Bucking the trend

The period 2013-14 was a time of consolidation for the infrastructure sector. With the markets looking up, many infrastructure stocks have also had a good run. But do the fundamentals justify the euphoria surrounding these scrips? Rahul Kamat writes.

With the performance of the CNX Infra Index at its best during the quarter ended March 2014, coupled with good individual stock performance, infrastructure analysts feel that the good days will be back after the elections.

While the Prime Minister's Project Monitoring Group is leaving no stone unturned by clearing more than 147 projects, entailing investments worth Rs 5 lakh crore, investment sentiments are high among private players. While the optimism is not without reason, safety of capital at this point in time is more important, given the unpredictability of an election outcome, and the fact that the status quo will rule as far as interest rates are concerned till the end of FY15.

SP Tulsian, Mumbai-based independent research analyst, believes that it has become essential for infra companies to take cautious steps. Normally if any project of a company is delayed in the range of six to ten years, then the company is under tremendous stress. He further added that majority of the infra companies are overburdened and have borrowed well beyond their capacity. “They must go for monetisation and for that they (infra companies) must bring down their debt equity ratio to level of 2:1 or 2.5:1.”

To some extent Tulsian is right as companies such as GMR, GVK, IVRCL, NCC and JP Associates, are facing issues on the debt front, coupled with low cash generation and the burden of interest. On the other hand, there are companies – IVRCL, Lanco, Reliance Infrastructure, HCC, Simplex Infrastructure – which also face regulatory hurdles. Meanwhile, domestic stock broking companies such as Angel Broking, Anand Rathi, Emkay, Karvy, Citi, Hem Securities and Nomura are of the opinion that there are quite a few infrastructure companies that have managed their debt equity ratio well and have strong fundamentals.

Since the new government will take time to set its house in order and it will be likely 4QFY15E before any meaningful earning per share (EPS) recovery takes place, Infrastructure Today did a detailed analysis of the top five infrastructure stocks to look for in the year 2014-15. Based on the strong fundamentals and project execution abilities, these stocks are likely to outperform in FY15.

Experts highlighted that from a 'portfolio basket perspective', Larsen & Toubro, ITNL, IRB, Engineers India and VaTech Wabag are companies with fewer red flags, backed by a strong asset mix and healthy balance sheet. But stocks like Cairn, Ashoka Buildcon, NCC, Sadbhav Engineering, KNR Construction and Reliance Infrastructure are also to be considered.

Here are five top pics that stand apart in this segment:

Larsen & Toubro (L&T)

L&T will continue to occupy a unique position in the Indian engineering and construction (E&C) segment as a diversified and large engineering play, with exposure to areas ranging from power, defence, nuclear and equipment, in spite of short-term concerns.

At present, the management has slightly revised its guidance of order inflow growth from 20 per cent to 15-20 per cent and maintained its guidance of 15 per cent growth in revenue for FY2014. L&T has secured orders worth Rs 21,722 crore during 3QFY2014, which is likely to grow up to Rs 26,000 crore taking the order book to Rs 176,184 crore. Order inflows were mainly driven by major orders bagged in the infrastructure (85 per cent) and others (12 per cent) segments.

For 3QFY2014 on the top-line front, L&T reported revenues of Rs 14,388 crore, registering a healthy growth of 11.8 per cent y-o-y. The healthy growth in revenues was mainly driven by strong execution in the E&C and the metallurgical segment. On the EBITDA front, the company reported a y-o-y increase of 186 bps to 11.6 per cent, mainly on account of strong execution in the infrastructure segment and lower sub-contracting expenses.

On the bottom-line front, L&T reported a y-o-y growth of 22.4 per cent to Rs 1,241crore owing to better-than-expected execution and one item exceptional item from asset sale of Rs 104 crore.

Overall, according to analysts, the company is best placed to benefit from a gradual recovery in the capex cycle, given its diverse exposure to sectors, strong balance sheet and cash flow generation as compared to its peers, who grapple with issues such as strained cash flow, high leverage and limited net worth and technological capabilities.

IL&FS Transportation Networks (ITNL)

ITNL with an established track record of successfully bidding, developing and operating road projects on a commercial basis, is another stock to look for in the current year. With strong performance at its side (the company witnessed consolidated revenue increase by 11.4 per cent y-o-y to Rs 1,966 crore in 3QFY2014), it is expected that ITNL's consolidated revenue will grow by 11.7 per cent y-o-y to Rs 2,157 crore for 4QFY2014.

The strong performance on the revenue front was mainly on account of increase in operation and maintenance (O&M) income, growth in toll or annuity income and pick up in execution in its under construction projects during the quarter.

Going forward, analysts expects that ITNL will report a revenue (CAGR) of 9.5 per cent over FY2013-15. This would be on the back of an order book of Rs 12,000 crore, indicating order book-to-sales ratio of 1.8 times trailing revenues. Further, the company has an incremental equity investment of Rs 1,300 crore over the next three to four years. Hence it would be able to fund most of its equity fund requirements through internal accruals from operational projects and the construction business.

Analysts believe that ITNL, being a market leader, is well poised to leverage the growing opportunities in the build, operate and transfer (BOT) space, owing to strong parentage (it belongs to the IL&FS Group); experienced management at the helm of affairs (rich experience of over 22 years in the infrastructure business); unique business model (present across the value chain).

IRB Infrastructure Developers

IRB's integrated business model ensures the timely completion of projects, reduces its reliance on subcontractors and controls costs. Further, it allows capturing the entire value in the BOT development business, including engineering, procurement and construction (EPC) margins, developer returns and O&M margins.

IRB has a robust order book of Rs 5,830 crore, which lends revenue visibility. Although a slowdown in order awarding by NHAI in the road sector has been witnessed in FY2014, IRB expects ordering activity to improve going ahead. IRB is currently pre-qualified to submit bids for projects worth Rs 35,401 crore. Recently, the company, has bagged two major orders worth Rs 2,300 crore and Rs 3,200 crore from NHAI. Further, IRB's internal accruals would substantially fund equity requirement of its current portfolio. Further, the company would be able to keep its debt-equity position within reasonable limits. On the toll collection front, IRB reported a growth of 22.8 per cent y-o-y to Rs 438 crore in 3QFY2014 with an average toll collection of Rs 4.9 crore/day from its existing BOT portfolio. IRB expects toll revenue to grow by around 10-12 per cent on a yearly basis as a result of higher traffic growth. On the EBITDA front, IRB's margin increased by 494 bps y-o-y to 49.6 per cent. This is due to increase in BOT toll revenues with some of its BOT road projects going operational. Further the E&C segment reported an EBITDA of 31.8 per cent led by strong execution in Ahmedabad-Vadodara BOT projects.

Going forward, analysts believe that IRB is a good bet as the company is looking at both organic and inorganic options for growth with a threshold of 18 per cent equity IRR and intends to allot 20 per cent of its consolidated cash flow post debt repayment towards acquisitions.

Engineers India Ltd (EIL)

EIL, with expertise in hydrocarbons and petrochemicals, has over the years developed a track record of working on landmark projects with various Indian and global energy majors. The company has a healthy balance sheet and the company has consistently maintained this over the years. As of FY13, the company has consolidated cash flow of Rs 1,890 crore and current investments of Rs 545 crore, together accounting for 50 per cent of its current market cap of Rs 5,064 crore. The company has a track record of posting strong operating cash flows, which has helped it remain debt free over the years. Moreover, being a government owned company, it has strong track record of giving dividend to its shareholders. Dividend payout ratio in the last 3 years has remained in the range between 30-32 per cent, which is quite impressive within the PSU segment.

Going forward, despite strong fundamentals, the stock has not moved up significantly. However the downside of the stock is very limited, considering its strong balance sheet and stable business. The future earnings growth prospect will improves on pick-up in order inflows and strong future order pipeline. The company also has a huge cash balance of Rs 2,500 crore, which is 50 per cent of its market capitalisation. Hence EIL, can be considered as a defensive bet with limited downside risk.

VA Tech Wabag

A promising entrant, VA Tech Wabag is a company to look out for, according to domestic broking firms. Focused on providing a complete range of water and wastewater treatment solutions, the company has posted robust results for the quarter ended December 2013. The consolidated revenue has increased by about 66 per cent at Rs 589.30 crore for the quarter under review as compared to Rs 354 crore for the quarter ended December 31, 2012.

The nine month order intake for FY14 stood at Rs 3,047.5 crore comprising domestic orders worth Rs 1,844 crore and Rs 1,203.50 crore overseas. The inflow includes EPC orders worth Rs 2,621.30 crore comprising 86 per cent of the order inflow while O&M orders stood at Rs 426.20 crore representing the remaining 14 per cent. Municipal order inflow was at Rs 2,233 crore while industrial orders were at Rs 814.50 crore. Going forward, the company aims at improving its margins in international business.

With the backlog of robust order book backed by funded projects along with its strong inherent execution capability; the company expects to have strong FY14. It also expects healthy order inflows to continue in FY15 on back of orders in the pipeline.

Going forward, with asset light model, robust order pipeline, strong balance sheet, leadership position in Indian market and increasing geographical presence with strong brand image, Va Tech Wabag revenue visibility looks strong.

In the past 12-18 months, there has been no respite for infrastructure companies from persistent headwinds such as inflationary pressures, slow order inflows, high interest rates and policy paralysis. However, infrastructure stocks have rallied strongly in fourth quarter of FY14 on expectation of stable government which is expected to undertake policy action to remove bottlenecks such as delays in environmental clearances and land-acquisition issues. Analysts prefer companies having a comfortable leverage position; superior return ratios and less dependence on capital markets for raising equity for funding projects. The stocks mentioned in this report have been selected based on feedback from industry analysts. Readers are requested to do their own due diligence before investing in any of the scrips mentioned in this article.