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IRB & ITNL: Strong EPC execution drives Q3 performance

With rate cycle easing, many under construction projects expected to go on stream and new road project awarding seen picking up, analysts expect the two companies to do well

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The top two leading players in road construction and management space, and IL&FS Transportation Networks () have reported better than expected results for the December 2012 quarter. Post the results, the Street is upbeat about the prospects of the two companies considering strong earnings growth, attractive valuations and easing challenges in the sector. There are certain issues such as lack of new orders and high debt in the books, but analysts believe that could be resolved in the medium-term besides it will be compensated by higher contribution from the construction business. They also expect awarding of the new road projects and traffic growth to improve in the next fiscal year. Importantly, at current levels, both the stocks are trading at seven times estimated earnings, which is reasonable considering that earnings are estimated to grow by about 15% annually over the next two years.

During the December 2012 quarter, both the companies have shown strong execution in the construction business (growth of 29-38% year-on-year) leading to robust growth in overall revenues. The growth in construction business was led by strong order book for both the companies. This is also a reason that with the rise in contribution of this low-margin business the players saw some pressure on overall margins. While IRB’s EBIDTA margins are down both year-on-year as well as sequentially, ITNL’s is down 750 basis point to 25.5% (on year-on-year basis though ITNL has done relatively better with margins up slightly). Notably, for both companies, the build-operate-transfer (BOT) or toll-based business, which enjoys high profit margins, has seen marginal growth as a result of lower traffic growth.

On the other hand, interest expenses relating to recently executed projects have been going up. ITNL, which is the more leveraged than IRB with a debt-equity ratio of about 3.8 times, has seen its interest cost going up by 53% year-on-year to Rs 284 crore in the December 2012 quarter (IRB’s was up about 12%). Thus, growth at the net profit level has been lower.

Meanwhile, despite these issues the companies remain in good position. For one, the rate cycle has peaked and interest rates are expected to go down. On the other hand, economic growth cycle has also bottomed out with a pickup in growth expected in FY14. And, the companies are also doing their bit.

"With 10 projects becoming operational over next 18 months, toll/annuity collections are set for an upswing. Declining interest rates will provide a further fillip to the stock (ITNL). A 100 basis point decline in interest rates increases our SOTP by 13%," says Parvez Akhtar Qazi, who tracks ITNL at Edelweiss Securities.

The construction business, which accounts for almost 70% for both the companies, is expected to report strong revenue growth in the coming quarters given the existing order book. ITNL's current order book is almost three times its construction revenues in FY12. Similarly, IRB has strong order book to sales of four times, which should help in sustaining growth.

Meanwhile, in first none months of current fiscal, has awarded projects of just 1,000 km compared to the annual target of 9,500 km, which has rubbed off negatively on the stock valuations of road project companies like IRB and ITNL, say analysts.

"IRB’s valuations look attractive with the current portfolio of projects (excluding Goa-Kundapur) contributing Rs 121 a share. Valuations appear to be factoring in the current slowdown in traffic growth and other concerns," says Atul Tiwari of Citi Research in a note on the company.

But, with the order flows expected to improve in the following years, the sentiments should get a boost. Any positive development on traffic front and flow of new orders could help these companies gain higher valuations. Analysts are hoping for a revival in FY14 as the government is now taking the steps to boost investments and NHAI is also sorting out its issues pertaining to clearances and land acquisition.

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