Concerns over growth

Slowdown in new orders inflow, project execution uncertainties along with rising debt will weigh on the stock in the medium term.

The stock of Hindustan Construction Company (HCC) has underperformed broader indices such as the Nifty since November over concerns regarding its core business and Lavasa project. Below expected results for the quarter and for the year-ended March, led most analysts to reduce their price targets and earnings estimates.
 

SUBDUED PROFIT GROWTH
In Rs  crore	Q4FY11	FY11	FY12E
Sales	1,202.0	4,090.0	4,726.0
% change	11.0	12.7	15.5
Ebitda	166.2	537.0	643.9
Net profit	22.6	71.0	77.3
% change	-47.0	-12.8	8.9
E:Estimates  Standalone financials   Source: Analysts' reports

For 2010-11, though standalone profits were down 12.8 per cent, consolidated loss stood at Rs 64.6 crore, as against a profit of Rs 5.8 crore in the previous year. The management indicated that the losses were largely due to the consolidation of Lavasa, whose several subsidiaries are making losses.
 

SUM-OF-THE-PARTS  VALUATIONS
Per share value(Rs)
Core construction  business	11.2
Real estate projects	19.3
Road assets	11.9
Total	42.4

All these events reflect concerns. Parvez Akhtar Qazi, who tracks the company at Edelweiss Securities, highlights several concerns, “Slowdown in project awards, stretched working capital cycle and high interest rates continue to hurt HCC’s profitability. Environmental concerns on Lavasa remain, delaying progress on the project and its potential listing. There is uncertainty over any potential penalty on Lavasa as well.”

At Rs 34.85, HCC’s market cap works out to be Rs 2,113 crore. Considering its net debt, the enterprise value (EV) works out to Rs 5,300 crore. While valuations look reasonable — EV of about seven times estimated operating profits for 2012-13 and estimated SOTP-based worth of Rs 37-42 per share — the stock is likely to remain under pressure in the medium term, unless concerns subside.

DEBT WOES
For the quarter ended March, the company reported a 10.8 per cent year-on-year growth in standalone revenues to Rs 1,202 crore. Helped by improved margins, operating profits grew 35.1 per cent. However, as interest costs more than doubled to Rs 90.3 crore, standalone net profits fell 47 per cent to Rs 42.9 crore. High interest cost is the result of high debt and general increase in rate of interest. The company’s working capital days in the past have increased significantly from 164 days in 2007-08 to 192 days in 2008-09 and further to 288 days in 2010-11.

“The increase in working capital is the result of the delays in payments or receivables and project execution from the client side,” says Praveen Sood, chief financial officer, HCC. The higher working capital has also led to a increase in the overall debt of the company, which has risen to about Rs 3,200 crore or to more than two times HCC’s shareholders’ fund. “Out of the total debt, about Rs 1,000 crore is due to the working capital loan. We are trying to bring down our working capital requirements,” adds Sood.

VISIBILITY 

The issues of high debt and working capital will weigh heavily on the company’s financials. “Our revised estimates factor that net debt-equity (ratio) would grow to 2.5 times by 2012-13. This in a rising interest rate environment would hurt earnings growth over and above the execution slowdown due to higher funding requirements,” says Ashutosh Narkar , who tracks HCC’s stock at HSBC Securities in his report on the company.

That apart, there are also concerns on account of new order inflows. While the company has an order book of Rs 18,100 crore, over 2.5 times its consolidated revenue, the concern is that it has seen a dip in new orders in the quarter ended March. Rising capital costs are likely to keep the flow under check in the near-term for the sector on the whole.

In this backdrop, the company’s earnings are likely to grow in single digits in the current financial year, believe analysts, who say that 2012-13 would be better with profits seen growing faster at around 20 per cent plus.