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Analysis: Reliance Infra: Near-term upside capped on subdued outlook

Lower visibility in EPC business and high interest costs are likely overhangs for the stock

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While Street expectations were running low, Reliance Infrastructure surprised by posting results which were ahead of the market estimates. However, the September 2012 quarter profits were largely driven by higher other income (includes treasury income), which helped offset the decline in profitability of the engineering, procurement and construction (EPC) business and surge in interest cost.

Post results, the stock reacted positively and it was up 1.4% on Wednesday to Rs 485. But, this can be partly attributed to its underperformance in the last one month -- down 10% against a flattish Sensex. Going ahead, analysts do not see significant upside in the near-term as they believe lower order book, falling revenues and profitability of the business and lastly, high interest cost (in infrastructure business) could act as an overhang on the stock. Positively, valuations look attractive (0.5 times its consolidated book value) and capture most of these concerns. Also, analysts expect a pickup in the company’s performance in FY14. In this backdrop, they believe patient investors could consider the stock from a 1-2 years perspective.

EPC drags Q2 show

During the September 2012 quarter, the company reported a marginal 3.7% year-on-year decline in total revenue to Rs 5,515 crore. The decline was largely on account of the EPC business (accounts for 33% of total revenue) reporting an 18.6% decline in revenues. This business saw lower execution following completion of some of its active projects.

In contrast, the Electricity (Power) business did well with 10% revenue growth helped by power tariff hike at Delhi. Although, the infrastructure business reported 43.1% growth in revenues to Rs 110 crore, it did not have much impact considering that it still accounts for only 1.4% of total revenue. Positively, it turned around with an EBIT of Rs 56 crore versus an Rs 7.5 crore loss in the year ago quarter (Profit of Rs 36 crore in June 2012 quarter). With more projects going on stream, expect further gains going ahead.

However, lower revenue and declining margins, both in the EPC and electricity business impacted performance -- operating profit thus fell by almost 10% year-on-year to Rs 544.4 crore in the quarter. Thanks to a 123% surge in other income to Rs 282 crore, the 61% increase in interest cost to Rs 404 crore was fully offset. This along with a 40% decline in taxes helped the company’s net profit come ahead of Street expectations.

Outlook

The issues surrounding the EPC business are unlikely to ease in a hurry. At the beginning of FY13, the company was targeting revenue of Rs 12,000 crore from this business. Revenue expectations were lowered to Rs 9,000-10,000 crore in the last quarter. Considering that it has done only Rs 3,500 crore in first half, the revised revenue targets may be difficult to achieve. The company, too, has again lowered revenue expectations to Rs 7,500-8,000 crore recently.

The prospects of the EPC business for FY14 also remain in doubt given the lower visibility. The EPC order book has fallen to Rs 13,910 crore currently compared to Rs 15,560 crore at end-June 2012 and Rs 17,300 crore at end of March 2012. However, the management is confident that the order book and revenue issues will get sorted out. "There are many projects in the pipeline, including the large one such as Tilaiya and Krishnapatnam power projects. Even a single project can add Rs 15,000-16,000 crore to order book. We are in talks with Reliance Power and are confident that over the next few months we will be able to scale up our order book. With the help of new projects we will be again be on track and start hitting Rs 9,000-10,000 crore annual revenue," says Lalit Jalan, CEO, Reliance Infrastructure.

Nevertheless, analysts remain cautious as they see potential for delays in getting additional orders given the issues in the power sector. This comes at a time when the capital employed in the infrastructure business is rising. The same stands at Rs 8,513 crore or almost 34% of the total capital employed in the business. Since many projects are at implementation or early stage of operations, it is leading to higher interest cost. In this light, it is essential to scale up revenues in this business.

Positively, the Electricity business will provide steady growth and cash flow. The largest contributor to financials is expected to see better growth following tariff revisions and recovery of regulatory assets.

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