McNally Bharat: Good for the long term

Though the company has been able to win orders, their execution remains key.


McNally Bharat Engineering’s stock has gained over 4 per cent in past two trading sessions on the back of Rs 733-crore ACC order. The order is a full cement contract and also opens a new business avenue, as it is the first time in India that the job has been bagged by the company.

After achieving highest ever turnover and net profit (reported) in FY12, McNally reached another milestone this year with highest ever order inflow of Rs 2,898 crore (till date), already exceeding annual order inflow target of about Rs 2,600 crore. There could be further order inflows of around Rs 1,500 crore given the back-of-the-envelope calculation. On top of this, typically, the last quarter is busiest for companies in the infrastructure sector.

Says Deepak Khaitan, chairman of the company, “The current (consolidated) order book stands at Rs 4,000 crore. We hope to open with an order book of about Rs 4,500 crore for the next year. Further, the company is planning to execute Rs 900-1,000 crore worth of orders in the last quarter.”

Though the company does not see things improving drastically in next six months, it expects economy to pick up next financial year. The pipeline also remains robust at around Rs 12,600 crore. Hence, the pace of order inflows looks sustainable even from a medium-to-long term perspective.

Valuation

However, the stock is grossly undervalued given the market capitalisation of Rs 314 crore as on December 18 and FY12 consolidated revenues of Rs 2,643 crore. Valuation of 4.6 times FY14 estimated earnings is also way below the average target multiple of 6 times.

The Street has been pessimistic towards the stock as the company’s balance sheet has deteriorated in the past few years due to stretched working capital on account of payment delays. The company’s standalone gross debt to equity ratio of 1.1 times in FY12 jumped to 1.8 times as on September 2012 quarter (same as consolidated debt to equity ratio in FY12).

This also led to leap in interest costs and squeeze in profitability. Despite performing extremely well on the operational front (amid tough market conditions, competition and mere 9.4 per cent rise in revenues) with operating profit margin jumping 133 basis points (bps) year-on-year to 7.7 per cent in first half of FY13, net profit margin (NPM) slipped by 30 bps to only 1.8 per cent, as interest costs jumped 74.5 per cent and ate away 61.3 per cent of the operating profit earned.

Though the stock is a good long-term pick and provides further 30 per cent upside potential, concerns on profitability of incremental order inflows (from newly ventured low margin business like infrastructure and construction that formed 24 per cent of order inflows in six months ended September 2012), profitable execution of current order backlog and rising debt will act as factors for resistance.