RITES IPO: Valuation reasonable, growth prospects look good

The initial public offering (IPO) of RITES, a government-owned mini-ratna, primarily providing consultancy and construction services for transportation projects, is an opportunity for long-term investors wanting to cash on India’s infrastructure growth.
 
The IPO entails disinvestment of 12.6 per cent stake by the government. Given the growth prospects, order book, healthy financials and reasonable valuation, investors could subscribe.
 
RITES initially provided consultancy services to the railways. It has diversified to other transportation sectors such as metro rail projects, roads, airports, etc, enhancing its growth outlook. Consultancy services are still over 60 per cent of revenues but with RITES coming under Indian Railways (IR), it has also started exporting locomotives, rolling stock, equipment and spares. The latter now forms 28 per cent of its revenue.
 
Most business segments are growing well. In addition to export, RITES is also doing well in leasing services and turnkey construction. The leasing of locomotives, a good margin business, has improved its revenue contribution to about seven per cent. Turnkey construction is growing faster and, having procured orders from the railways (doubling of rail lines, electrification, etc), is expected to become the second largest contributor (a fifth of overall revenue), from only 2.3 per cent in FY17.
 
Given its diverse services across the transportation spectrum and expanding clientele, the rising investment in railways, metros and other infrastructure projects point to a robust growth outlook.
 
Strong financials
 
Given its ownership, it is not surprising that the government accounts for 77 per cent of the order book (pending execution), say analysts (at Rs 48.2 billion or almost 3.6 times the FY17 revenue). With the government and railways as clients, RITES has reported a compound annual growth of about 15 per cent in revenue over three years and a high operating margin, of 35-42 per cent. Return on equity, an important parameter for investors, has remained at close to 18 per cent. The dividend history is strong, too.
Valuation
 
Given the company’s parentage, established position in the business, healthy growth prospects and reasonable IPO pricing, most analysts have a 'subscribe' rating. Angel Broking says the pre-issue price to earnings ratio works out to 12, based on annualised FY18 earnings. It being a preferred consultant of IR and other government authorities, having international operations and at fair valuations, investors could apply for the issue.
 
Kotak Securities and IIFL have a similar view. In fact, Kotak Securities says on an enterprise value (equity plus debt) to operating profit basis, the stock is trading at 11.9 times its FY18 estimates, a discount to listed peer Engineers India (15.2 times). IIFL says RITES is valued at 11 times the FY18 earnings (annualised) and is at discount to both Engineers India and NBCC.
 
However, they are concerned on the increasing mix of the lower-margin turnkey business in overall revenue. Still, turnkey projects are a high-growth business as compared to consultancy, where RITES works on a cost plus margin basis. So, while higher costs are a pass-through, the company ensures about 8.5 per cent margin, which boosts profits; working capital is provided by clients as an advance.
 
Says chairman and managing director Rajeev Mehrotra, “We have added businesses which are sustainable and growing. As long as I am adding to the profits, percentage analysis could be deceptive.”
 
IPO subscribed 60% on Day 1
 
The Rs 4.6-billion IPO of state-owned engineering company RITES garnered 60 per cent subscription on Wednesday, the first day of the issue. The centre is divesting 25.2 million shares (13 per cent stake) of the company through the IPO.
 
The price band for the IPO is Rs 180 to Rs 185 per share. Retail investors are being offered a discount of Rs six per share. The retail portion of the issue was subscribed 1.64 times. At the top end of the price band, Rites will be valued Rs 37 billion. Many analysts have recommend investors to subscribe to the IPO citing attractive valuations. Rites is valued at 12 times its annualized earnings per share of Rs 17 for 2017-18. The issue closes on Friday.
 

BS REPORTER