: PEL posted yoy top-line growth of 26.0%, which was
much better than peers, aided by real estate revenues and better execution in the
US subsidiary. Operating margins at 15.2% (18.7%) came in below our estimates
mainly on account of lower contribution from the hydro segment. Management
has guided 20% growth in top- and bottom-line for FY2011. Earnings came in at
`43.6cr, a yoy jump of mere 7.2% mainly on account of subdued operating
margins and higher other income in 2QFY2010.
Outlook and Valuation: PEL has exposure to the high-margin hydropower and
irrigation segments owing to which it clocks higher margins than peers. The
company has substantial L1 orders (`2,100cr) pending for the last 3-4 quarters,
and we believe that post conversion of the same would be one of the triggers for
the stock. PEL has also ventured into the power and real estate businesses, which
we believe would be other catalysts for the stock going ahead. Hence, we
maintain a Buy on the stock, with a SOTP Target Price of `565, based on a Target
P/E of 14x FY2012E EPS of `32.7 and valuing the company’s investments in real
estate, power and road at `108/share.
Project updates
PEL has invested equity to the tune of `250cr in its power ventures, which we have
valued at 1x. Land for the first phase (1,050MW plant in Nagapatnam district,
Tamil Nadu) has been acquired and coal linkages are also in place from the
Mahanadi coal fields. Management expects financial closure by December 2010
and construction work is likely to start in 2QFY2012. Further, regarding bringing in
a strategic partner, management clarified that it would happen only in CY2011
when the construction work starts gaining visibility and the venture attracts right
valuations.
In real estate, the company has mentioned that the progress is satisfactory with
bookings of nearly 1,100 apartments for Smondoville-1 out of the total 1,123
apartments, which also implies that the project does not require cash and would
be self funded. During 2QFY2011, PEL booked `54cr from real estate from its
Smondoville Bangalore project, as against our expectation from 2HFY2011. Over
the next couple of years, this project is expected to generate revenues of `240cr
and `240cr from Phase I and II. The Jogeshwari tower project work has
commenced; total project cost is `200cr with expected lease revenue of more than
`100cr pa @ `125/sq ft.
Outlook and Valuation
Hydropower is one of the lowest cost modes of power generation, and India's
hydro power potential is estimated at 148,701MW, which is primarily concentrated
in the north and north-eastern regions due to the availability of ample hydel
resources. Moreover, the Twelfth Five-Year Plan ((2012-17) provides significant
opportunity for the construction companies (read PEL) in the hydropower segment.
Around 30,000MW hydropower capacity is expected to come up in the Twelfth
Plan compared to the existing 36,917MW capacity.
Against this backdrop, we believe that PEL will be able to maintain its 22% share
going ahead and garner orders of ~`15,250cr over the next few years.
PEL has exposure to the high-margin hydropower and irrigation segments owing to
which it clocks higher margins than peers. The company has substantial L1 orders
(`2,100cr) pending for the last 3-4 quarters, and we believe that post conversion
of the same would be one of the triggers for the stock. PEL has also ventured into
the power and real estate businesses, which we believe would be other catalysts for
the stock going ahead. Hence, we maintain a Buy on the stock, with a SOTP Target
Price of `565, based on a Target P/E of 14x FY2012E EPS of `32.7 and valuing
the company’s investments in real estate, power and road at `108/share.
Investment Arguments
Present in niche high-margin segments
Traditionally, PEL has been concentrating on niche segments to maintain its
margins and effectively use its resources. Its core competence lies in the
construction of hydro power plants and upstream irrigation projects. It has been
involved in ~22% of the total hydro power plants in India. Hydro power projects
are complex, require high level of technological expertise and fetch significantly
high margins. Also, past experience and technical competence is critical in winning
contracts for hydro power and upstream irrigation projects. Therefore, it effectively
serves as an entry barrier restricting the number of bids to 4-5 in hydro power and
7-8 bidders in upstream irrigation segment. Further, the benefits of hydro projects
and upstream irrigation projects are that the pass on of incremental costs is high
compared to the other segments. In perspective, the pass on of incremental costs
in hydro projects is as high as 90% and in irrigation projects it is in the range of
70- 80%. Overall, this aids the company to maintain its margins especially in the
current rising commodity prices and interest rate regime. It also explains the high
margins enjoyed by PEL over the years.
Real estate, power ventures potential value creators in long run
PEL has rationalised its expansion plans in the real estate projects and adopted a
more cautious approach. Its Jogeshwari corporate park is operational and other
launches (Bangalore and Noida) are seeing good response making it
self-funded. We see significant value locked in its land bank of 1,127 acres,
acquired at a cost of `250cr. The company has already monetised part of it in
Mumbai, Bangalore and Noida (not part of the above-mentioned land bank).
However, we have currently valued these real estate projects conservatively,
leaving a significant chunk that can be potentially value accretive. Further, PEL is
developing two power projects, one thermal in Tamil Nadu and another hydro in
Arunachal Pradesh. It has secured approvals to develop a 1,050MW thermal
power project in Nagapatnam district, Tamil Nadu, for which land has been
acquired and partial environment clearance obtained. Financial closure for the
project is likely by December 2010. PEL will likely offer 49% stake in the project to
a strategic investor, which we believe would set a benchmark for valuing these
projects and create value.
Compelling valuations
Over FY2007-10, although the company registered a healthy execution rate at
~34%, the pace of order book was slack at a mere 20% and its order book
exposure to AP was substantial. We believe that these are the major reasons for
the stock’s underperformance on the bourses. However, we believe that with a
better liquidity position post the fund infusion (raised `340cr via QIP), strong
bidding pipeline (L1 for orders worth `2,100cr), signs of improvement in AP and
robust outlook for the sector, its only a matter of time before the stock outperforms
and fetches investor fancy. Moreover, PEL is one of the cheapest stocks in our
coverage universe trading at single-digit P/E multiple - adjusted for its subsidiary
valuations with strong execution capabilities in the EPC space. We believe that
current valuations are attractive and does not factor in PEL’s premium position in
high-margin businesses, strong growth prospects and value unlocking potential.
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