Infra firms in a sweet spot, most players trading at attractive levels

Infrastructure and construction were among the top performing segments in the industrial growth numbers for October. Growth in these two segments have been a consistent five to eight per cent since October 2017. The momentum is expected to remain, with the strong order book of companies and improving execution.

The record level of orders, both issued and those in the pipeline, for key players till the March quarter had turned the sentiment significantly positive for infrastructure stocks. Still, the share prices fell, with focus shifting on execution, progress on land acquisition and funding requirement for projects. The concern on financial closure of the awarded contracts continue, given the bank financing constraints. Especially for exposure to public sector banks, with their bad loan mess. Reversal of the interest rate cycle further added to Street concern on project costs and working capital.

 

After the recent correction in infrastructure stocks, tightening liquidity and selective disbursement to projects, there is a good opportunity to invest in some companies, say analysts at Elara Capital. Those with a quality balance sheet have successfully tied up financing for new projects. And, despite a seasonally weak quarter, most companies did better than the consensus expectations. Early signs of a revival in capital expenditure and the management commentary suggest the execution momentum is likely to continue, say analysts. Elara has picked PNC Infratech, Ashoka Buildcon, NCC and PSP Projects.

Though the euphoria of order momentum might have subsided, analysts say that after the significant correction in share prices, the stocks do factor in most of the concerns. Robust execution is expected to sustain the trajectory, while a strong order book should provide a cushion. After road project awards in 2017-18 touching new highs, crossing 17,000 km, the National Highways Authority of India (NHAI) award so far at 7,400 km (worth Rs 1.2 trillion) means the revenue visibility for construction firms remains strong. Confidence on execution is also visible from the latest ICRA data. Implementation, according to the rating agency, increased at a compounded annual rate of 27 per cent to 3,017 km in FY18, from 1,500 km in FY15. NHAI’s actual execution during the first half (H1) of this financial year is estimated at 1,300-1,400 km. Since it is typically lower in H1 due to the monsoon, ICRA estimates full-year execution at 3,800-4,000 km (though 33-37 per cent less than the FY19 target of 6,000 km). More, the pending appointed date (AD) for hybrid annuity model (HAM) projects, according to analysts, should not be seen as a concern when financial closure has been achieved.

On new orders, analysts at Edelweiss say factors such as the coming general election and limited appetite for HAM projects are likely to restrict the FY19 project award of NHAI to 3,000–3,500 km. However, they expect substantial ramp-up in project award from FY20 onward, given the strong pipeline of Bharatmala projects.

Even so, the prospects of those in the sector do not hinge on road projects only. There are opportunities in other segments such as the railways, including metro rail projects, affordable housing for all, the power transmission and distribution sector and even waterways. Uttar Pradesh itself is witnessing planned infrastructure activity worth Rs 1.4 trillion. Key contractors include PNC Infratech, Sadbhav Engineering, Dilip Buildcon, IRB Infrastructure and Larsen & Toubro. Among other states, the metro railway is an opportunity. Dilip Buildcon was the preferred bidder in the Bhopal metro rail, J Kumar Infrastructure benefitted from the Mumbai ones and NCC from the Pune metro, among others.

For picking of stocks, the trailing 12 months’ sales to order book, current balance sheet and valuations need to be considered, says Santosh Yellapu of India Nivesh Research. Valuations are attractive, with most stocks trading at sub-10 times the FY20 price to earnings multiple. The industry’s earnings growth, return ratios and net debt to equity are currently much better than the January 2010 to January 2014 period, say analysts at Edelweiss. Their picks include NCC, Ahluwalia Contracts and Ashoka Buildcon, given revenue visibility and strong balance sheets.