Infrastructure Opportunities
There is no doubt that the state of infrastructure in India is far from comparable with the same of the developed countries or even developing countries like China. Infrastructure got its due attention only in the current (11th) Five Year Plan (2007-2012) when the Planning Commission of India emphasised the need for investments worth $500 billion towards setting up of infrastructure as compared to $220 billion in 10th plan. While these estimates itself suggest the vast opportunities in the space, the Planning Commission estimates that to sustain a GDP growth rate of 8-9 per cent, investments into infrastructure will have to be stepped up to around $1,000 billion during the 12th plan period (FY2013-17).
“Taking into consideration both new and latent demand, CRISIL Research estimates infrastructure expenditure across the 11 identified sectors to nearly double to Rs 32 trillion ($700 billion) over the 2009-10 to 2013-14 period. We believe that even if new demand for infrastructure across sectors is ignored, bridging the latent demand itself presents a huge investment opportunity,” says Ajay D'Souza, Head, CRISIL Research.
While this represents huge long-term opportunity for the companies operating in the sector, expect them to benefit in the near-term, too, on account of the increased allocation for infrastructure in the recent Union Budget. Infrastructure allocation has been increased to Rs 1,73,552 crore, which is about 20 per cent higher as compared to the previous year and almost 46 per cent of the government’s planned expenditure for 2010-11. Also, the Budget has emphasised on faster execution of the projects, increased availability of the credit through infrastructure bonds and increasing the participation of the private players through the public-private partnership (PPP) model.
To begin with, things at the ground level have started to improve. During last year’s slowdown, many companies took a hit on their revenue and profitability. Also, the inflow of new projects slowed down, and revenue visibility for companies deteriorated. In fact, certain segments were significantly impacted due to slowdown in capex and delays in award of new projects.
But, that’s history and as a result of new orders flowing from the government and the private sector, the situation has improved somewhat. For instance, the order-book to sales ratio of construction companies, which had dropped to about 2.5, has now improved to about 3.2-3.4. Projects in the road, power and urban infrastructure segments have seen a visible improvement in off-take.
Secondly, the credit growth for the infrastructure, which had dipped to almost 32-35 per cent in November 2008, has recovered to about 47 per cent in November 2009. The improvement is also aided by the drop in interest rates enabling companies to deploy more funds for existing projects, thus, leading to improvement in execution. During 2009, due to the credit crisis the companies were not only finding it difficult to arrange funds, but the cost of funds was also high (interest rates of over 12-13.5 per cent). The companies are now, however, able to raise funds at about 11-12 per cent. With lower interest rates and stable commodity prices in the last two quarters, companies are now breathing easy and are able to report better profit margins.
Overall, given the vast growth potential and improving fundamentals, the infrastructure sector provides good investment opportunities for long-term investors. Notably, valuations of most companies are not as scary as they were (at the peak) in 2008. “We estimate strong annual earnings growth of 27 per cent over FY10-12, with possibility of positive earnings surprises. While the sector is trading at a reported P/E of 18 times 2010-11 estimated earnings, adjusted for BOT or real estate projects, the P/E ratio stands at an attractive 13 times,” says Satyam Agarwal, analyst, Motilal Oswal Securities.
It quite possible that some of these companies will grow at 25-30 per cent annually, considering the high revenue visibility in terms of strong order book for the next 2-3 years. However, the key risks in the near-term (6-8 months) remains on account of the expected increase in interest rates, which could play a spoilsport. Secondly, analysts believe that while the government has announced huge spending for 2010-11, the real pick up in spending might happen only after the government is able to procure funds for the same—this may take a few months.
Where to invest
Besides the large names, investors can also choose infrastructure companies within the mid cap and small cap space. These relatively smaller companies are also seen benefiting in the long run and notably, are trading at reasonable valuations. Companies like Patel Engineering, J Kumar Infraprojects, Pratibha Industries, Ahluwalia Contracts, Valecha Engineering and IRB Infrastructure are among key players in the infrastructure space. Many of these companies have large order books indicting good revenue visibility, and may be considered after introspection and based on ones’ risk appetite.
Meanwhile, here are some of the leading companies in terms of the market capitalisation, which are fairly diversified, have strong order book and generate good returns on capital employed. Notably, they are well poised to deliver good returns going ahead.
Hindustan Construction
Hindustan Construction Company (HCC), which built the landmark Bandra-Worli sea link (in Mumbai), is a leading player in the hydro power, water, transportation sectors. Hydro power projects, which typically require high capex and where growth opportunities are immense, accounts for 56 per cent of HCC’s order book and earns robust operating margins.
HCC’s order book at end-December 2009 stood at Rs 15,700 crore, which is 29 per cent higher as compared to the year ago period and provides high revenue visibility for the next 3-4 years. Besides, as the opportunities are opening up in the road segment, the company’s portfolio of six build-operate-transfer (BOT) projects worth Rs 5,500 crore should help increase the revenue share of the transport segment from the current levels of 28 per cent.
Meanwhile, on the back of its strong order book analysts expect HCC’s net profit to grow by about 35 per cent annually over the next two years. The profit growth will also be aided by the expected improvement in margins and low interest cost as a result of lower debt in the company’s books. HCC’s net debt-equity, which stood at 2.2 times in 2008-09, is expected to come down to 1.2 by 2010-11.
Analysts value the stock on SOTP basis at about Rs 150-160 per share, including Rs 60 for its real estate business. Further value unlocking could happen as the company moves ahead to list its real estate subsidiary, Lavasa Corporation, which is expected to report revenues of Rs 500 crore and net profit of Rs 100 crore in 2009-10. This real estate subsidiary has long-term plans of developing a city near Pune over 18,000 acres of land it owns.
| RIDING THE INFRA BOOM | ||||||||||||||
| in Rs crore | Financials for the year ending March 2009 ^ | 9 mths ended Dec'09 ^ | ||||||||||||
| Sales | % chg y-o-y | PAT | % chg y-o-y | D/E (x) | RoCE (%) | OPM (%) | Sales | % chg y-o-y | PAT | % chg y-o-y | TTM PE (x) | CMP (Rs) | Market cap | |
| Larsen & Toubro | 40,371 | 37.7 | 2,934 | 30.7 | 1.2 | 18.3 | 12.8 | 23,300 | 0.5 | 1,985 | 26.7 | 24.5 | 1,603 | 96,521 |
| JP Associates | 4,775 | 13.8 | 424 | -38.5 | 2.5 | 8.0 | 38.5 | 6,744 | 83.0 | 491 | -0.8 | 17.0 | 148 | 31,497 |
| IVRCL Infra. | 5,074 | 30.4 | 226 | -20.3 | 0.7 | 9.3 | 9.4 | 3,531 | 7.3 | 130 | -11.2 | 21.6 | 339 | 4,523 |
| Hindustan Cons. | 3,560 | 18.9 | 59 | -35.9 | 3.4 | 9.6 | 14.7 | 2,558 | 9.6 | 54 | 161.5 | 49.4 | 146 | 4,436 |
| Nagarjuna Cons. | 4,772 | 31.9 | 182 | 8.8 | 1.2 | 12.4 | 10.6 | 3,254 | 7.6 | 130 | 12.4 | 24.9 | 163 | 4,189 |
| D/E: Debt-equity ratio; % change is year-on-year, RoCE is return on capital employed Price date March 2010 ^ Results for 2008-09 are consolidated wherever applicable, while the same for 9 mths to Dec' 09 are standalone profits are adjusted for extra-ordinary items Source: CapitaLine Plus | ||||||||||||||
IVRCL Infrastructures
IVRCL, a leading player in the infrastructure space and known for its execution capabilities, has recently restructured its business and transferred its BOT business to its listed subsidiary, IVR Prime, where IVRCL will now hold up to 80.5 per cent. IVR Prime has a portfolio of four BOT projects, including three road projects, in which the company has already invested about Rs 350 crore by way of equity. IVRCL Infra will operate in the construction segment, whereas IVR Prime will own the infrastructure assets in the BOT space.
The advantage of this move is enhanced clarity on the business structure and strong balance sheet size. Besides, the company will also be able to leverage the assets of IVR Prime to participate in the large PPP projects. IVRCL is a well established player in water and irrigation related projects where again, the opportunities are plentiful. The company is also present in the buildings, power and road related segments.
Also, the company has been successful in expanding its presence into other parts of the country. Currently, it has presence in over 20 states, including Andhra Pradesh, which accounts for 22 per cent of its total order book. The company’s order book of Rs 17,300 crore, which is about 3.5 times its 2008-09 revenues, also provides good earnings visibility.
Considering its strong order book and improved execution, analysts are expecting the company's revenue and profits to grow at about 25 per cent each over the next two years. IVRCL could be a good long-term play on the infrastructure sector considering its diversification, execution capability and strong order book. While the stock is currently hovering around Rs 325 levels, analysts have estimated its SOTP value at Rs 360-400 based on IVRCL’s stake in listed companies, IVR Prime and Hindustan Dorr Oliver.
Nagarjuna Construction
Nagarjuna Construction is well placed to take the advantage of opportunities in the construction sector. The company is well diversified and has presence in sectors like buildings, transportation, water, electrical and irrigation. It has also forayed into other segments like power generation, oil & gas, metals and mining.
The company is also developing three power generating plants with a total capacity of 1,700 mw, including a 1,320 mw plant which is expected to be commissioned by 2014. The company has acquired the land and secured 70 per cent of the coal requirements for this project.
In terms of revenue visibility as well, the company’s current order book of about Rs 16,000 crore, which is 3.8 times its 2008-09 revenues, provides comfort. The company is also in the BOT road projects space, with two operational BOT projects totalling 113 km, including the 50 km Bangalore-based elevated road project which became operational in January 2010. By the end of March 2010, the company will be commissioning two more BOT and annuity projects measuring 142 km. Following this, one more BOT project of 36 km is expected to become operational by July 2010. Notably, the company is pre-qualified for over 30 projects worth Rs 27,000 crore, which in turn should help it procure more projects in this segment.
Meanwhile, on the back of strong order book in its core construction business and portfolio of BOT projects, the company's revenues and net profits are expected to grow at about 20-25 per cent annually over the next two years. Considering the company’s different businesses, the stock’s SOTP-based valuations work out to about Rs 185-190 per share. Also, additional trigger could come when the company completes the financial closure of its 1,320 mw power plant, which is due in some time.
| ORDER BOOK MIX (%) | |||||
| HCC | IVRCL | NCC | PATEL | SIMPLEX | |
| Transport | 15 | 23 | 4 | 8 | 27 |
| Water | 29 | 48 | 29 | 45 | 4 |
| Power | 56 | 6 | 11 | 39 | 26 |
| Buildings | - | 23 | 25 | - | 8 |
| International | - | - | 22 | 8 | 22 |
| Others | 1 | - | 9 | - | 13 |
JP Associates
JP Associates is a diverse play with presence in segments like road construction, power, cement and real estate. The construction business undertakes projects for building expressways, hydro power plants and real estate among others, which together account for about 55 per cent of the company’s revenue and is growing fast. In the road segment, the company is executing India’s largest expressway, the Ganga expressway, measuring 1,047 km besides, the 165 km Yamuna expressway. These two road projects also bring along with it real estate in the vicinity, which currently accounts for 32 per cent of the revenue.
The company is developing about 3,300 million square feet of land around the Ganga expressway and another 6,250 acres (roughly 275 million square feet) in the case of Yamuna expressway. This is fairly large and will be the revenue drivers for the company in the long run. That apart, the company is also active in the power sector. It currently has operational capacity equivalent to 700 mw and is executing projects of about 4,920 mw, which will gradually take its capacity to 5,620 mw by 2019.
Currently, the cement business with a capacity of almost 23 million tonnes accounts for about 32 per cent of JP’s revenues. The company intends to increase this capacity to 35 million tonne by 2012. The company has added about 8 million tonne of new capacity in last 9 months which will drive volumes by about 40 per cent in 2010-11.
Considering its different businesses and subsidiaries, analysts value the stock on the SOTP basis at about Rs 180 per share. While this indicates a 25 per cent upside from current levels of Rs 145, investment in this stock with a long term perspective (considering the company’s diversification and large asset base) should yield robust returns.
| A MULTI-BILLION DOLLAR OPPORTUNITY | |||||
| Segments | 2004-05 to 2008-09 | 2009-11 to 2013-14 | |||
| Sectoral | Sectoral (%) | ||||
| Rs billion | Share (%) | Rs billion | Share (%) | Change | |
| Power | 2635 | 19.7 | 7032 | 20.4 | 166.9 |
| Roads | 2155 | 16.1 | 5216 | 15.2 | 142.0 |
| Oil and gas | 2898 | 21.6 | 4958 | 14.4 | 71.1 |
| Railways | 1258 | 9.4 | 3041 | 8.8 | 141.7 |
| Irrigation | 1455 | 10.9 | 2984 | 8.7 | 105.1 |
| Urban Infra | 853 | 6.4 | 2650 | 7.7 | 210.7 |
| Education | NA | - | 2627 | 7.6 | - |
| Telecom | 1740 | 13.0 | 2485 | 7.2 | 42.8 |
| SEZ | NA | - | 1711 | 5.0 | - |
| Ports | 272 | 2.0 | 733 | 2.1 | 169.5 |
| Healthcare | NA | - | 557 | 1.6 | - |
| Airports | 142 | 1.1 | 261 | 0.8 | 83.8 |
| Warehousing | NA | - | 172 | 0.5 | - |
| Total | 13408 | 100 | 34427 | 100 | 156.8 |
| NA: Not available, Source: CRISIL Research | |||||
Larsen & Toubro
India’s largest engineering company, L&T has strong presence in construction and engineering, which includes projects for sectors like infrastructure, hydrocarbon, power and process engineering apart from shipbuilding, defence and aerospace. While infrastructure projects still account for about 40 per cent of its order book, the share of power sector orders is on the rise. As a result of its diversification, the company has a strong order book of Rs 91,100 crore, which provide good revenue visibility for the next two years. Analysts, thus, expect the company's revenue to grow at about 25 per cent over the next two years. The growth will be led by increasing revenue from the infrastructure and power related businesses.
In the power business, the company has been able to bag a lot of orders in the recent past thereby establishing a strong position in this segment next to BHEL, which is currently the leader in the power EPC space.
Besides, the company is leading player in the hydrocarbon sector, which accounts for about 14 per cent of its order book. Analysts believe that hydrocarbon business will also witness an increase in flow of orders in the coming years considering that the opportunities (such as oil and gas pipelines) are coming up in big way. That apart, the company is also aiming to secure new orders from the oil producing countries in light of the revival in crude oil prices as well as capex. Its industrial segment (accounts for 16 per cent of order book), too, is expected to do well as the private capex revives in the country on the back of higher economic growth.
Overall, L&T is best placed to ride on the industrial and infrastructure capex in the country given its leadership and diversification. On the sum of part basis, analysts value the stock at about Rs 1,800 considering the value of its different subsidiaries like L&T Infotech, L&T Finance and others.
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