Poor outlook caps R-Infra's near-term upsides

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

While Street expectations were running low, Reliance Infrastructure, on Tuesday, surprised by posting results which were ahead of market estimates. However, the September quarter profits were largely driven by higher other income (including 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 per cent on Wednesday to Rs 485. But, this can be partly attributed to its underperformance in the last one month — down 10 per cent 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 EPC 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 pick-up in the company’s performance in FY14. In this backdrop, they believe patient investors could consider the stock from a one to two years perspective.
 

BETTER OUTLOOK for FY14
In Rs crore	FY12	Q2'FY13	FY13E	FY14E
Net sales	24,272	5,515	20,622	22,238
% change y-o-y	60.4	-3.7	-15.0	7.8
Ebitda	2,783	670	2,841	3,461
% change y-o-y	11.5	-4.6	13.8	15.6
Net profit	1,587	382	1,617	1,733
% change y-o-y	2.3	5.6	1.9	7.1
Adjusted EPS (Rs)	60.3	14.5	61.5	65.9
PE (x)	8.0	NA	7.9	7.4
Source: Nirmal Bang Institutional Equities Research

EPC drags Q2 show
During the September quarter, the company reported a marginal 3.7 per cent 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 per cent of total revenue) reporting an 18.6 per cent 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 per cent revenue growth helped by the power rate hike at Delhi. Although, the infrastructure business reported 43.1 per cent growth in revenues to Rs 110 crore, it did not have much impact, considering that it still accounts for only 1.4 per cent of total revenue. Positively, it turned around with an earnings before interest and tax (EBIT) of Rs 56 crore versus a Rs 7.5-crore loss in the year-ago quarter (profit of Rs 36 crore in the 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 per cent year-on-year to Rs 544.4 crore in the quarter. Thanks to a 123 per cent surge in other income to Rs 282 crore, the 61 per cent increase in interest cost to Rs 404 crore was fully offset. This, along with a 40 per cent 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 the 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 the 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 ones, such as Tilaiya and Krishnapatnam power projects. Even a single project can add Rs 15,000-16,000 crore to the 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 on track and start hitting Rs 9,000-10,000 crore annual revenue," says Lalit Jalan, chief executive officer, Reliance Infrastructure.

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. It stands at Rs 8,513 crore or almost 34 per cent 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. Positively, the electricity business will provide steady growth and cash flow. The largest contributor to financials is expected to see better growth following rate revisions and recovery of regulatory assets.