Valuations attractive for R-Infra after recent sell-off

The market is ascribing little value to its core business of power generation, EPC and infra assets

Reliance Infrastructure, which fell after the recent carnage in the mid-cap space and broader selling pressure in the markets, has seen some accumulation at lower levels as valuations turned attractive. The stock fell sharply from around Rs 550 in January this year to around Rs 315 levels (nine-year lows) by end-March before rebounding to current levels of Rs 365 in the last fortnight wherein it trades at 0.4 times its book value and seven times FY14 estimated earnings.

Interestingly, even now the stock is trading at attractive levels. The value of its 36.5 per cent stake in Reliance Power (its listed associate) alone works out to Rs 276 per share (excluding the holding company discount), which is 76 per cent of the current share price of Reliance Infrastructure. In other words, the market is ascribing little value to its core business of power generation, engineering, procurement and construction (EPC) and infrastructure assets.

Its standalone business of power generation, EPC and infrastructure, which clocked revenues of Rs 17,906 crore and net profit of Rs 2,000 crore in FY12, is being valued at just Rs 2,233 crore (market cap excluding actual value of Reliance Power's stake). Although concerns remain, things are likely to improve for the company. Hence, patient investors may want to consider it.

The Street has earlier shown its concern over the issues at the company’s metro projects, falling order book in EPC business, lower execution and issues in power generation and distribution businesses. Most of these verticals are facing challenges, but notably, a large part of these concerns are already priced in the stock valuations as well as the company’s performance. For the nine months ending December 2012, standalone revenues were down 11 per cent year-on-year (y-o-y), while net profit (excluding extraordinary items) fell 19.9 per cent y-o-y to Rs 1,075 crore.

Even in a worst case scenario, assuming 50 per cent discount to parent’s discounted cash flow (DCF) for write-off of 100 per cent of group treasury, 50 per cent discount to subsidiaries’ value and no value to Delhi discoms (electricity distribution entity) and realty assets to factor in risks, Bank of America-Merrill Lynch analysts have a price objective of Rs 453 per share for Reliance Infrastructure.

The biggest worry stems from the slowdown in EPC business. Thanks to shrinking capex in the infrastructure segment and delays in ordering of power projects from Reliance Power, order book in EPC business has fallen from Rs 17,300 crore at end of March 2012 to about Rs 10,000 crore currently, which is less than one time its EPC revenues in FY12. Since this segment accounted for a large chunk (over 50 per cent) of the company’s revenue, its performance is bound to have an impact on overall performance.

The issue of visibility, however, may get resolved if the company is able to get EPC work (it is expecting to get in near future) for the Chitrangi and Krishnapatam (both 8,000 Mw) power projects undertaken by Reliance Power. These orders alone could improve the visibility given the size of work for these projects, which is to the tune of Rs 25,000-30,000 crore. Both these projects are currently facing challenges over fuel issue.

Secondly, if the Krishnapatam ultra mega power project (UMPP) case (regarding cost of imported coal) is settled by CERC like in the case of Adani Power and Tata Power, it could add to the order book.

Meanwhile, the various infrastructure assets such as Delhi Metro Project (resumed operation) and Mumbai Metro-I (reaching completion) and eight operational road projects (out of 11) should now start contributing to revenues. “As the infrastructure business gains footing, we expect the share of the company in the total sales to improve from two per cent presently to 15-20 per cent in FY16,” says Rupa Shah, who tracks the company at Prabhudas Lilladher.

In the electricity distribution business, investors fear lack of tariff hike in Delhi and Mumbai circles could hurt earnings. In Delhi, this has led to accumulation of Rs 14,800 crore dues (or regulated assets). Recovery of such regulatory assets is still pending, but any positive move on this front should lead to improvement in cash flows and earnings.