The Planning Commission has good news for all those who complain about lack of infrastructure in the country. It proposes to double the investment in infrastructure from Rs 20,54,000 crore in the 11th Plan to Rs 40,99,000 crore in the 12th Plan (2012-17). Increased spending will ensure robust business for infrastructure-related firms, making the sector one of the most attractive for investment opportunities. "We are bullish about the medium-term prospects of the Indian construction sector, which is driven by an improving order intake, stable margins and value unlocking opportunities," says Satyam Agarwal, an analyst at Motilal Oswal Securities.
While conglomerates will benefit from this opportunity, it's the smaller construction companies that will gain the most. These aim for medium to semi-long term (1-3 years) contracts and, unlike infrastructure developers, their fortunes are not tied to financial closures and success of the project. As they get paid on the completion of a contract, their only worries are the order book and project execution.
In 2009-10, the revenues of construction companies were hit by reduced order inflows and execution delays. However, they solved the problem by raising low-cost funds, improving the quality of manpower and procuring hi-tech machinery. Now, they have begun to witness a higher order intake and are expected to report robust revenues. "Improving backlog ratios should lead to a better execution, which will feed the revenue and earnings growth, albeit at lower levels compared with the 40-50 per cent compounded annual growth rate during 2003-8," says Nitin Bhasin, an analyst at Execution Noble.
Stocks to Buy: While the outlook for the industry has improved, not all stocks can be categorised as investment grade. One reason is the huge rise in stock valuations in the past year. At current valuations, largecap construction firms like Larsen & Toubro are trading at price to earnings (PE) multiples of around 25 times. Even if they have better prospects, the current valuations are closer to the upper band of historical averages, leaving little room for a further rise from current levels. Compared with these, mid-cap construction firms like Nagarjuna Construction Company (NCC) and IVRCL are trading at much lower multiples of around 13 times the 2010-11 estimated earnings per share (EPS). "There exists a discount between large-cap and midcap companies. However, mid-cap companies may trade at 15 times the PE multiples in their core businesses due to strong order inflows and a stable margin outlook," says Macquarie analyst Inderjeet Singh Bhatia. Mid-cap stocks have historically traded at a 35-40 per cent discount to large-cap stocks. After the rise in stock prices, this gap has widened to 50 per cent. However, it is expected to reduce when mid-cap construction companies report higher revenues.
If one considers the order books, mid-cap companies are on a better footing. The consolidated order book to sales coverage ratio of prominent mid-cap firms, such as NCC, IVRCL, Patel Engineering, Hindustan Construction Company (HCC), Gammon India, Simplex Infrastructure and Sadbhav Engineering, is already at 3.7 times. As the companies execute the orders, they are expected to report higher revenues.
The road segment alone can bring in higher orders. The National Highways Authority of India is planning to award contracts for 11,800 km of roads this year. If mid-cap companies manage to get even 12 per cent of these, they will have an order inflow of Rs 14,400 crore. This amounts to 17 per cent of the current outstanding order book (Rs 83,308 crore) of the top 10 mid-cap firms. In this segment, HCC and NCC are the preferred stocks. Last year, NCC reported an order inflow of Rs 8,800 crore, while the management had projected only Rs 6,200 crore. So, analysts expect a revenue growth of more than 20 per cent this year. "Nagarjuna Construction's subsidiaries remain undervalued at about one time the P/B value, despite most road projects being close to commissioning," says Bhatia.
HCC has also reported a strong order backlog of Rs 16,870 crore for 2009-10, which is 20 per cent higher than for the previous year. The company has bid for orders worth Rs 4,390 crore. At 4.7 times the 2009-10 revenues, its present order book provides strong revenue visibility for the next two years. "A further rise in unit sales in its upcoming township Lavasa and its likely IPO will be the main triggers for the stock," says Bhasin.
So, if you want to build a profitable portfolio, it may pay to invest in infrastructure stocks.
