Interest burden will continue to hurt

Companies in the construction sector will continue to face interest cost pressure on bottom line, despite better revenue growth rate.

Aggregate revenues of 11 construction companies, excluding Punj Lloyd, are expected to grow 16.5 per cent year-on-year (y-o-y) to Rs 31,196 crore in the March quarter, thanks to the improved execution of robust order book position (average four times FY10 sales) and strong performance by Larsen and Toubro, IVRCL Infrastructures and Projects and Gammon India. Execution of projects in Andhra Pradesh is a key moniterable for Hindustan Construction, IVRCL and Patel Engineering.

Revenues had grown at sub-15 per cent (average) in the December 2010 quarter as extended monsoon affected execution. Companies are likely to end FY11 on a subdued note, as the performance in nine months ended December 2010 has been weak.

Despite about 75 per cent of most companies’ contracts having a price variation clause, the operating profit margin is likely to drop marginally by 20 basis points (bps) to 14.5 per cent, due to impact of rising input costs on fixed contracts. Average commodity prices (steel and cement) in FY11 have been higher than FY10 levels.

Companies will continue to disappoint in terms of net profit, expected to be up 5 per cent at Rs 2,267 crore. The net profit margin is expected to decline 80 bps to 7.3 per cent due to increased interest cost (average 6 per cent of sales) on account of rising interest rate scenario, deterioration in working capital and higher funding requirements for BOT (build-operate-transfer) projects.

While financial performance is less likely to provide any major negative surprise, order inflows could disappoint and analysts expect most companies to miss their FY11 order inflow guidance. However, they are optimistic about the same in FY12 as interest rates have almost peaked, leading to better economic activity. Moreover, as the Eleventh Five Year Plan comes to an end in FY12, there will be pick-up in ordering activity from all segments since clients will rush to meet their investment targets.

It is already visible in roads and power transmission, with a string of orders awarded by National Highways Authority of India and Power Grid Corporation recently. Industrial and real estate activity lagging expectations is a concern.

Overall, the outlook for construction is positive. An average 35 per cent correction in stock prices in the past six months has made valuation of average 15 times FY12 estimated earnings (including Punj Lloyd) attractive and the downside risk is limited.
 

NOT SO STRONG
	P/E FY12E	Sales (Rs cr) Q4FY11e	YoY chg  (%)	OPM (%) Q4FY11e	YoY chg  (bps)	NPM (%) Q4FY11e	YoY chg  (bps)
Hindustan Construction	31.40	1272.30	17.30	12.56	122.01	2.20	-174.27
IVRCL Infrastructures	11.70	2395.00	26.70	9.44	-103.46	3.90	-55.58
Jaiprakash Associates	12.30	3531.00	5.60	26.63	112.77	8.60	122.33
Nagarjuna Construction	11.90	1722.20	13.10	10.12	-320.62	3.50	-323.55
Simplex Infrastructures	12.00	1429.80	14.20	9.82	-48.83	2.90	-74.00
Larsen and Tourbo	21.00	15994.00	19.60	13.43	-33.03	9.20	-77.61
IRB Infrastructure	15.20	740.50	47.50	41.68	-433.24	15.70	-1257.67
Patel Engineering	11.20	986.00	-17.60	12.98	36.69	2.60	-337.81
Sadbhav Engineering	14.40	581.75	27.00	10.79	-437.95	4.90	96.89
Gammon India	16.10	1959.50	17.50	9.54	288.86	4.00	38.50
Madhucon Projects	12.40	584.00	19.70	8.24	182.24	2.50	101.27
Aggregate		31196.00	16.50	14.50	-21.19	7.30	-79.71
Source: Analysts' reports Note: Consolidated wherever applicable; bps is basis points (1%= 100 bps)