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Bigger orders, better bets

The state of a company’s order books is a good indication not only of the market demand but also of its capacity to generate higher returns on its stocks.

R Sree Ram        Print Edition: September 4, 2008

The Indian markets have lost a third of their value in the past six months amid concerns that the slowing economy might lead to lower sales. These concerns are well-founded going by the performance of companies in sectors like real estate and automobiles. There is some good news, though. More and more experts are coming around to the view that companies with a definitive earnings visibility will be able to weather the downtrend better than the others. One way to identify such firms is to check their order backlogs. If these are strong, it will help them sustain the earnings growth.

Firms with strong order backlogs...

CompanyTotal order backlog (Rs Crore)Times the 2007-8 total revenuesOrder bookings in first quarter (Rs Crore)% Year-on-year growth in total order backlog
IVRCL Infrastructure12,4003.448030
Welspun Gujarat7,2001.83,50060
Simplex Infrastructure10,0163.62,00056
Crompton Greaves6,0401.62,42418
Larsen & Toubro58,2002.012,30040
Bhel95,0004.914,50045

“The earnings visibility through the state of order books is definitely a point of consideration in determining the growth potential of companies and in analysing their future performance,” says Deven Sangoi, head, equities, ICICI Prudential Asset Management Company.

Take Simplex Infrastructure. The company that booked orders worth Rs 2,000 crore in the previous quarter has seen its total order backlog for the year rise by an impressive 43% to Rs 10,016 crore. The order book, which is 3.6 times the company’s turnover for the previous year, provides a long-term earnings visibility for the company as the orders are executable over the next two years. Backed by a 71% growth in the first-quarter revenues and one percentage point expansion in margins to 10.83%, the company has seen a phenomenal 94% rise in quarterly profits. The stellar performance, experts say, is largely due to the company’s faster execution capabilities and a higher share of lucrative international orders. In the previous quarter, the company’s international revenues zoomed up 247% year-on-year.

Other companies that recorded a robust order intake due to a sustained expenditure in their respective user industries include Larsen & Toubro, Crompton Greaves and Welspun Gujarat. None of these firms has a substantial exposure to BOT (build-own-transfer) projects, which demand long gestation periods for their investments. There has also not been a significant deterioration of assets such as land holdings.

“If the current sales are worth Rs 100 crore and and the order book is worth Rs 400 crore, then even after a 5% cut due to a delay in execution and cancellation of orders, the company will be worth Rs 300-400 crore in twothree years as it executes the order backlog. These stocks are better bets as the companies have a good revenue visibility in the form of order books,” says Amar Ambani, vice-president, research, Indiainfoline.

Execution and margins: The problem with order books is that virtually all capital goods and construction companies have order backlogs. Does this automatically make them good picks? Sadly, no. Some companies might witness a slowdown in the order intake due to a deteriorating business environment in their user industries. Also, not all these companies demonstrate good execution capabilities, which is why firms like Gammon India, HCC and Madhucon Projects are seeing a slowdown in revenues. Slipping up on order deliveries has a cascading effect on the future contracts as a substantial amount of money is tied up in current projects, impacting the cash flow. So the company cannot take new orders due to a lack of leeway in infusing fresh working capital into the new contracts.

...and with price escalation clauses, are good picks

CompanyGrowth in sales (%)
PAT growth (%)
Profit* margin (%)Has price escalation clause for
June 2008-9June 2007-8
IVRCL Infrastructure
37.414.98.88.293% of total order backlog
Welspun Gujarat35.22.616.016.5Not applicable#
Simplex Infrastructure71.095.610.89.865% of total order backlog
Crompton Greaves3438.012.811.760% domestic, 30% intl order
Larsen & Toubro53.233.310.59.670% of total order backlog
Bhel34.033.08.69.6Not available
*Profit=EBIDTA; #Freezes raw material price at the time of booking orders

 

The key to identifying a good stock is looking for companies with good execution capabilities and ones that continue to have a healthy order intake. A proven track record of the management and generation of enough cash flow to support the new orders augurs well for a good investment. “There are a lot of companies with good order book positions which have not lived up to expectations. The lacklustre performance is clearly visible in the first-quarter results, as they couldn’t perform well due to high input costs and lack of timely execution of orders. So the companies that generate a good cash flow and have a sustained order intake make for a good buying opportunity at current levels,” says Jignesh Desai, head, institutional sales, SBICAP Securities.

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