No relief for construction firms

Analysts see the sector as one of the worst performers in the second quarter.

This earnings season is unlikely to bring cheer to investors in construction companies. Analysts’ previews suggest these companies will be among the worst performers in terms of profit growth, with many of them likely to see an erosion in earnings in the September quarter. Higher interest expenses, rise in working capital loans and poor execution are going to weigh on construction firms. NCC, Gammon India, IVRCL Infrastructures and Hindustan Construction could see the biggest fall in profits.

Infrastructure companies with a high working capital debt have seen their interest costs move up along with higher commodity prices. Companies are borrowing at an average 12-13 per cent a year. Given the thin margins in the construction business, higher interest costs impact profits. For instance, the interest cost-to-sales ratio is expected to reach 6-6.5 per cent in the September quarter, as against 4.5 per cent last year. “We expect a 50-bps rise in the average interest cost for all construction firms. Therefore, net profit margins are likely to drop 100 bps year-on-year, given an increase of 100-120 bps in interest costs (as a percentage of revenue),” says Dhirendra Tiwari of Motilal Oswal Securities.

Apart from the profit growth knock, analysts expect companies to report a marginal revenue growth, at about 8-10 per cent, in the September quarter. Along with shrinking order books, this reflects the worries on the execution front due to funding issues. According to analysts’ estimates, the aggregate order book-to-sales ratio at the end of the March quarter was 3.3 times, down from 3.5 times in the first quarter of FY11. “We expect construction companies to post 5-10 per cent year-on-year revenue growth, as funding issues and a deteriorating working capital cycle are likely to impact project execution,” says Manish Kumar of SBICAP Securities. Thus, it is possible that some of these companies guide lower order book and revenues for the entire year, which could lead to further earnings downgrades, as the case could be, for individual companies. Analysts like companies such as IRB Infrastructure and IL&FS Transportation Network in the road segment, which have good visibility and better valuations. That apart, Larsen & Toubro is among the preferred picks, given its strong order book, relatively better visibility, strong balance sheet and correction in valuation.